After researching Chevron, we were not too optimistic on Eastman Chemical. As a backgrounder, Eastman Chemical Company (“EMN”) is a United States-based Fortune 500 company, engaged in the global manufacture and sale of chemicals, fibers, and plastics. Founded in 1920 and based in Kingsport, Tennessee, the company now has 44 manufacturing sites worldwide and employs approximately 13,500 people. Eastman Chemical was spun off from parent Eastman Kodak in 1994. Unlike Chevron, while the company does not have a spotless environmental record, it has not been the subject of many environmental/pollution controversies (source: Wikipedia).
This company positively surprised us. It was not ranked as highly (no. 30) as Chevron (no. 6). However, the deeper we dug, the better the company and its trends looked. It’s employee review rating was 4.6 (out of 5) and has increased significantly over the last year. The above rating was based on over 800 employee surveys. Within the 4.6 rating are 5 subcategories of which the company scored 4.2 or higher. A whopping 95% of employees approve of Eastman’s CEO Mark J. Costa and an equally large percentage would recommend the company to a friend. An example comment is below:
Eastman Chemical also received awards and accolades just like Chevron. But there was a difference. Several of Chevron’s were from Glassdoor, whilst Eastman’s were from a diverse group including the United States EPA ! (See below. For a complete list, please refer to Eastman’s page on Glassdoor).
We also conducted a CSRHub review and again, found similar trends. Not only was Eastman Chemical’s rating higher than Chevron’s but it ranked sharply higher in certain subcategories such as Environment and Governance. As in the Glassdoor ratings, Eastman’s CSR rating trend rose consistently for the total lookback period starting in October 2012 and ending in late 2014. Of course, the company is no Prince-Charming, and still needs some work in the areas of Community Development, Philanthropy, and Diversity & Labor Rights. While the company is rapidly moving into Earth-friendly chemicals, we note that it supplies a key ingredient used to manufacture cigarette filters.
CSRHub flagged it for being an Animal Test User. This was significantly lower than the 8 flags for Chevron. In all fairness, we note that the large scale and nature of Chevron’s business leaves the company at a disadvantage. For example, as an oil & gas producer, it is likely to be involved in Fracking.
Is it a good time to purchase Energy-related companies?
We believe now is a good time to begin acquiring shares of energy and chemical companies given the recent heavy selling. The selling has been almost panic-based, which one can see from the heavy volume and sharp downtrend over the last three months (see chart below of the SPDR Energy ETF). Concurrently, crude oil prices have declined over 45% from their highs, but one must remember they cannot decline forever as most producers are not profitable below $50/bbl oil. Thus, the energy sector will likely “self-correct” during the next year, meaning unprofitable and leveraged producers will likely rationalize production. Already producers have announced 20% CapEx spending cuts with many more to come. Commodity traders have also flagged that the oil market has shifted from Backwardation to Contango. This means that longer-term oil futures are now “predicting” more expensive prices compared to spot (present-day) prices.
|Source: Google Finance|
Eastman Chemical (EMN)
Eastman Chemical, while not an E&G Producer, has declined in sympathy with the Energy industry (see chart below). Consequently, we believe now (Dec’14-Jan’15) is a good time to opportunistically purchase shares of EMN.
On a side-note, many SRI portfolios are heavily-weighted towards consumer and technology companies. Investing in a chemical company is a great way to diversify SRI portfolios, especially considering (as we do) that the stock market is nearing a top. Once the monetary-morphine-drip stops, the market is likely to drop, taking down high P/E shares with it. Diversifying into lower-P/E and lower Beta companies allows the portfolio manager to maintain a fully-invested position while lowering total portfolio risk.
As noted earlier, the shares are trading near their yearly low, as they have fallen in sympathy with oil & gas extractors. However, Eastman Chemical is not a producer of petroleum but a user of petroleum products (called NGLs). NGLs such as propane are key raw materials; in fact, Eastman may benefit from lower prices.
Eastman Chemical has been moving away from commodities and into higher-end, faster-growing specialty chemicals.These markets tend to have higher profit margins and are less cyclical than commodities. Business risk is also reduced as specialty chemicals tend to be in diverse industries and countries. It is executing this business strategy via divestitures and acquisitions. Some of the more interesting products include those for durable plastics, tire additives, and consumer hygiene.
The company presented itself on Investor Day in November 2014. Readers should download this report to better understand Eastman’s business strategy. Two slides from the company’s presentation are shown below:
On a share-basis, we note that the company has been repurchasing shares and has nearly $750mm remaining on its $1bn share repurchase program. Continued repurchases are supported by the company’s expectations of $1bn in annual free cash flow. Management also recently increased its dividend payment which we believe is significant in light of investor worries of energy companies cutting their dividends. Companies rarely raise dividends unless management feels confident in the long-term future of the firm, as they know that a cut could cause shares to fall sharply.
The flip-side of Eastman Chemical’s business strategy is that the company may undergo execution risks given the large numbers of acquisitions it has made. Certain of those acquisitions, such as Solutia Inc., were partially debt-financed. Also, we stated that low oil prices may be “good” for the company. However, if the oil price decline is symptomatic of a weaker global economy, then the company will suffer as it is reliant on industrial demand. Lastly, all energy chemicals are exposed to existing and changing regulations which may increase the cost of doing business.
We view Eastman Chemical’s shares as undervalued. Consensus-earnings are forecast to grow 12% in 2015 and ROIC will grow > 12%. EBITDA margins are increasing sharply, yet the shares trade at only 10x earnings for 2015E. We believe the company’s growth alone justifies a P/E of 12x; however, if the shares trade similar to other specialty chemical players, then a P/E of 14-15x is justified. (Sources: Thomson Reuters, S&P Capital IQ)
Using an estimated P/E range of 12x – 15x returns a stock price range of $93 – $116. In other words, Eastman’s shares could rise between 22% and 53% during the next year – not too shabby for a boring industrial company !
Disclosure: The author does not own EMN but may in the near future.