This Chemical Stock Is on a Roll – Don’t Miss It

By Neha Chamaria - August 28, 2012 | Tickers: CE, DD, EMN, HUN, DOW | 0 Comments

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I always find a 52-week high or a 52-week low situation interesting. While most perceive it to be an almost certain sell or buy time, respectively, I think it throws up an opportunity to see if the particular stock truly deserves to be where it is, and what’s next.

I have been watching Eastman Chemical’s (NYSE: EMN) run up closely. The stock has gained a whopping 41% in a year’s time, and hit its 52-week high some days back. But if you think you can overlook Eastman now, think again. Because it looks like there’s still a lot of steam left in the stock.

At the top of its game
If you take a look at how Eastman has fared in the past twelve months, its soaring share prices don’t seem unwarranted. The table below tells you how the company’s top line growth has been the best among peers, while gross and net margins are more or less in line with others.  A good part of the growth in revenue can be attributed to higher selling prices, which again was an industry-wide trend. To tackle soaring input costs, chemical companies aggressively increased product prices throughout last year – a move that largely helped offset low sales volumes.  

All Trailing Twelve Months (TTM) figures

Looking beyond operational performance, you might twitch your nose at Eastman’s high total-debt-to-equity ratio of 181%. But wait, there’s a reason behind it, and it’s the kind that actually shows the company in good light.

Growing big, and fast
Eastman has emerged as a highly acquisitive company, making four acquisitions in the past 12-15 months. But the one deal that caught analysts sleeping was also its biggest ever – acquiring specialty chemical and performance materials company Solutia in a multi-billion dollar deal.  With this acquisition last month, Eastman has added an additional $2.4 billion worth of long-term debt to its books, which explains its high debt-to-equity ratio.  

But I am not too worried as one, it’s an acquisition that will take Eastman far (read along to know how), and two, there’s enough comfort in its financials. An interest coverage of 11.6 times, free cash flow of nearly $3 billion, and steadily rising operating income (operating margin for past twelve months stands at 13%) look great. To top that, Eastman’s dividend payout ratio of 25.6% seems pretty modest for its debt levels and provides some margin of safety, especially when compared to Huntsman which has a higher dividend payout of 27.6% despite more debt.

Solutia mojo
Now that Solutia is in Eastman’s lap, investors have a lot to look forward to. As I mentioned earlier, acquiring Solutia could turn Eastman’s fortunes around. It gives the company a huge opportunity to gain traction in the emerging markets, particularly in the Asia-Pacific region. And the way every other company is eyeing this market speaks volumes of the growth potential available. Dow has joint ventures in China, and is setting up plants everywhere from Vietnam, Korea to Thailand. Huntsman is injecting more money in its plants in China and expanding capacities across Asia. DuPont is adding more research and development centers across the region in line with its aim of generating more than 20% sales growth from there. And Celanese has just entered into new ethanol projects in Indonesia and is also expanding facilities in China.

Eastman is already balancing its act well by acquiring smaller companies in places like Brazil and announcing joint ventures in China. Here’s an interesting assumption -- considering Eastman derived roughly 24% (excluding Solutia’s impact) and Solutia 30% (before it was acquired) of their revenue from the region, I am expecting the combined entity to be able to grab a much bigger share of the Asian pie.

Note that a wider geographic footprint is not the only advantage here. Some of Solutia's technologies complement Eastman's, and some end markets, such as auto, are common too. Adding synergies such as raw material sourcing and supply chains, Eastman is likely to save nearly $100 million in costs annually by next year. The best part – the deal will be accretive to Eastman’s earnings immediately (we should start seeing Solutia’s positive contribution from the third quarter onwards), prompting it to raise its full-year earnings per share guidance to $5.30. Now if I tell you that Eastman’s EPS for 2011 of $4.56 was a record for the company, you know where the company is headed to this year.

I’ve got value!
Not that Eastman’s shares at 52-week high are obnoxiously priced. It still falls in the reasonably-valued category. Here’s a quick glance at how the company’s valuation stacks up next to peers-

As you can see, Eastman is definitely not the most expensive stock up there. One look at its low forward P/E, and it is clear that the company's earnings are expected to grow, suggesting a good upside potential for the stock. Don’t miss out Eastman’s impressive return on equity and decent dividend yield of 1.9%.

The Foolish takeaway
Operational efficiency, financial stability and foot firm on growth – Eastman has shown promise, and looks like it will continue to deliver. So the next time you see a stock at its peak, do not run away. Instead, take it as an excuse to delve deeper into the company and find out where it stands. Meanwhile, if the argument above seems convincing, add Eastman Chemical to your personalized stock watchlist now. Click here to do it. And if you have a different viewpoint, share it through the comments section below.

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