Eastman Chemical: A Great Long-Term Dividend Stock At The Right Price
Summary
- Price increases drive revenue growth.
- Volume declines have been muted.
- The company offers a good, growing dividend yield.
- A slowdown in sales and an increase in inventory pose short-term challenges.
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Eastman Chemical (NYSE:EMN) serves attractive end markets. Since the stock’s return has a high positive correlation with the market, it suffers immense losses during bear markets. But, the company offers a good, growing dividend yield. Eastman Chemical would be an excellent company to own long-term if bought at the right price, at or below $79, where the stock would yield 4%. This bear market may yet offer a better entry point.
Price Increases Drove Revenue Growth
Eastman Chemical had good pricing power, but the strengthening dollar and lower volumes took some bite out of its overall sales growth. Since 2021, the company has consistently hiked prices (Exhibit 1). But, the overall impact on sales volumes has been limited thus far. The volume declines were muted but may accelerate in the coming quarters as demand falters across the economy. High-interest rates have pushed the U.S. housing market into a recession, and the auto market, recovering from supply chain issues, may soon follow suit. Moreover, the company may have run out of runways to increase prices further.
Exhibit 1:
Eastman Chemical Quarterly Y/Y Change in Sales Due to Volume, Price, & Impact of US Dollar (Eastman Chemical Investor Presentations)
The company’s adjusted EBIT margins have come under increasing pressure, but some of the impacts on its margins are due to divested businesses and planned or unplanned manufacturing maintenance. The company’s gross and operating margins have suffered, with gross margin dropping below 20% and operating margin falling to 12% in Q3 2022 (Exhibit 2).
In Q4 2022, the company expects headwinds to sales from softening demand and the strong dollar. The company is projecting adjusted EPS in Q4 2022 between $1.10 and $1.40 and a full-year adjusted EPS of between $8.05 and $8.35. The company trades at a forward multiple of 10.7x based on the low end of its adjusted EPS estimate for 2022.
Exhibit 2:
Eastman Chemical Gross, Operating, and Adjusted EBIT Margins (%) (Seeking Alpha, Eastman Chemical Investor Presentation)
Eastman Chemical’s Fate is Closely Tied to the Market's Performance
A monthly return analysis of Eastman Chemical and Vanguard S&P 500 Index ETF (VOO) shows a high positive correlation of 0.78. This level of correlation portends that the company’s monthly returns are very much tied to the market and the broader US economy. The company’s stock should do well if the market is doing well. Thus far in 2022, the Vanguard S&P 500 Index ETF produced a negative return of 15.4% [intra-day Dec 12, 2022], while Eastman Chemical dropped 26.9%. Although the returns of the Vanguard ETF and Eastman Chemical have a high positive correlation, Eastman Chemical has much higher volatility, as measured by beta.
A linear regression model of the monthly returns of Eastman Chemical and the Vanguard S&P 500 Index ETF between June 2019 and November 2022 yields a beta of 1.54, which is in line with the 1.50 Beta provided by Yahoo Finance. This Beta of 1.54 means that Eastman Chemical’s average monthly returns will change by 1.54% for every 1% change in the monthly return of the Vanguard S&P 500 Index ETF. This beta explains why the stock has underperformed the Vanguard S&P 500 Index ETF by a wide margin in the past year.
Given its correlation with the market, this stock likely cannot protect a portfolio during market downturns. In fact, during bear markets, the company’s stock amplifies the negative returns of the market in a portfolio.
High Inventory Levels are a Concern
The company has seen an increase in inventory due to faltering demand in building, construction, and industrial end-markets. At the end of 2021, the company had $1.5 billion in inventory. By Q3 2022, the company reported $1.9 billion in inventory, an increase of 31%. The company has an estimated 84 days of sales in inventory (Exhibit 3). These days sales in inventory are the second-highest inventory level in the past decade. It may take work for the company to sell this inventory in this economy in the face of declining housing, automotive, and industrial markets. This high inventory level can lead to more pressure on margins in Q4 2022.
Exhibit 3:
Eastman Chemical Days Sales in Inventory (Seeking Alpha, Author Compilation)
Increased Inventory Takes a Bite Out of Cash Flows
The increase of $569 million in inventory reduced operating cash flows to $948 million TTM, compared to $1.6 billion in 2021 and 1.45 billion in 2020. But, the inventory is a short-term issue, and if its sales stabilize, the company should see an increase in free cash flows. The free cash flow per share dropped to $2.25 TTM for a yield of 2.6% (Exhibit 4).
Exhibit 4:
Eastman Chemical Free Cash Flow Per Share (Seeking Alpha)
Eastman Chemical Offers Good Dividend Yield & Growth
The company offers a reasonable dividend yield of 3.7% with a low payout ratio of 34%, even in this depressed profit environment. The company can maintain its dividend, but investors can look for a 4% yield given that the US 2-year Treasury yields more than 4%. Any further market sell-off may allow investors to acquire Eastman Chemical close to $80 and increase their current dividend yield. Over the past five years, the company has grown its dividend by an average of 8% annually.
The company has a good share repurchase program, having spent $4.5 billion [share repurchase - share issuance] on its program over the past decade. The company has reduced the share count by 13% over the past decade (Exhibit 5). The company’s debt to EBITDA and current ratio is at 2.4x and 1.5x, respectively, at healthy levels (source: Seeking Alpha/YCharts).
Exhibit 5:
Eastman Chemical Share Issuance & Buybacks (Seeking Alpha)
The company is trading at a compelling valuation with a TTM GAAP PE of 9.3x and forward PE of 11x, compared to a five-year average of TTM GAAP PE of 17x and forward PE of 12.7x. The company is trading at less than 1x sales and a forward EV to EBITDA of 7.9x.
Conclusion
The company may not return to its 52-week low of $69.91, but if there is any near-term sell-off that takes the shares to $79, that would be a reasonable entry price for Eastman Chemical. The company enjoyed sales growth due to price increases and muted volume declines. But the steep rise in inventory levels may point to demand destruction across its various end markets. But, the company offers good cash flow yield, has manageable debt levels, and offers a good dividend. Below $79 per share would take the dividend yield to 4%. The company has increased its dividend annually. At the right price, Eastman Chemical is a good dividend growth stock to own long-term. This bear market may yet offer a good buying opportunity.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of EMN, VOO either through stock ownership, options, or other derivatives. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (10)
Thank you for highlighting the potential for growth in its "circular economy" business. Its deal with Pepsi is attractive, and I will follow it closely. Thank you!
