Olin's Stock Price Presents Opportunity

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About: Olin Corporation (OLN)
by: Faloh Investment
Summary

Following my warning on Olin Corp. in 2017, the stock's rally continued, before cratering to 33% below the price I encouraged investor caution at.

The business is positioned well and continues to offer a regular quarterly dividend just as it has for 92 consecutive years.

Today's price appears to be right on the nose of my forecast owner earnings for the business, and I think there's potential here for investment with a long-term horizon.

Back in 2017, I pointed out the then price of Olin Corporation (OLN) at $30.83 was trading at a substantial premium to the fair value I pinned on it, concluding the article with:

although the stability in this name is welcome the stability doesn't also justify the large premium to fair value asked today.

Long-term investors in OLN may enjoy modest growth in their dividend but it's likely to be coupled with capital loss as I believe OLN will be repriced soon.

I rate this an avoid especially for new buys.

Source: Olin Too Expensive!

Today, the common stock has dropped over 40% and the company is trading at $21.63 for a $3.51 billion market capitalization, from a high of $38.84 set at the beginning of the year.

Now, a few weeks of price stability has investors asking whether or not the stock is consolidating on strength or weakness. I believe the times are highly uncertain for the company because its income is dependent on continuously robust U.S. and international industrial activity. However, the stock has come down in price to such a degree that there appears to be a long-term opportunity here.

The Big Picture For Olin

Since its 2015 acquisition of Dow Chemical's chlorine business is fully integrated by this time, the company has returned to its classic no-growth position. Every incremental gain or loss for the business from here on out is likely to come purely from the pricing of its primary and derivative chemical products. This puts us, as investors, in a position to pick a confident position relative to Olin because we can simply judge whether or not forecasted earnings are likely to generate a return we are satisfied with. More on the potential returns below under the heading "Stock Valuation".

Dividends

The company's 4th quarter dividend of $.20 per share marks the end of its 92nd year as a consistent dividend payer, and its pace of $.80 per year makes for a yield of 3.8% at today's price of $21.63.

Total dividend distribution is on track to consume $133 million of cash per year, which is well below the rating of $250 million per year I give to its long-term owner earnings rate. Since Olin Corp's payout ratio is in such good shape, I rate the quarterly dividends of $.20 safe except in the most dire of recessionary environments.

Business Positioning

The company's biggest earning product is caustic soda, although it produces and distributes a large variety of chemicals. Outside of chemicals, Olin owns the Winchester ammunition business, although its contribution to incomes is relatively small:

Caustic soda is the single largest contributor to income for Olin, generating more than 50% of the Chlor Alkali & Vinyl contribution to income.

CFO Todd A. Slater gave away what may turn out to be a valuable nugget of experience in the field as he mentioned when going into recessions the price of caustic soda has, for some unclear reason, gone on an incredible run upward.

For example, leading upto June 2008, the price of the stuff was steadily climbing year over year and reached $440USD per metric ton in the U.S. From $440 in June, the price went on a tear to reach a high of $956 per metric ton in December. I have not been able to acquire a data point for today's pricing, but when a major product such as caustic soda has rallied 100%, these things tend to be mentioned somewhere in the financial press or spoken of by a company such as Olin's management.

Of course, there is no guarantee any dramatic rally in caustic soda will lead another earnings recession despite the historical pattern, but it's something to look out for those investors willing to sell a position when a particularly bad omen appears. So far, caustic soda appears to be on a steady trend upward and is not giving the key warning sign of trouble ahead.

Stock Valuation for Olin

The model is a variant of the classic discounted cash flow method for evaluating investment opportunities. The tool gives an idea of where the stock price is valued at today relative to my forecast for the company's owner earnings, and I used it to go against the grain and pick against a popular semi-conductor stock (see "Fresh Data-Based Insight On Ultra Clean Holdings"):

A fair value of $21.32 per share is the result of a projected $250 million in owner earnings.

I forecast $250 million annual owner earnings because the scale of its operations is sufficiently wide to maintain sufficient earnings to prevent capital destruction throughout economic slowdowns, and while reported income for the trailing twelve months exceeding $700 million dwarfs the owner earnings figure of $250 million, long term the company has quite a bit of debt to pay down at $3.5 billion. Additionally, I am marking down from the recent $700 million net income report because weighing on long-term profits is Olin's manufacturing business' necessary and large capital investment programs, which are not entirely represented in the regular earnings figures due to timing issues.

Overall, the model's output indicates the company is trading right on the nose of its fair value.

Final Word

OLN stock is in a sweet spot for picking up some shares. The stock is offering the safe yield of a long-term durable dividend on track to return cash at 3.8% each year considering today's price of $21.63. And as a bonus to the long-term earnings per share the company will achieve, it is intent on increasing buybacks during the 4th quarter and beyond, as per management statements during the Q3 conference call.

If you're babysitting this position, look out for a rapid rally in caustic soda, historically a key indicator of danger ahead despite contributing positively to Olin's results in the short term.

I'm rating OLN a buy with a price target of $37, at the top of its market value range, and a potential 5-year compounded annual return of 11.6%.

Disclaimer: This article represents the opinion of the author as of the date of submission. This article is based upon information obtained from public sources that the author believes are reliable. The author does not guarantee the accuracy or completeness of this article. It is merely the author's interpretation of the information contained in the article. The author encourages all readers to do their own due diligence. This is not a recommendation to buy or sell any security.

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Disclosure: I am/we are long OLN.

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.