Since I first pitched Huntsman (HUN) more than six months ago, the stock has gained nearly 30%, more than tripling the return of the Dow Jones. In this article, I will run you through my DCF model on the chemical producer and triangulate the result against the fundamentals of agricultural/chemical firms Potash (POT) and Mosaic (MOS). I find that Huntsman is still meaningfully trading below intrinsic value despite aggressive risk discounting.
First, let's begin with an assumption about the top-line. Huntsman finished FY2011 with $11.2B in revenue, which represented a 21.3% gain off of the preceding year. I model 16.3% per annum growth over the next half decade or so as the domestic economy returns to normalcy.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 84% of revenue versus 9% for SG&A, 1.5% for R&D, and 2.7% for capex. Taxes are estimated at 30% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital to get free cash flow. I estimate this figure hovering around -1% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 12% yields a fair value figure of $19.43, implying 27.6% upside.
All of this falls within the context of strong performance despite a challenging business environment:
"Adjusted EBITDA for our Polyurethanes division in the first quarter 2012 was $177 million, an improvement of $63 million compared to the prior year of $114 million. Sales volume for our MDI products increased 4% compared to the prior year. We saw improved demand geographically in each of our regions and across the majority of our end market segments. Despite troubling economic headlines, we saw growth in Europe with stronger demand in Northern Europe where we sell the majority of our product, far outweighing the negative impact of the recession-plagued Southern Europe. We continue to see growing demand in U.S. automotive and insulation".
From a multiples perspective, Huntsman is also attractive. It trades at a respective 11x and 6.9x past and forward earnings versus 13x and 11.1x for Potash and 11x and 10.1x for Mosaic.
Consensus estimates for Potash's EPS forecast that it will decline by 1% to $3.47 in 2012 and then grow by 9.8% and 2.1% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $3.78, the stock would hit $52.92 for 25.6% upside. The company is around 30% more volatile than the broader market and trades at 4.3x book value. By contrast, Huntsman only trades at 1.9x book value with a beta of 2.6.
Consensus estimates for Mosaic's EPS forecast that it will fall by 0.2% to $4.40 in 2012 and then grow by 15% and 9.3% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $5.03, the stock would hit $70.42 for 37.6% upside. In terms of volatility, the company falls between Huntsman and Potash at a beta of 1.6. Over the last 6 months, the stock has fallen 13.1%; but, my price target, is still below the 52-week high of $74.31. For investors willing to take on the risk, the long-term rewards will more than compensate as the economy nears full employment.
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