Affirm Buy on Double-Digit EPS Pace ex Kingsport Incident
• Specialty chemical volume growth accelerated in 3Q. Exiting Eastman’s second quarter 2017 earnings call we were encouraged by a combination of volume strength in higher value specialty chemical lines, decent margin trends, and mounting evidence that innovation efforts are gaining traction. 3Q results and commentary served to enhance our conviction. In particular Eastman’s Additives & Functional Products (A&FP) segment posted impressive volume growth of 14% boosted by (A) heat transfer fluid sales for use in solar energy applications; (B) solid execution in legacy Taminco in animal nutrition and personal care; and (C) strong sales of tire resins thanks to innovation and environmental restrictions in China. While volume growth of 14% may not be sustainable, evidence is mounting that a pace of high-single digit volume growth – similar to that witnessed in 1H17 – is sustainable, at least for a while. What is more, we expect margins among Eastman’s specialty chemical lines to improve with higher selling prices in 1H18. Looking ahead, Eastman faces a messy 4Q17, when EBIT could be hit as much as $100mn from the explosion at Kingsport, TN in early October and ensuing disruption to the company’s ability to gasify coal. The good news is that operations could be back on track in January 2018. As we “look through” this incident, we believe that Eastman should be able to grow underlying EPS at a pace of 10%+ in 2018 following ~12% growth in underlying EPS this year. In this context, we consider shares inexpensive on nearly all valuation metrics, notwithstanding share price appreciation of 23.7% YTD. EMN remains among our top picks along with DWDP, HUN and GRA.
• Top 10 takeaways: (1) 3Q17 EPS of $2.19 ex-items exceeded our $1.99E and consensus of $2.03; (2) in EPS terms, operating profit came in $0.18 ahead of our forecast and $0.16 better than consensus; (3) volume growth accelerated to 5% y-y in 3Q from +3% in 2Q; (4) A&FP posted remarkable volume growth of 14%, whereas growth was muted elsewhere and negative in Fibers at -2%; (5) 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; (6) roll off of commodity hedges has contributed $90mn to 2017 earnings YTD, including $30mn in 3Q, partially offset by unfavorable FX hedges of $20mn YTD; (7) the net EPS impact of propane and FX hedges could be...
• Model changes: We raise our 2017 EPS estimate by $0.20 to $7.40 from $7.20. Changes to our financial model include higher projected earnings in A&FP, partially offset by a larger than expect earnings hit in 4Q17 from the explosion at Kingsport, TN. Likewise, we increase our 2018 EPS estimate by $0.50 from $7.75 to $8.25, which includes minimal insurance proceeds in 1H18. This suggests a two-year EPS CAGR of 10.6% from 2016 through 2018, excluding the benefit from prospective share repurchases or bolt-on acquisitions, which we do not include in our financial model.
• We raise our target by $10 to $107. Our revised target of $107 suggests upside potential of 17% including a dividend yield of 2.2%. Eastman offers top quartile 2018 FCF yield at 8.5% coupled with a well below-average P/E multiple at 11.3x our estimate of 2018 EPS, a 37% discount to the sector average. 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 $123. Using our relative valuation framework, our P/E multiple implies a fair value of $105 while our EV/EBITDA implies a fair value of $93 per EMN share.
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Huntsman Corporation (HUN: Buy, $40 PT)
Shares Can Fly Solo
• We think HUN shares can fly without the Clariant MOE. In our 12 October report entitled “With or Without You” (link), we made the case that HUN shares are worth ~$3 more (over the short term anyway) in a standalone scenario vs. the then pending merger of equals (MOE) with Clariant. Indeed, HUN shares took the announcement of the Clariant deal break in stride, rising 4.2% on Friday’s session, supported by strong 3Q results in excess of elevated expectations. With the MOE now nixed by mutual consent, we expect investors’ attention to shift to three issues (A) positive near-term momentum in MDI; (B) prospects for ongoing balance sheet improvement, driven by solid FCF and liquidation of Huntsman’s remaining 75% stake in Venator (VNTR) and (C) a wide valuation gap – unsustainably so in our view – between HUN shares and industry peers. Polyurethanes posted record EBITDA, despite a $15mn headwind from hurricanes and a loss in MTBE. As MDI prices continued to ascend through 3Q, the setup remains favorable for 4Q in our view. While we expect MDI prices to moderate from current levels, particularly in Asia, we are encouraged by industry supply-demand dynamics and see a runway of positive performance measured in years. Meanwhile, net debt was only $2.4bn at 30 September and only $0.6bn or 0.5x our 2018E EBITDA pro forma for the sale of Huntsman’s interest in Venator, so Huntsman has multiple avenues for value creation in years to come.
• Top 10 takeaways: (1) 3Q17 EPS of $0.67 exceeded our above-consensus $0.53E and the Street’s $0.51; (2) better price and volume in Polyurethanes drove the upside; (3) Huntsman sustained $50mn of cost headwinds from hurricane Harvey, split as $35mn in Performance Products and $15mn in Polyurethanes; (4) Clariant and Huntsman mutually agreed to terminate their MOE due to activist intervention by White Tale in Clariant shares; (5) while the break is mutual, the termination agreement specifies that Clariant could owe Huntsman $60mn or more if certain Clariant assets are divested, or if Clariant itself is sold, within the next...
• Changes to our model: We increase our 2017 EPS estimate by $0.30 to $2.70 on 3Q earnings upside and an improved outlook for Polyurethanes (MDI) in 4Q17. Given the higher earnings base, we also raise our 2018 EPS estimate, although we expect MDI selling prices to moderate in Asia and perhaps elsewhere as the year progress, particularly if global producers can run assets reliably. The combination of higher EBITDA and a lower interest expense results in an EPS increase of $0.20 to $2.45 from our $2.25. While our 2018 EPS estimate is lower than 2017 optically, recall that the IPO of Huntsman’s Pigments & Additives business (Venator) resulted in a net y-y reduction of $183mn in EBITDA earned in 1H17, or ~$0.65 per share. Pigments & Additives was reclassified as a discontinued operations as of 1 July 2017.
• We rate shares of HUN Buy, and increase our PT by $6 to $40. Our revised price target implies total return potential of 30%, including a dividend yield of 1.6%. Now that the MOE with Clariant has been abandoned and the IPO of Venator complete, we are adjusting our valuation framework from a sum-of-the-parts model for HuntsmanClariant to a framework that is more consistent with the way we value industry peers, Eastman Chemical and Celanese. We now value Huntsman based on the value of its stake in VNTR (~$7 per HUN share) plus an average of the following three methodologies on an ex Venator basis: DCF analysis, a relative P/E framework, and a relative EV/EBITDA framework. Our DCF suggests a warranted value of $44 for Huntsman on a standalone basis, i.e. ex Clariant and ex VNTR. Using our relative valuation framework, our P/E multiple at a 35% discount to the S&P500 multiple implies a fair value of $29, while our EV/EBITDA-based valuation incorporates a discount of 2.75 turns vs. our coverage average, and implies a fair value of $27 per HUN share – again, ex Clariant and ex VNTR. W add an additional $7 per share to each of these figures to account for the value of Huntsman’s ownership interest in Venator, which we assess at $8.15 per HUN share pretax or $7.34 aftertax at a VNTR share price of $24.81.
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LyondellBasell Industries (LYB: Buy, $108 PT)
Bumping PT a Bit on Deleveraging, Solid 3Q Results
• Decent 3Q results suggest earnings trajectory remains on an even keel. In one of the more chaotic quarters on the US Gulf Coast, Lyondell acquitted itself well, despite numerous Harvey-linked outages that affected the majority of the company’s petrochemical capacity and resulted in an earnings hit of $200mn in the quarter. Excluding a gain on sale, 3Q EPS of $2.40 came within $0.02 of our $2.38E and the outlook for 4Q appears constructive to us across the company’s portfolio with the possible exception of Europe, where benchmark ethylene margins are under pressure. Looking ahead, we expect the hurricane-inspired US price surge to unwind by 1 April 2018 such that integrated polyethylene (PE) resin margins decline by $0.06-0.07/lb in 2018. Based on recent trends, we suspect that Refining will be able to pick up a portion of this slack, especially if the unit is able to run reliably, unlike recent history. So what about the stock? Shares have run 22.6% since our upgrade on 8 May vs. +7.6% for the S&P500, but we believe there is more to go. We consider LYB shares still attractive at 7.3x our 2019 trough EBITDA, which puts the stock in the top quartile of the 16 name sin our coverage.
• Our top 10 takeaways: (1) headline adjusted 3Q17 EPS of $2.67 includes $108mn in pretax gain, or $0.27 per share, related to the sale of the Geosel business, which is non-recurring; (2) ex the gain EPS of $2.40 beat our $2.38E, but missed the Street’s $2.45; (3) Hurricane Harvey was a $200mn pretax, or ~$0.35 EPS headwind, larger than the $0.26 we had estimated with 60% in O&P Americas ($120mn), 20% in I&D ($40mn) and the remaining 20% in Refining ($40mn); (4) adjusted for the $40mn headwind, EBITDA in Refining was $98mn, the highest level since 3Q15 and an annual run rate of nearly $400mn; (5) the timeline for Lyondell’s Hyperzone PE expansion at LaPorte was...
• Changes to our model: We raise our above-consensus 2017 EPS estimate a bit further to $10.20 from $10.15. Likewise, we increase our 2018 estimate to $9.50 from $9.30. Our model changes reflect 3Q earnings upside in Intermediates & Derivatives and improved Maya 2-1-1 crack spread in Refining as well as a slightly lower share count, partially offset by lower projected earnings in Olefins & Polyolefins in both the Americas and EAI.
• We rate shares of LYB Buy and increase our price target by $2 to $108. Our price target suggests total return potential of 13%, including a dividend yield of 3.6%. As a reminder, our LYB price target is based on an average of two valuation frameworks; a relative EV/EBITDA multiple and a relative normalized P/E multiple. Our relative EV/EBITDA multiple uses a 2.75x discount to the group average multiple and reflects a stock price of $113, while our normalized P/E methodology reflects a warranted stock price of $102 based on our normalized EPS estimate and a multiple equal to a 30% discount to the sector average multiple.
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