Eastman Chemical: Overlooked And Undervalued

| About: Eastman Chemical (EMN)

Summary

After falling slightly shy of analyst estimates on the top line, Eastman Chemical tumbled 8% on Tuesday, July 29th.

Eastman has lagged many of its peers despite solid sales and earnings growth.

The recent selloff presents an excellent entry point to buy a quality company at a discount.

The chemical business isn't exactly the most alluring of industries, but boy is it lucrative.

A Day Late And A Dollar (Or 50 Million) Short

On Monday, July 28th, Eastman Chemical Co. (NYSE:EMN) released its Q2 earnings report. The company beat on the bottom line as net income increased 11% year over year, but thanks to the company's $100 million stock buyback, EPS increased 14%. Despite the earnings beat, revenues fell slightly short of analyst expectations of $2.51 billion, coming in at $2.46 billion. Year over year, revenue for the quarter was flat. The company is expecting total EPS for 2014 to fall between $6.70 and $7.00. At the current stock price of ~$82, that would put it at a P/E between 11.71 and 12.23 - assuming that the stock price remains constant through year's end.

Although, in my humble opinion, the company reported solid earnings, the market reacted quite differently. It seems as though the $50 million revenue shortfall was cause for concern in the market's eyes, sending Eastman tumbling 8% to close at $81.50.

Eastman's Performance And Valuation

Eastman currently trades at very attractive multiples relative to the industry averages. The company's P/E of 11 compares very favorably to the industry average of 16.7. Additionally, the company sports higher than average profit margins (12.3% vs 8.5%) as well as ROE (33.1% vs 20.9%). Despite these metrics, Eastman has lagged many of its peers over the past year, returning only 1.36%. In comparison, The Dow Chemical Company (NYSE:DOW) has returned a whopping 52.54%, and BASF SE (OTCQX:BASFY) has grown 22.54%

While you may be inclined to think that such poor performance can be attributed to slumping sales or earnings, the past two years have proved that the company has no problem growing both the top and bottom lines.

Below is a chart of the company's eight most recent quarterly revenue numbers (click to enlarge).Click to enlargeOver the past two years, the company has generally shown strong revenue growth - save for the past two quarters which have been relatively flat. Normally this would send up a red flag, but the company has been effective at maintaining a solid bottom line growth rate (especially on a per share basis) as shown below (click to enlarge).Click to enlarge

While Eastman isn't growing at a consistent breakneck pace, the company is still expected to grow earnings at an average rate of 8.33% each year over the next five years. Below we'll make some conservative assumptions to try to calculate a price target for the company.

Let's first assume that Eastman earns $6.85 per share this year, which is right in the middle of the company's target. If the company grows earnings at a modest 7.5% per year for five years after the end of 2014, earnings would reach an estimated $9.83 (6.85*(1.075)^5) by the end of 2019. At today's $82 price level, the company would be trading at an unfeasibly low P/E of 8.34. Now let's assume that the company maintains its 11x earnings multiple by the time we reach 2019 - the stock would be trading at $108.13, representing a relatively paltry 32% gain over 5 years. Heck, Dow Chemical made those gains one and half times over this year. So now let's assume that Eastman begins trading closer to its rivals like Dow and BASF, both of which are trading around 15x earnings. If Eastman were to reach that multiple by 2019, the stock would be trading at $147.45 - an 80% premium to today's closing price.

An 80% gain over five years sounds pretty good, but how would Eastman's peers compare?

Dow Chemical (assuming a FY14 EPS of $2.95 with a subsequent 10% annual growth rate and a P/E of 15) would return 33% over the next five years.

BASF (assuming a FY14 EPS of $7.57 with a 5.4% annual growth rate and a P/E of 15) would return 36% over the next five years.

I don't know about you, but I'll take an 80% profit over a 33 or 36% profit any darn day of the week (hell, I'll take an 80% profit over a 33 and 36% profit!)- especially when considering that I didn't even account for dividends, stock buybacks, or higher than expected earnings growth.

Now Seems To Be A Great Time To Jump In

At current valuations, especially considering Tuesday's selloff, it would appear that now is a great time to add Eastman to your holdings if you're looking to add some chemical exposure. Compared to its behemoth peers Dow and BASF, Eastman seems to have been overlooked by many, written off as the ugly stepchild in the diversified chemical producing family. But sooner or later it'll be Eastman's time to shine.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in EMN over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.