Huntsman: A Reasonable Choice

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About: Huntsman Corporation (HUN)
by: Tien Duy Vo
Summary

Huntsman's shares are now traded at a reasonable price compared to both its historical PE and peers' EV/EBITDA.

The company has an established model with limited number of competitors.

The future demand for MDI - a main chemical product of Huntsman - is on the rise.

However, the company may face a downside risk from the expansion of Wanhua.

Due to the recent market turmoil, the stock price of Huntsman (HUN) has dropped to $21.81 (as of Feb. 10, 2019). This is an attractive price compared to its historical highs. Comparisons can be found on our database: the current PE is 8.60, while the average historical PE is 18.06. Compared to some peer companies such as Cabot (NYSE:CBT), Eastman (NYSE:EMN), or Celanese (NYSE:CE) – which are currently traded at 6x to 9x EBITDA – HUN’s multiple of 5.37x EBITDA is quite favorable. In addition to that, the company’s business model is very established with relatively limited competition. Therefore, we think Huntsman's shares are now offering a good risk/reward trade-off.

Table 1. US Chemical Companies’ PE comparison

(Source: US chemical companies)

Figure 1. Huntsman’s historical PE

An established business model

Huntsman Corporation is one of the main global producers of commodity and differentiated chemicals. The company’s main business segments comprise of Polyurethanes, Performance Products, Advanced Materials, and Textile Effects.

Figure 2. Huntsman’s business segments

Huntsman offers a broad product slate, including titanium dioxide, propylene oxide, ethylene glycol, MTBE, and other commodity products. It is also a leading global manufacturer of polyurethanes, surfactants, epoxy resins, etc. This diversified product portfolio allows the company to participate in different sectors of the manufacturing industry.

Figure 3. Application of Huntsman’s products in different sectors of the manufacturing industry.

Figure 4. Typical EBITDA margin according to sectors.

A leading global producer of Methylene diphenyl diisocyanate (MDI)

MDI is the main chemical used to produce Polyurethanes, which is Huntsman’s most important product. Until now, there are only a limited number of big players in the field, with Huntsman, Dow (NYSE:DWDP), Wanhua, BASF (OTCQX:BASFY) and Covestro (OTCPK:CVVTF) (OTCPK:COVTY) accounting for approx. 90% of the total production. It is the high initial investment for new ventures that hinders new players to enter the field. Due to the lack of investment in production capacity in the past, together with a rise in the market demand for construction and production, MDI's price has surged in 2018. This implies potential for higher future revenues and profit margins for MDI producers, including Huntsman.

Figure 5. Main producers of MDI

Figure 6. Comparison of MDI Competitive Intensity

(Source: MDI production)

Ranking among the four largest global producers, Huntsman has the advantage of offering the highest level of differentiation. This allows the company to meet diverse market needs in a large number of sectors. According to the company’s analysis, the demands for MDI and other plastic chemical products will continue to rise in the long term, which opens up favorable market potential for Huntsman in the future.

Figure 7. Future market demand for MDI

The decrease in feedstock price is another advantage for the company's future growth

In order to run production, Huntsman must buy different types of feedstock such as Ethane, Propane, Butane, etc., prices of which are tied to crude oil price. In recent years, the crude oil price has fallen compared to its peak in 2008. This allows Huntsman to lower the cost of sales and improve profit margin for its chemical products.

Figure 8. Feedstock for production

Figure 9. Decreasing crude oil price in recent years

More importantly, the decline in oil price is not just a temporary effect. According to the Trump administration, Conserving oil is no longer an economic imperative for the US, and that the main goal now is to rather keep oil price low. Therefore, we could expect this price level to maintain at least for the next 2 years.

Huntsman on numbers

Huntsman Corporation is one of the largest global producers of commodity and differentiated chemicals. In 2017, revenues and EBITDA totaled $8.4 billion and $1.3 billion, respectively. The company’s numbers for the first three quarters of 2018 show improved results, with adjusted net income increasing by ~64% compared to the prior-year period, at $685M. Together with an increase in net income, adjusted diluted income per share also rose from $ 0.67 to $0.84. Looking at its past performance, Huntsman's differentiated adjusted EBITDA has grown steadily with a CAGR of 10%.

Besides, the company also managed to reduce its debt and upgrade its investment grade. As of Q3 2018, the company’s balance sheet continues to strengthen with net leverage of 1.3x. Net cash provided by operating activities was $295 million, and free cash flow generation was $226 million. The current financial performance suggests that the investment in Huntsman is a good risk/return trade-off since the company is gradually strengthening its balance sheet and generating good free cash flow.

Downside risks

One potential risk for Huntsman would be associated with slower economic growth. Its key product lines are tied to global economic trend; thus, downward global economies could cause underperformance, such as weak demand for chemical products and rising pressure on selling prices. However, this is a common risk factor for all companies, so we won’t focus on it.

The main risk of Huntsman is the expansion of Wanhua. The Chinese company is expanding at a very fast speed and is ramping up its production. It is now already the top producer in plastic products. However, it seems that Wanhua might be just fine with the recent development of the plastic oligopoly and is not reaching for a monopoly since it will cause political trouble. Moreover, the US is taking actions to protect its domestic producers by placing tariffs on Chinese imported products. Even though Wanhua has invested in a new plant in the US, it does not seem that the company will compete on price. In particular, Wanhua has announced a rise in MDI price.

Conclusion

If Huntsman continues to grow at the current growth, then next year EBITDA would be around $1.43B. With a current EV/EBITDA of 5.37x, it means that the next year target price would be $25.12, representing approx. 16% upside potential from the current price level. If we are a little bit more optimistic and take a P/E of around 11x, then there is around 28% upside potential for Huntsman's shares. Keep in mind that the average PE of the chemical industry is 20, so there is still room for growth in the future. Therefore, this might be a good risk-return trade-off.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.