Olin: Steep Sell-Off Sets Up A Strong Buying Opportunity

| About: Olin Corporation (OLN)


The company’s updated guidance disappointed investors as weaker than expected domestic caustic soda demand adversely affected results.

Additional factors adversely affecting guidance included higher raw material costs; lower chlorinated organic results; and non-cash mark-to-market expenses.

The sell off in the company’s shares was due in part to the “disappointing” guidance, but also near-term profit taking given a strong share run up from 52-week lows.

Significant late 2015 and early 2016 insider purchases of the company’s shares signal to us that insiders strongly believe in the company’s transformation strategy.

Integration of acquired Dow Chemical businesses will make Olin less cyclical and will present greater cost synergies than expected.

Investors hammered shares of Olin Corporation (NYSE:OLN) in late July 2016 as the company announced updated guidance for its second quarter and full year 2016. Shares of OLN sold off by over 20 percent on the date of such updated guidance. Was the sell off simply a product of OLN's disappointing guidance or was another factor at play as well? We think the steep sell off resulted from a combination of such "disappointing" guidance along with the fact that short-term investors were up significantly on their investment in OLN shares and were highly likely engaged in near-term profit taking. Anyone who has followed OLN shares will note that the company's shares sold off sharply in late 2015 through early 2016. Much of the sell off in OLN shares likely resulted from investors having too much near-term optimism with respect to the results from OLN's acquisition of Dow Chemical's (NYSE:DOW) chlor alkali and other businesses. The near-term costs and risks of such an acquisition the size of the DOW acquisition are likely to distort OLN's earnings results in the near term as the integration of such acquisition takes place. Investors must remember, however, that OLN's shares dropped to about $12 a share over the last several months and recovered over 100 percent to over $25 until the recent sell off on the company's guidance. With an over 100 percent return in the last six months, near-term investors used OLN's guidance as an opportunity to lock in gains.

OLN's announced updated guidance for its second quarter 2016 indicated that it expects net income to be about breakeven and adjusted EBITDA to be about $180 million. The company explained that such updated guidance was primarily due to weaker than expected domestic caustic soda demand during May and June, which led to export sales comprising a higher percentage of total caustic soda volumes. As a result, OLN's average caustic soda pricing was lower than expected. Such factors resulted in an impact of about $20 million to OLN's adjusted EBITDA. The company explained further that in its post DOW-acquisition system it typically experiences a 3 to 6 month lag in the realization of price indices increases. OLN noted additional factors adversely affecting its second quarter adjusted EBITDA included: 1) higher raw material costs, mainly due to an increase in ethylene and natural gas pricing, of $15 million; 2) lower chlorinated organic results of $8 million, reflecting weak demand from refrigerant, packaging, and agriculture customers; and 3) non-cash mark-to-market expenses and other timing items totaling approximately $10 million.

Given the second quarter adverse circumstances OLN faced, the company now expects full year 2016 adjusted EBITDA to be in the range of $840 million to $900 million. OLN expects that second half 2016 performance will benefit from higher domestic and export caustic soda pricing. OLN also continues to expect second half results to benefit from improved profitability in its Epoxy business, reflecting increased volumes, improved productivity, and the absence of any significant planned maintenance outages, which lowered the business' first half 2016 performance. OLN continues to expect its Winchester division results for the full year 2016 to exceed 2015 levels. The company also noted that its revision to full year 2016 adjusted EBITDA results also reflects: 1) continued weakness in chlorinated organic sales, reflecting ongoing softness in demand from refrigerant, packaging, and agriculture customers; 2) lower than expected export pricing for ethylene dichloride; and 3) increased raw material costs. The company noted that it "faced several unexpected headwinds that impacted our expected second quarter results, but the fundamentals of its business are unchanged."

OLN continues to expect long-term benefits from favorable trends developing in the caustic soda market, evidenced by lower exports from China, European mercury cell chlor alkali capacity rationalizations, and a lack of new capacity being brought on line. The company also noted that its DOW business acquisition integration process remained on track, and there are significant cost and operational synergy savings to be realized over the next 18 months. The company expects procurement and maintenance related cost and operational savings of $125 million to $150 million over the next four to six quarters, as well as an additional $20 million of savings from the optimization of administrative activities that were outsourced or covered by transition service agreements at the time of the DOW transaction. Finally, OLN reiterated its continued belief that its businesses have the opportunity to earn, in mid-cycle economic conditions, in excess of $1.5 billion of annual adjusted EBITDA through the continued improvement in the Epoxy business, the achievement of synergies and with favorable market dynamics in chlor alkali products and ethylene dichloride pricing. We believe in OLN's reiterated pronouncements of its intermediate and long-term opportunities for revenue and earnings growth in addition to cost-saving synergies resulting from its DOW acquisition transaction.

We initially profiled OLN over the past year in regard to a broad range of significant insider purchases of the company's shares that began in late 2015 and restarted again in early 2016. We believe that one of the most positive signs to a potential investor in a company's stock is multiple insider purchases of shares on the open market. In an earlier article, we pointed out that in late 2015, multiple insiders purchased OLN shares and the most significant late 2015 insider purchases included: 1) Donald Bogus purchasing 50,000 shares at $19.92; 2) Richard Rompala purchasing 50,000 shares at $19.51; 3) Philip Schulz purchasing 21,100 shares at $20.08; and 4) James Varilek purchasing 15,000 shares at $19.27. A quick review of the November 2015 insider purchases shows that such purchases were at about the $19 to $20 price range. In February 2016, multiple OLN insiders stepped up again to make multiple substantial insider purchases of the company's shares including: 1) Joseph Rupp purchasing 70,000 shares at $14.26; 2) Pat Dawson purchasing 20,000 shares at $12.90; 3) Gray Benoist purchasing 15,000 shares at $12.54; and 4) Randall Larrimore purchasing 8,000 shares at $12.64. These substantial insider purchases are the clearest indication to us as to when insiders consider OLN's shares to be at a value price.

OLN's share price, subsequent to its updated guidance sharp sell off, is now approaching the purchase zone where insiders initially stepped up to buy the company's shares. Investors recognize the near-term costs and risks of an acquisition the size of the DOW acquisition. (For a more detailed discussion of OLN's DOW acquisition see our earlier article on OLN.). Investors may have been disappointed with OLN's recently updated quarterly guidance, but insiders' past significant buying activity is telegraphing to potential investors such insiders' belief in the DOW acquisition (See this article to see the benefits of DOW transaction as indicated by OLN.) and the company's ability to recognize underappreciated cost-saving synergies from the DOW business acquisition. Such cost savings will also allow the company to reduce its debt and decrease its overall leverage. Remember further that the in total multi-million dollar insider purchases by OLN executives are more likely purchases with intermediate-term holding periods of three to five years while large institutional investors are much more near-term in their investing horizons.

Our view

The recent sharp sell off in OLN shares has presented a buying opportunity, but we believe an even greater buying opportunity is likely if the overall market sells off. During an overall market sell off, investors may be able to pick up OLN shares in the $17 to $19 price range. As noted above, we believe the single-day 20 percent sell off was motivated in part by the company's disappointing updated second quarter guidance. We also believe, however, that the sell off in OLN shares was motivated by the rise in the company's shares from a 52-week low of about $12 to over $25 in a few short months. In other words, profit taking was also a likely factor. Now, of course, fundamental factors are also at play in OLN's weak performance in recent years as it has been adversely affected by global economic weakness.

The integration of the acquired DOW business will present risks as noted by Moody's credit ratings service, but the DOW acquisition will be credit positive for OLN over the long-term as such transaction increases the company's size and earnings diversity, and establishes a long-term, integrated position into the ethylene feedstock, an important raw material needed for the acquired business. (Moody's also noted that OLN incurred approximately $3.5 billion in additional debt as a result of the DOW transaction and such debt will pressure the company's financial flexibility, but believes the company will reduce its debt over the next 18 to 24 months. The DOW acquisition has diversified OLN's product and geographic base in a way that will enable it to be less cyclical. Such acquisition also broadens OLN's customer base and will allow for continued reductions in freight and logistics costs. Finally, OLN's long-term, exclusive ethylene supply contracts with DOW will allow it to continue to benefit from DOW's cost-advantaged North American ethylene feedstock. In addition, OLN expects to benefit from increasing demand for caustic soda, chlorine, other chemical products and ammunition.

OLN's forward price to earnings ratio is about 17.20 based on 2016 earnings estimates of $1.20 and 12.65 based on 2017 earnings estimates of $1.63. We should note that OLN's earnings estimates for 2016 and 2017 have decreased in recent months. The average price to earnings ratio for OLN's peers is about 13, but OLN likely deserves a premium valuation to such average price to earnings ratio given it is expected to grow revenue and earnings at a greater rate, given the positive benefits expected from the DOW transaction. Although the updated second quarter guidance was disappointing and a near-term setback, the long-term advantages of OLN's DOW transaction will drive revenue and earnings growth for the reasons noted above. Further, we believe that the multiple and substantial OLN insider purchases over the past year are a sign of confidence that the DOW transaction will benefit OLN over the intermediate and long term. With OLN's shares trading at a price slightly above the price range paid by OLN's insiders, potential investors may want to start a partial position now and a full position when OLN shares drop to the upper teens level. Once purchased, OLN investors will have the opportunity to collect an almost 4 percent dividend while the company integrates and benefits from the DOW transaction.

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Disclosure: I am/we are long DOW.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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