Specialty chemicals manufacturer OMNOVA (OMN) has had its share of ups and downs since hitting a 52-week high in October. Disappointing 3Q 2012 sales and 4Q 2012 earnings estimates that missed big time - analysts expected $0.13 per share and results were $0.07 per share - have sent the share price on a roller coaster. OMNOVA is sensitive to global demand and the domestic U.S. economy; global sales are what tanked sales in 2012. However, CEO Kevin McMullen said that a "recovering U.S. housing market, growth in oil and gas exploration and a better outlook for the automotive and transportation segments in North America and Asia should help improve earnings in fiscal year 2013."
Since reporting 4Q 2012 earnings on January 22, share price has been trending as some investors seem to agree with CEO McMullen. What do the metrics say? An analysis of fundamentals agree with McMullen: OMNOVA is selling at a discount and presents a buy opportunity. Let's break down the numbers:
Tobin's Q: Assets
Tobin's Q is a simple and easy quick-check of a company's value based on assets. Tobin's Q compares (divides) the market value of the company to the total assets of the company. A result less than 1 indicates that a company is undervalued based on assets. How does OMNOVA score? With a market value of $372 million and total assets of $874 million, we get a Tobin's Q of 0.43. Not enough information to make a purchase decision, but this is a promising step in the right direction.
"Buffett-Style" Formula: Discounted Net Income
While Warren Buffett has never laid out a nice pretty formula to guarantee investing success, he has dropped hints over the years. These hints have been used to create what is known on the street as the "Buffett Formula." Start with Net Income, add back Depreciation and subtract Capital Expenditures. Divide this result by the average investment grade bond yield, and then divide by the number of shares to get an intrinsic value. This formula ignores industry and market factors and calculates a value solely on the company's results. OMNOVA's Buffett Formula intrinsic value is $27.42 for a 71% margin of safety. Too high, in my opinion, but it agrees with Tobin's Q that the company may be undervalued.
Valuation by Multiples: Industry Comparison
Valuation by multiples has historically been one of value investing's best tests for value. It is a layered formula that compares the target company to a basket of its closest competitors, which we will call "comparables." For OMNOVA I selected The Dow Chemical Company (DOW), HB Fuller Co. (FUL), Albemarle Corporation (ALB) and Stepan Company (SCL) as comparables.
Investors can use any price-to-performance ratios they choose, such as P/E, P/S, P/CF and P/BV. For example, we will compare OMNOVA's trailing twelve months P/E, P/S and P/BV ratios to the ratio's of its comparables:
HB Fuller Co.
We see that OMNOVA has lower P/E and P/S multiples but a slightly higher P/BV ratio. Next we multiply the basket average against OMNOVA's per-share metric to reach an intrinsic value, using the following metrics:
P/E times EPS
P/S times Revenue per Share
P/BV times Book Value per Share
Average Target Price
We get a $16.12 intrinsic value based on these three metrics. A concern I have about this price is how dependent it is upon DOW's high P/E. Personally, I prefer to include as many ratios as possible in order to smooth out basket outlier's such as DOW's P/E. Bringing in other ratios, including P/CF and P/EBITDA, I get a more conservative target price of $14.02 for a 44% margin of safety.
Tobin's Q, the Buffett Formula and Valuation by Multiples all agree that OMNOVA is undervalued. The $14 target price is a couple dollars more than the highest analyst target, but I expect my target price to fluctuate a tiny bit each quarter as new results come in. The 44% margin of safety tells me I have a 44% "buffer" in the movement of the target price before I risk losing my investment. My confidence in the formulas combined with this acceptable margin allow me to trust my $14 target price.
Disclosure: I am long OMN.