Wednesday, September 12, 2012

Eastman Chemical - Sell or Hold?

As I pointed out in my last post, EMN's valuation is worth studying.  I bought EMN at an average cost of $52.93/share (four separate purchases to build the position).  Today, it's trading up slightly at $56.50.  I could sell and lock in gain of 6.74%.  But before I do, I want to revisit my analysis of the stock's valuation.

The chart below shows EMN's earnings, PE, dividends, and stock price for the past 15 years:

Based on this history, the market has priced EMN at 16.8 x earnings, a normal PE of 16.8.  At today's price and PE of 11.1, the stock appears to be nicely undervalued (the black line in the graph).  However, per my portfolio rules, I like to look nearer term at the average PE for the past six years, which I feel gives a more accurate account of the what the market is willing to pay recently, and including during and after the "great recession" years of 2008/2009.  Here is the same graph, but now shortened to a six year history:

The market has been pricing EMN at only 11.1 x earnings, a PE of 11.1 (the blue line and text).  Based on this look at the valuation, EMN is undervalued vs. earnings (the orange line), but right at fair value for the what the market has been paying for EMN earnings these past six years.

Next, I look at the dividend history of the company:

On the positive side, it's maintained a dividend for years, and has recently been increasing the dividend.    For 2012, the company has announced a dividend increase from $0.99 to $1.04, an increase of 5%.  I would have preferred to see a larger increase for 2012 given their nice EPS growth.  That said, as the chart above shows, an investment in EMN back in 1998 would have outperformed the S&P by 1.9%.

How about growth now and into the future?  The chart below shows earnings last year, expected for this year and next (based on company projections), and then a 5 year forecast based on the average of the 13 analysts covering the stock.

From this data, you see earnings growth in 2011 was 28%, 14% likely in 2012, and 19% estimated for 2013.  Beyond 2013, analysts are expecting 8% growth per year.  Based on these projections, the current price (black line) falls below the "fair value corridor" (orange lines), and looks to be undervalued.  I question why analysts are projecting only 8% growth, given the company's recent growth.  I need to look into the analyst reports, and company's latest 10Q.

From the 10Q:

n the first half of 2012 the Company progressed on both organic (internal growth) and inorganic (external growth through joint venture and acquisition) growth initiatives including:

entering into a definitive agreement to acquire Solutia, a global leader in performance materials and specialty chemicals, which acquisition was completed on July 2, 2012 and is expected to:
broaden Eastman's global presence, particularly in Asia Pacific;
establish a combined platform with extensive organic growth opportunities through complementary technologies and business capabilities and an overlap of key end-markets; and
expand Eastman's portfolio of sustainable products;
completing PCI segment capacity expansions to support its non-phthalate plasticizer business, including retrofitting the acquired Sterling Chemicals, Inc. ("Sterling") idled plasticizer manufacturing unit and increasing capacity of 2-ethyl hexanol ("2-EH") to support expected growth in the plasticizers, coatings, and fuel additive markets;
entering into an agreement with a third party to purchase propylene from a planned propane dehydrogenation plant, further improving the Company's competitive cost position over purchasing olefins in the North American market;
completing Specialty Plastics segment capacity expansions for cyclohexane dimethanol ("CHDM"), a monomer used in the manufacture of copolyesters, and cellulose triacetate;
completing the formal commercial introduction of acetylated wood, branded as Perennial WoodTM, to select markets;
commercial introduction of the new Eastman CerfisTM technology; and
in third quarter announcing a joint venture to build a 50,000 metric ton hydrogenated hydrocarbon resin plant in Nanjing, China.  The venture will be equally owned by Eastman and Sinopec Yangzi Petrochemical Company Limited and is expected to be operational by the end of 2014.

EMN purchased Solutia for $4.8 Billion on July 2, 2012.  That explains the spike in earnings this year and next, but not the relatively modest 8% growth going forward.  Looking at revenue and earnings for EMN absent the Solutia acquisition, we see basically a flat revenue from 2011, and a slight decrease in earnings.  It will be interesting to see how they grow 2, 3, 4 years out, and how the acquisition pans out.

Based on my rules, the valuation is close to fair value.  The undervaluation is at least partially a result of the recent acquisition.  This integration will take time, and the future growth prospects of the company need to play out over the next two years more fully.  I don't like the recent small increase in the dividend, it's history of no increases in the dividend, nor do I like the current yield of only 1.8%.  I'm not comfortable holding this stock for the long term until I see a better track record for management post acquisition.

I'll be placing a trailing stop loss on the stock today, with the intent to sell the entire position when a dip triggers the stop.  I'll put the proceeds from the sale to work in existing undervalued holdings, or a new holding to be identified.

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