Cigarette Driven Growth
Eastman Chemical has spread its facilities over seven countries while focusing on chemicals, plastics, and fiber. Part of the recent business strategy has been to diversify end-markets, putting a greater focus in the Asian markets and reducing the importance of the US market. An important characteristic is the firm’s low production cost, achieved by the use of coal for methanol production. Although that is an important characteristic looking forward, it is worth noting that is only tangible when producing at full capacity.
To ease production costs increments, Eastman Chemical have successfully passed some of the costs to its customer without experiencing a drawback on demand. Looking forward, the firm continues to diversify its portfolio and the 2012 acquisition of Solutia confirms so. Now, product offering has added safety glass, solar modules, window tinting, and tires, among other products to a strong specialty chemicals portfolio. Acetate tow, used in the manufacturing of cigarette filters, remains the star product in that portfolio, and is expected to continue driving growth as the number of smokers in China and Russia rise exponentially.
Amid a strong performance during the last quarter, where the Additives & Functional Products and Advanced Materials doubled profits, earnings guidance for the full year was reduced. So far, business restructuring, cost-cutting measures, and increased capacity additions have not offset higher raw material and energy costs. Nonetheless, the initiatives that have reduced cyclicality by 40% and further improvements are expected. Specifically, the firm developed a partnership with Sinopec Yangzi Petrochemical for the construction of a 30,000 ton acetate tow manufacturing facility, and the startup of the recently acquired non-phthalate plasticizer manufacturing facility in Texas City.
The balance sheet for Eastman Chemical is strong amid a high debt related to recent acquisitions. Currently trading at 15.5 times its trailing earnings, the stock trades at a 16% discount to the industry average. Andreas Halvorsen is the largest guru holding a stake in the company, and shows no changes since June when stock price began to rise. At the same time Leon Cooperman and Steven Cohen made important acquisitions. I share their optimism, and stock performance has backed their decisions. However, the entry point for a long term investment has passed.
Domination Is Not Enough
There is nothing new that can be said about Dow Chemical, just remind the readers about the market dominant position achieved by the business thanks to its massive size. Hence, the company´s products are present in almost every industry known to men and sold in over 160 countries worldwide. The recent business strategy is focusing on a wider specialty chemicals offer, and securing a tangible cost advantage for feedstock. In line, management has preferred to somewhat overlook the benefits offered by current low US gas prices due to their volatility.
Thanks to structural integration, production technology, and lower-than-average energy and feedstock costs, Dow Chemicals has few rivals in the low-barrier basic chemicals segment. Growth of the segment will be pushed by the a $20 billion joint venture with Saudi Aramco, that will see some of the lowest feedstock costs and serve the rising eastern markets. However great hopes may be for the basic chemicals segment, the reader should not forget that specialty chemicals will grow disproportionately.
Evidence of a greater focus on the specialty chemicals can be found on Dow Chemicals’ new joint ventures and acquisitions. Rohm & Haas widened product offerings and turned the firm into the world’s leading specialty chemicals and advanced materials. On another note, Dow AgroSciences has partnered with Monsanto for the development of next generation of advanced weed and insect control technology in corn. This holds a great potential for growth given that Monsanto has already successfully introduced an insect resistant soybean trait. This grand strategy is being supported by an aggressive group of cost-saving initiatives, in addition to policies aimed at reducing earnings cyclicality.
The balance sheet for Dow Chemicals is strong amid thin operating margins. Currently trading at 16.3 times its trailing earnings, the stock carries a 12% discount to the industry average. Jean-Marie Eveillard has turned into the largest guru holding a stake in the firm after a strong buy, taking Steven Cohen´s place who sold out. I am contrary to Mr. Cohen´s decision this time, and feel the company holds interesting future prospects.
Window of Opportunity
For an investor who prioritizes a long-term investment, timing is the key to winnings, and discounts dictate the right moment to buy. I share that reasoning and consequently prefer Dow Chemicals over Eastman Chemicals. Most importantly, Dow Chemicals’ management has been working around its weak spots in order to improve performance while rewarding shareholders.
Disclosure: Vanina Egea holds no position in any of the mentioned stocks.