Differentiated chemicals producer Huntsman Corporation (HUN) has received plenty of shareholder pressure over input inflation. Much of this has been exaggerated, in my view, since I find that the impact of rising prices will be more than offset by TiO2 demand normalizing while construction resumes. Although investors have reason to be concerned about the vulnerability that Huntsman has to a double dip (the stock has a beta of 2.25 after all), a stimulus package that would represent a boon to the construction industry is most likely on the table should this occur. As I argued earlier, companies like Caterpillar (CAT) and US Steel (X) are thus much more skewed towards reward than risk.
From a value perspective, it appears likewise for Huntsman. The stock trades only at a respective 10x and 6.2x past and forward earnings. Dow Chemical (DOW) meanwhile trades at 9.1x forward earnings, but offers a dividend yield at 3.57% - just 16 basis points more than Huntsman's. The main value driver will be growth, as the company has $3.5B worth of net debt - more than its entire market capitalization. Comparatively, DOW has $17.5B in net debt, which represents only slightly more than half of its market capitalization. Management nevertheless has nevertheless been targeting improvements in the balance sheet.
The growth will largely depend on the macro environment and spending. Concerns over Europe, China, and debt must be alleviated with reductions in leverage and improving demand. On the second quarter earnings call, CEO Peter Huntsman noted:
"During the second quarter, we saw a sluggish global GDP and Europe revised its growth to a meager 1.3% and further announced a revised first quarter GDP to a sluggish 0.4% growth. It would appear that much of the global economy is somewhere between slow and stagnant growth. However, if I look at our past quarter's performance, combined with that of the previous quarter, we are off to one of the strongest years in our history. As I've said in the past, I believe that within the range of our global markets, our technology, our talented associates and commitment to improve our balance sheet, that we will continue to create shareholder value."
The acquisition of Exxaro, a major ore supplier for the chemical company, by Tronox will put pressure on Huntsman to find a new partner as commodity volitility concerns kick in - ore prices are rising and cutting into margins. That said, the company is properly realigning business in Asia through a restructuring in Textile Effects while experiencing less variance in MDI demand domestically. Increasing capacity for MDI domestically will help to offset the supposedly soft environment in Asia and Europe.
MDI growth is helping to offset commodity volatility elsewhere. Says the CEO:
"We've seen general inflationary pressure on our raw material cost. Benzene cost increased approximately 20% compared to the prior year. As a result of our strong pricing initiatives, we were able to improve our earnings in the second quarter and recapture margin previously eroded due to raw material pressures. In total, we're seeing growth in our MDI sales volume most notably during the second quarter".
Elsewhere, polyurethanes represent a major opportunity for profit expansion. This product is used mainly in building and construction, transportation, and bedding and furniture. However, it meets a variety of applications: everything from coatings and insulation to flexible plastics and footwear. During the second quarter, adjusted EBITDA accelerated to $143M from $70M last year. I anticipate that this product, through increased specialization, will help grow margins from 15.8% in 2010 to around 19.2% in 2012. This could potentially boost operating margins above DOW in time, which has an OM of 7.9% (550 basis points above Huntsman's). This strength will set Huntsman on a favorable course to sustainable increases in scale.
Perhaps the greatest asset of Huntsman is how it is diversified across a variety of chemicals: MDI, titanium dioxide, amines, polymers, amine, among many others. Lagging demand in one sector can easily be relieved through performance in another. Outside of Asia, business has been, for the most part, normal.
With the stock down by 14.61% by the time of this writing (management is currently giving its third quarter earnings call), now is an attractive entry price for investors. The firm has strong fundamentals and is led by stellar management. Huntsman's recent sale of stereolithography resin within the Advanced Materials division to 3D Systems Corporation has raised $41M and is possibly a cue to the debt reduction strategy going forward. If the firm can streamline operations through selling assets, that will produce greater efficiency while improving the balance sheet. Market share gains against DOW will naturally follow in the process.
Analysts currently rate the stock a "buy" while competitor DOW receives more of a "hold" rating. Consensus estimates for EPS are that it will grow by 108.4% to $1.73 in 2011 and then by 9.2% and 25.9% in the next two years. I model revenue growing by 26.5% to $11.7B and then by 1.7% in 2012. Despite a weak environment, Huntsman is improving its global position optimally by operational restructuring in capacity and balance sheet changes. Although the short-term could very well be volatile, high-risk adjusted returns remain lucrative in the long-term given management's actions.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.