Huntsman Corp.'s (NYSE:HUN) Sale of $2 Billion in Assets Will Spur Aggressive Buybacks Over The Next Year
When Huntsman Corp. announced the asset sale on August 7, 2018, and gave its presentation to analysts the next day, it made clear that a major portion of the net $2.07 billion in proceeds would be used to "accelerate" share repurchases. HUN also provided detailed forecasts of both its expected adjusted EBITDA and expected free cash flow ("FCF").
HUN made it clear that investors could expect $944 million in stable EBITDA earnings once the loss-making subsidiary is sold. They also explained that 40% of EBITDA will convert into FCF. Investors can now expect stable FCF of close to $400 million next year as the sale should close by the end of the year. This can be seen in the financial tables that the company presented:
Source: HUN Presentation 8-7-19
The sale will bring in $1.66 billion in after-tax proceeds. Since there is still $608 million left on the share repurchase program, investors can now expect most of that program will be spent on share repurchases over the next year. Management even stated that if the stock price multiples stay "anywhere near" these levels (meaning today), they would "aggressively look" at accelerating the share repurchase program. They also put this in their slide presentation:
Total Yield is Now Expected To Be 12.7% of Market Cap
Total Yield is the dollar amount of dividends paid to shareholders plus the expected dollar amount of share repurchases divided by the market value of a company. HUN's dividend rate is $.65 per share (it has paid $0.1625 for the past 7 quarters), so the dividend yield is 3.22% today (Aug. 12, 2019). Now, there is $608 million left on HUN's share repurchase program. This represents 13% of HUN's market value. When the asset sale closes at the end of the year, HUN could easily afford to "accelerate" that buyback program. That would use up just 38% of the $1.6 billion in after-tax proceeds. Here is how I calculated the expected buyback yield over the next year:
Source: Hake estimates
These tables show that I estimate HUN will buy back $162 million during the second half of 2019 using its normal free cash flow. Then, after the $1.6 billion asset sale closes at the end of 2019, HUN will accelerate the share repurchase program, buying the remainder of the $608 million shares available under the existing $1 billion program. Note that this means that 6.68 million shares will be expected to be bought in H2 2019 and 15.3 million shares in H1 2020, or 22 million shares. This assumes the stock rises 15% in both half-year segments.
Why Does This Matter?
Since there are 232.1 million fully diluted shares outstanding as of Q2 2019, the share repurchases would reduce the shares outstanding to 210 million. That is a 22 million share reduction or 9.5% of the original 232 million shares outstanding. So, now, if we assume that the same dollar amount is spent on dividends, or $148.7 million, with the lower amount of shares, the net new dividend per share within a year would 9% higher:
Source: Hake estimate
So, even if HUN did not increase its payout ratio or increase the dollar amount of dividends it spends as a percent of FCF, its DPS can be expected to increase 9% to $0.71 per share annually. It's also theoretically possible HUN could pay out a special dividend on top of the share buybacks. In addition, given that there would be only $446 million left of the $1 billion share repurchase program by the end of the year, which would represent just 29% of the $1.6 billion net after-tax proceeds from the asset sale, and given management's stated aim of accelerating the buying back program, it is very possible they would announce a new $1 billion share repurchase program.
Obviously, there are a lot of assumptions here. For example, if the stock rises dramatically before the accelerated share buybacks were instituted, management might hold off. If economic outlook turns down significantly, they might be more cautious. On the other hand, my analysis above assumes a 44% increase in the average price over the next year from $20.20 to $29.09 while the company is buying back the shares. If the stock does not rise that much, then HUN could end up buying back more shares, and the net new DPS could be set even higher.
I want to make one financial point about my model that might make this analysis a little too optimistic. Management has made great efforts to emphasize that they expect EBITDA conversion to be 40% during both 2019 and 2020. That means that FCF will end up being 40% of adjusted EBITDA. Note also that management indicated that the last 12 months pro forma business without the assets sold would have generated $944 million in adjusted EBITDA. (You can see that in the tables above and the presentation.) So, multiplying 40% of $944 million means expected FCF will be $386 million in 2020. But the dividend payments at $0.65 per share would cost HUN $148.7 million, or 38.5% of FCF. That leaves only $237 million that could be spent on buybacks without using up some of the $1.6 billion in cash received from the asset sale. My point is that the assumed buyback yield of 9.5% ($608 million/$4,688 million market value) entails spending $371 million more ($608 million - $237 million) than the company's FCF can support without drawing down cash.
I don't have any issue with this for one simple reason: management has made it clear they will accelerate the share buyback program if all other conditions stay the same. Let's think about that for a second. How long could HUN continue to spend more than FCF allows on buybacks? Assuming FCF stays at the same $371 million, it would take 4.3 years to use it up. This is calculated by dividing $1.6 billion by $371 million. So, maintaining the 9.5% buyback yield spend will likely not be an issue for at least several years. The net result: shareholders can expect 9% increases in dividends per share for at least the next 2 to 3 years, even if FCF does not increase.
What is HUN Worth?
If you have read any of my previous articles, you know that I like to use an adjusted comp valuation to value stocks. Here is how that works. I use the financial metrics management uses to describe their company and compare them these to its peers. In this case, it is three metrics: EBITDA, FCF, and dividends. Then, I find the EV/Sales, EV/EBITDA, FCF yield and dividend yields of the industry and derive a per-share value. Before I finalize this, I also adjust HUN's value based on how well it performs against the industry in terms of EBITDA margins and FCF margins. In addition, if the dividend payout ratio is lower at HUN, I increase the value based on the higher industry dividend payout ratio. You can see my analysis below:
Source: Hake estimates
The table below shows that HUN has lower EBITDA and FCF margins, and also a lower payout ratio than its peers:
Source: Hake estimates
Making these adjustments to the expected true value, HUN is still undervalued compared to its peers:
Source: Hake estimates
Based on these assumptions, HUN is worth over 53% more than today's (Aug. 12, 2019) price, or $31.00 per share.
Summary and Conclusion
I like stocks like HUN that are cheap and where management is looking out for shareholder value. HUN sports a 3.2% dividend yield that is now well supported by forecasted cash flow. Its large asset sale will spur a major buyback program. These buybacks are reasonably expected to yield 9.5% of HUN's market value. This effectively means HUN's total yield will be 12.7% per year over the next several years. I have also shown that HUN is worth $31.00 per share, over 53% higher than today's price. It is very highly likely HUN has a good chance of reaching that price, given the large accelerated buyback activity expected over the next year.
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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.