AFP = Amazing Financial Performance in 3Q
• Eastman delivers against elevated expectations. 3Q17 EPS of $2.19 ex-items comes in well ahead of our $1.99E and consensus of $2.03. Our numbers had actually moved higher into the print following management comments in early October regarding improved results. In EPS terms, operating profit came in $0.18 ahead of our forecast and $0.16 better than consensus. Volume trends continue to improve, up 5% y-y, led by Additives & Functional Products (AFP), which posted remarkable volume growth of 14%. Among Eastman’s segments, A&FP also posted the largest positive earnings variance vs. our model, while Fibers and Chemical Intermediates delivered upside as well. Advanced Materials was a modest headwind to our estimates, while an elevated corporate cost was an additional $0.02 drag. Eastman repurchased $100mn worth of shares in 3Q, consistent with the 2Q level, bringing deployment to $275mn YTD. Despite the repurchases, net debt declined $160mn q-q to $6.5bn or 3.0x our 2017E EBITDA.
• Management affirmed prior guidance. On 9 October, 2017 Eastman updated the street on financial performance following an explosion at the company’s Kingsport facility. At that time management guided full year EPS growth toward the higher end of the prior projected range of 10-12%, excluding the costs associated with the explosion and subsequent outage. While Eastman continues to expect $50-100mn in total net costs from the outage, the company now sees $100mn in costs registering in 4Q, followed by potential insurance recovery in 2018. Importantly, “excellent progress in repairing the facility” is being made such that EMN expects to return to normal operations in early 2018.
• AFP carries the weight for specialty segments. In EPS terms, A&FP was a $0.14 tailwind against our numbers. Organic sales in the segment continue to grow at an impressive clip, up 17% y-y. Operating leverage on those sales has been sub-par due to elevated raw material costs and a weaker mix. However, contribution margins improved dramatically to 19.4%, up from the -15% reported in 2Q, allowing the impressive top line beat to carry through to operating income. We see more room for improvement on the margin front, as contribution margins remain below the 21% segment level. Elsewhere, Advanced Materials segment earnings were more in line as 1% volume growth decelerated a bit from the 3% reported in 2Q and 10% growth in 1Q. Better margins offset some of this headwind.
• Fibers improved sequentially. EBIT of $66mn is a $0.04 tailwind vs. the $59mn we had penciled in. The segment results had been flattening, and a recent report from peer Celanese supported this notion. Thus the sequential improvement in the Fibers segment is a pleasant surprise. Looking ahead, we are interested to hear about the potential implications from the explosion at Kingsport. A large supplier to the filter tow business, Rayonier Advanced Materials, has cut its sales guidance for 2017, due to “an operational upset earlier this month at a major customer.”
• Chemical Intermediates (CI) results hold in better than feared. EBIT of $81mn represented only a modest sequential decline vs. the more dramatic 11% we had modeled. While propane prices rallied on the quarter, we suspect that the remaining commodity hedges helped to dampen some of the earnings impact. On the 2Q17 call, management had been open to weakness in CI in the second half, so the report is welcome within this context. Looking forward we await the call to discern more specific implications of the facility explosion for 4Q17.
• We rate EMN Buy with a price target of $97. Our price target of $97 suggests upside potential of 9% including a dividend yield of 2.2%. As a reminder, we value Eastman based on an average of three methodologies; DCF analysis, a relative P/E framework, and a relative EV/EBITDA framework. Our DCF suggests a warranted stock price of $110. Using our relative valuation framework, our P/E multiple implies a fair value of $96 while our EV/EBITDA implies a fair value of $86 per EMN share.
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Huntsman Corporation (HUN: Buy, $34 PT)
Clariant Deal Breaks; MDI Powers Big 3Q
• Polyurethanes strength drives substantial earnings upside in 3Q. Adjusted 3Q17 EPS of $0.67 beat our $0.53E and consensus of $0.51 handily. Likewise, adjusted 3Q EBITDA of $340mn surpassed our estimate of $303mn by 12% on much stronger sales ($2.17bn vs. our $1.99bn) and margin upside, particularly in Polyurethanes. On balance, the upside was driven by operations as we estimate that a higher 3Q tax rate of 23.7% actually pinched EPS by $0.02 relative to our forecast rate of 21.5%. Importantly, Huntsman estimates that EBITDA was depressed by $50mn due to Hurricane Harvey. On a segment basis, Polyurethanes posted the largest positive earnings variance vs. our forecast, while Advanced Materials and Textile Effects were in line and Performance Products came in a touch light. FCF likewise looks good. HUN generated adjusted FCF of $227mn in 3Q17 making $560mn YTD, which puts the company on track to once again exceed the FCF goal of $450mn. Aided by Venator (VNTR) IPO proceeds, net debt declined by $1.17bn in 3Q to $2.42bn or 2.0x our 2018 estimate of EBITDA. We look forward to diving deeper during the company’s upcoming earnings call at 10:00AM ET.
• Clariant Deal breaks by mutual agreement. With activist White Tale having accumulated more than 20% of Clariant shares outstanding as per yesterday’s filing, the deal break comes as no surprise. Whereas normally, we would expect risk arbitrage-related selling pressure on HUN shares in this scenario, at least on a temporary basis, we expect shares to trade materially higher on today’s session for two reasons: (A) quarterly results look that good; and (B) given strength in Venator (VNTR), we estimate that HUN shares are actually worth more now ex MOE with Clariant. Please see our recent note entitled “With or Without You” (click here) for a more detailed analysis and discussion of this deal-break scenario as well as fundamental strength in MDI. HUN remains among our top picks in the chemicals sector along with DWDP, EMN and GRA.
• We rate HUN shares Buy with a price target of $34 and upward tension in this deal-break scenario. Our $34 target for HUN reflects a return of 16%, including a 1.7% dividend yield. Our existing target price is based on our sum-of-the-parts (SOTP) analysis, wherein we value each of the individual businesses within Huntsman and Clariant based on comparable company values, and we incorporate the value cost synergies as well as the separation of Venator (VNTR), which we value at a recent market price of $25.00 for the purpose of our SOTP analysis. Our published target breaks down as $31 per share of value for Huntsman ex VNTR plus $3 per share of value for Huntsman’s 75% stake in VNTR pro forma for the Clariant merger. As indicated in our prior research, our target is likely to move higher by ~$3 per share in a deal-break scenario.
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