Since today’s specialty chemicals industry supplies most finished goods manufacturers, the economic and consumer recession had a direct impact on this particular industry’s results since the end of 2009. Eastman Chemical Company (EMN) wasn’t the exception. The firm has made an emphasis on its acetate tow production, mainly used for cigarettes. The company stands out for using coal as its input, in contrast with other competitors using petroleum and gas, both more expensive for production. This mark up has allowed Eastman to transfer some of its increasing costs onto prices, without compromising its sales revenue.
In addition to this, the acquisition of Solutia Inc. (former global leader in performance materials) completed on July 2, 2012, broadened Eastman’s specialty chemicals output by adding automotive and solar end products to its portfolio.
Although Eastman is a highly diversified company, it has proven to be severely affected by negative cycles of the economy. Even though this feature is not appealing whatsoever to investments, it certainly has caused it to become a cheap alternative. And, a quite promising one, since the economic recovery boosted its revenue, as a result of Eastman’s focus on cost-advantage production methods.
Other specialty chemical competitors, such as Ashland Incorporated (ASH) didn’t show such a promising comeback, and the drop in revenue during 2012 was anticipated by investor Jean-Marie Eveillard (Trades, Portfolio), who sold out his 3.9 million share position by the third quarter of that year.
Another industry giant, Huntsman Corporation (HUN) did show more promising results, and less volatile revenues during these last years. This, of course, has led to a high price to earnings ratio discouraging investors as we see later.
On 2012, almost 50% of Eastman sales were generated in North America, while more than 25% were in Asia and 20% in Europe, Middle East and Africa. This diversification is to be taken into account since it guarantees long-term revenue, even if cigarette consumption decreases in some specific region (for instance, American sales declined in recent years), which would stabilize acetate tow demands worldwide.
Industrial Background and Gurus’ Preference
Eastman’s earnings per share growth was significantly higher than industry median (46.9% vs. 5.2%) but so was Huntsman’s, at 46.5%. The critical difference between these two industry giants stands out by looking at their price to earnings: Eastman’s is below median (16.4 vs. 19.1) while Huntsman rose up to 130.1, thus entailing a significant price premium relative to industry peers’ average.
Although Ashland does have an inferior price to earnings ratio than Eastman’s (11.5), there’s a significant difference in their earnings per share growth: 27%, probably caused by a decline in revenue.
This might have been one of the reasons that motivated investors David Dreman (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio) to significantly reduce their stake in Huntsman (both of them by more than 80% margin). In contrast, Leon Cooperman (Trades, Portfolio) and Scott Black (Trades, Portfolio), reinforced their positions in Eastman. Most notably, Ray Dalio (Trades, Portfolio) even sold out his Huntsman position and bought more than 50,000 Eastman shares and a smaller 5,600 share position at Ashland by the end of September.
Although being volatile, Eastman appears to show a promising future since it’s both cheaper and faster growing than its rivals in chemical industry. Guru holdings also demonstrate a general optimism regarding this company.
Disclosure: Victor Selva holds no position in any stocks mentioned.
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