With signs of the global economy improving quicker than anticipated, chemicals are looking hot. I am particularly bullish about Detrex Corporation (DTRX.PK) and TOR Minerals (TORM). These two regrettably under-followed firms are well-positioned to gain from greater press coverage. As an IR consultant, I believe it is only a matter of time before the Street catches up on their value. In the meantime, chemical investors will be overly focused on larger giants like Dow Chemical (DOW).
In this article, I will run you through my DCF analysis on Dow and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Huntsman (HUN) and DuPont (DD).
First, let's begin with an assumption about revenues. Dow finished FY2011 with $60B in revenue, which was a 11.8% gain off of the preceding year. Analysts model a 10% per annum growth rate over the next few years, and I view this figure as reasonable, in light of it being slightly below the S&P 500.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures and taxes. I expect cost of goods sold to eat 85% of revenue versus 4.5% for SG&A, 3% for R&D, and 4% for capex. Taxes are estimated at 23% of adjusted EBIT. We then need to subtract out net increases in working capital. I model accounts receivable as 17% of revenue, inventories as 15.5% of COGS, accounts payable as 8.5% of OPEX, and accrued expenses as 100% of SG&A.
Assuming a multiple of 14x and a conservative 2013 EPS of $3.34, the rough intrinsic value of Dow's stock is $46.76, implying 33% upside.
All of this falls under the context of strong momentum:
2011 was a year in which Dow demonstrated the strength of our transformed portfolio and delivered significant top and bottom line growth. Here are the headlines. Earnings per share grew 29% year-over-year, and revenue grew 18%, reaching a new level for the company. Sales in fast-growing emerging regions surpassed $19 billion for the first time in Dow's history, and sales in Asia Pacific were also a record topping $10.5 billion. Equity earnings reached a new milestone of $1.2 billion, and EBITDA rose 12% from 2010. We commercialized a steady stream of new innovations and launched strategic investments and partnerships that will catapult our ability to capture more demand in the world's fastest-growing regions, all from a cost advantage and integrated manufacturing position".
From a multiples perspective, Dow is on the higher-end. It trades at a respective 17.3x and 10.4x past and forward earnings versus 14.1x and 6.6x for Huntsman, and 14.5x and 11.2x for DuPont. Consensus estimates for Huntman's EPS forecast that it will grow by 6.5% to $1.80 in 2012 and then by 17.8% and 22.6% in the following two years. Assuming a multiple of 9x and a conservative 2013 EPS of $2.09, the rough intrinsic value of Huntsman's stock is $18.81, implying 33.7% upside. Huntsman has struggled under a challenging environment, and management is raising prices in the first quarter to offset the greater cost for benzene. Overall, I anticipate margins expanding.
Volumes have, however, picked up at DuPont. I like the firm's exposure to emerging markets - roughly a third of the business is weighted in those regions - and its acquisition of Danisco. As the integration continues, EPS accretion is mitigating downside. Accordingly, DuPont is one of the safer chemical firms.
Disclaimer: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.