Eastman – Time to Change the Messaging (and Possibly the Strategy)

gcopley
Print Friendly
Share on LinkedIn0Tweet about this on Twitter0Share on Facebook0

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

November 6th, 2015

Eastman – Time to Change the Messaging (and Possibly the Strategy)

  • Eastman continues to post strong earnings in the face of weakness in global economies, exchange rate headwinds and a poorly placed hedge on propane prices. Earnings are much better than all peers.
    • Despite this EMN remains one of the cheapest stocks in the Industrials and Materials space.
    • A better and more quantitative story line could drive the stock higher by as much as 50%.
  • EMN is valued more like a commodity than specialty company; at the low end of the commodity range.
    • Margins and stability are better than many specialty companies with much higher multiples.
  • The fault/issue, in our view, lies with management as the company is doing a very poor job of communicating strategy and the business drivers to potential investors.
    • The complexity of the story is a problem and EMN needs to find a way to articulate drivers of growth and margin in a way that is measurable.
    • The company needs to come clean on the exposure of its propane hedge – there is zero value in trying to dance around the issue.
    • Some shareholder friendly decisions on capital allocation are needed, in particular the yield as the dividend is too low to get attention from a large group of possible investors.
  • Valuation, both relative and absolute, is highly compelling, but to unlock that value EMN needs to work proactively to increase its investor appeal – a dividend increase could be an easy first step.
    • EMN is the cheapest stock in our coverage (barring those close to bankruptcy) on our normal framework.
    • Near an extreme discount relative to Chemical sector.
    • Skepticism towards the stock is near its highs.
    • Stock is likely worth in excess of $100 per share with right message and focus.

Exhibit 1

Source: Capital IQ, SSR Analysis

Overview

Eastman is struggling either because of a lack of strategy or because the strategy is being very poorly articulated or both. The company is extremely cheap and despite very good relative earnings growth this year cannot catch investor interest. We think it is partly strategy but mostly messaging and in particular a tendency to talk around issues rather than about them. While the company has discussed the possibility of reallocating cash to shareholders rather than deals; it has not been specific. For every potential shareholder we have spoken to who talks about portfolio complexity, we find another who starts with the yield being too low to pass the test – EMN should know this and should know that by increasing their dividend they would look more like their peers and find some new interested parties.

Second; the company has a propane hedge in place this year and next year – it is a fixed contract with fixed terms, and even if it is not fixed, it will have a clear range of possible outcomes. The company is hurting itself by not being precise here – there is nothing to be gained – except the spread of doubt and concern – by dancing around the subject. Come clean and report its impact precisely on a quarterly basis; that way investors can model its effect. We would not necessarily blame the company for making the decision that it did on hedging at the time, but the lack of clarity in the reporting only adds to investor unease.

Third, the company needs to address the investor concerns about growth. Clearly the acquisitions make it hard to get to the underlying growth of each business and the company as a whole and there is a fear that growth is not there and that the strategy is akin to the FMC ag strategy – buy businesses that have reached their apex in terms of demand and harvest them for cash in as lean a cost structure as possible. If that is the case, say so and then have an appropriate strategy to reward shareholders through increased dividends or buybacks – the roll up only makes sense for equity holders if some of the cash from the “cash cow” comes back to them.

Our work suggests that while top line may be negative on an apples to apples basis, there are plenty of other companies with similar or worse problems that are trading at much higher multiples than EMN – Exhibit 2. Furthermore, if we adjust for the strength of the dollar and the below trend economic growth all over the world, this may not be a portfolio that is ex-growth. Management needs to talk about this more than they do and find a way to help investors model what is really going on.

Exhibit 2

Source: Capital IQ, SSR Analysis

Until investors and potential investors understand the strategy more clearly, understand what the drivers of value can be and understand how they are going to get paid, we believe that it would be very foolhardy of EMN to look at further acquisitions. The best measure of investor confidence in our view is relative PE and, as the chart in Exhibit 3 shows, this is at an all-time low. Whatever messaging and data management is using with investors is not working – it is time to try something new.

Exhibit 3

Source: Capital IQ, SSR Analysis

EMN is Producing Cash Like A Commodity Company….

 

Exhibit 4

Source: Capital IQ, SSR Analysis

… but it is Valued Like One as Well

Exhibit 5

Source: Capital IQ, SSR Analysis

However, the Product Mix and Margins Indicate Specialty Nature of EMN

Exhibit 6

Source: Capital IQ, SSR Analysis

Exhibit 7

Source: Capital IQ, SSR Analysis

Exhibit 8

Source: Capital IQ, SSR Analysis

Cost Structure is Lean – Limited Levers to Offset Propane Hedge

Exhibit 9

Source: Capital IQ, SSR Analysis

Exhibit 10

Source: Capital IQ, SSR Analysis

So Growth is the Issue

EMN’s low, commodity like cost structure is a blessing in one sense and a curse in another. Cost are low because EMN is not spending in R&D and tech service and all of the things that DOW, DD and others are doing to try and drive growth. DOW and DD are not getting the growth – or at least not enough to justify what they are spending – hence the activism and the changes of strategy. Others like PPG are getting the return. The question is then what is an appropriate game for EMN to play: keep going on the roll-up strategy – which is fine as long as there are properties to buy at attractive values and as long as money is cheap; make some additional investment to try and drive enough product innovation or customer intimacy to create growth, or hunker down, maximize cash flows and start buying back shares as rapidly as possible.

Organic revenue growth is not that bad compared to others – Exhibits 11 and 12 – and some can be explained by the significant decline in US propylene pricing and the impact that has had on pass through pricing in some of EMN’s more commoditized product lines. Again the company can do a better job of disclosure and messaging here, because the stock is very undervalued even if growth is slow or negligible.

Exhibit 11

Source: Capital IQ, Company Presentations, SSR Analysis

Exhibit 12

Source: Capital IQ, Company Presentations, SSR Analysis

Relative Valuation and Skepticism

The recent recovery in Exhibit 13 is the weakness in the sector not an improvement in value at EMN – the chart suggests that EMN is a good relative bet if you are concerned about the sector as a whole. The real opportunity for EMN would be to drive costs down such that it gets back to its historic (last 12 year) ROC trend – Exhibit 14 – the company will need cost focus, no propane hedge and some global growth to do that, but the trend drives an earnings number well over $10 per share. The company is currently under-earning, but as shown in Exhibit 15, valuation discounts further disappointments

Exhibit 13

Source: Capital IQ, SSR Analysis

Exhibit 14

Source: Capital IQ, SSR Analysis

Exhibit 15

Source: Capital IQ, SSR Analysis

©2015, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

Print Friendly