Editor's Choice

Why This Stock Could Heat up Over the Next Few Days

Neha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Huntsman’s (NYSE: HUN) shares have had an excellent run up in recent weeks, gaining 10% year-to-date, which also meant a fresh 52-week high in late January. For its shareholders, there could be more in store as the chemical giant checks in with its fourth-quarter numbers next week.

Huntsman has surprised in each of the past four quarters, even when peers failed to deliver. There are reasons to believe it can do an encore on Feb.12.

What’s holding back growth?

Huntsman’s revenue and profits have hardly grown over the past few quarters. The strikingly flattish graph indicates how hard the company is finding growth to come by. Naturally, when four out of five businesses struggle to stand against global slowdown, you can’t expect much.

<img alt="" src="http://media.ycharts.com/charts/a0644b70f0679569be352b7f5f082e8a.png" />

HUN Revenue Quarterly data by YCharts

Huntsman’s pigments business can take most of the blame. Destocking in the titanium dioxide (TiO2) market messed up the demand-supply balance, hitting every TiO2 player hard enough to knock their top and bottom lines down. What started several quarters ago still persists, a fact DuPont (NYSE: DD) confirmed recently. The largest TiO2 producer’s sales from the performance chemicals business slumped 15% on significantly low prices and volumes in this past quarter. DuPont expects even lower sequential sales for the first quarter, and doesn’t see a turnaround until the second half of 2013. Accordingly, it slashed its forecast margins further, expecting it to fall by a high single-digit percentage for the full year.

You might hear the same story from Huntsman next week. If its third-quarter TiO2 sales volumes slumped 30% year-on-year, the fourth quarter could be no different. You can safely expect another blow of about $350 per ton to its TiO2 margins in the fourth quarter as input costs remain firm. Tronox (NYSE: TROX), the ‘complete’ TiO2 player that not only makes the pigment but also the raw materials that go into its production, had to put up with a 45% higher cost of goods sold in its third quarter. Coupled with flattish sales, its gross profit plunged a massive 85%.

Likewise, while sales fell 14% for the other TiO2 specialist, Kronos Worldwide (NYSE: KRO) in its last quarter, a big jump in costs resulted in a 59% lower gross profit. For the full year, it expects to shell out at least 50% more on costs compared to last year. The double blow of soft demand and rising costs will prevail for some time. Tronox expects costs to remain high this year as well, and like DuPont, doesn’t see demand picking up before the middle of the year. We’ll know better when it suits up with numbers on Feb. 18. Before then, Huntsman will have already told us where the TiO2 market is headed.

Only, and interestingly, despite persistent weakness in the pigments business, Huntsman expects to end 2012 with record operating earnings. Before you jump, here’s what you need to know.

Be Foolish

Huntsman uses a non-GAAP metric called EBITDA, i.e., earnings before interest, tax, depreciation, and amortization, to measure its operating performance. More specifically, it is aiming at record adjusted EBITDA this year. Now what’s that? Adjusted EBITDA excludes charges such as those pertaining to restructuring, debt extinguishment, acquisitions, legal settlements, etc. Nothing wrong with that, you may say. Well, in Huntsman’s case, such charges matter more than you think.

One of Huntsman’s priorities over the past few quarters has been to turn around two of its ailing businesses – textile effects and advanced materials. Actions included shifting of operations from one country to another. So one can imagine how much the restructuring must have cost. As an example, in the third quarter of 2011, Huntsman’s EBITDA stood at $204 million, but restructuring and impairment costs amounted to $155 million. Adding the two, together with other charges, meant the company reported adjusted EBITDA of $346 million, which looked pretty decent. So if next week's headlines shout out Huntsman’s record earnings, you know what to make of it.

However, the good news is that such costs have diminished as the shake-up program nears its end. Both businesses showed some signs of life in the third quarter, and the fourth hopefully should confirm it. Though real savings from the entire restructuring move is still months away.

In top form

So is Huntsman’s fourth quarter numbers headed for disaster? All but one business could help the company save face – polyurethanes, which also happen to be its largest division. Key product methylene diphenyl diisocyanate (MDI) continues to demand higher selling prices as companies try to offset high input costs. Dow Chemical (NYSE: DOW) confirmed the strength in propylene costs when it released numbers some days back, mentioning how it increased by $0.15 in January and is expected to rise further. Yet, double-digit volume gains helped Dow maintain margins. The same should help Huntsman in its fourth quarter.

Dow is even ready to raise product prices further, and expects an uptick in demand from critical markets this year. Given that Huntsman is a bigger player than Dow in terms of MDI capacity -- Huntsman enjoys 18% market share compared to Dow’s 12% -- what it has to say next week will be critical for investors of both companies.

The takeaway

That Huntsman gets a good chunk of revenue from Europe shouldn't deter investors as most of it comes from MDI, which thankfully, is a profit churning product. Analysts expect the company to report 5% lower sales and an 18% fall in EPS from last year. That may not sound good, but Huntsman knows how to prove analysts wrong. A beat would be enough to bump its shares up again to its 52-week peak. Where the journey leads to will depend on its outlook and growth plans. Stay tuned as I tell you why Huntsman could still be worth your money. Click here to add Huntsman to your personalized stock watchlist. 

Neha Chamaria has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

blog comments powered by Disqus