03.26.18
Eastman Chemical Company (EMN: Buy, $111 PT)
Investor Day Preview; Innovation in Focus
• We see four key topics of interest to investors. Ahead of Eastman’s upcoming Innovation Day in New York on 6 February, we outline and discuss herein four salient topics of interest to investors: (1) selected innovation efforts and growth prospects among Eastman’s specialty chemical markets; (2) fundamental prospects in commodity chemical markets where Eastman participates and potential for any strategic action related thereto; (3) capital deployment; and (4) financial considerations related to Kingsport, TN where Eastman suffered an operational disruption in early October 2017. Exiting the company’s conference call on Friday, we also affirm our Buy on EMN shares and increase our price target by $3 to $111, which suggests upside potential of 14%.
• Innovation will be front and center. After all, the event is dubbed “Innovation Day”. Generally speaking, Eastman is not perceived by many investors to be an especially innovative chemical company, yet the company has enjoyed important successes in the recent past (e.g. Tritan) and is rightly proud of its R&D efforts. In recent years, the company has doubled spending on its top 10 innovation programs and likewise doubled its concentration in application development to 40% of the resources from 20%, while keeping overall R&D investment flat. So, the opportunity for Eastman will be…
• The “C3” spread has improved markedly as propylene prices hit a 3-year high in January. While investor days are meant to focus on medium- to long-term considerations, we are intrigued by at least one short-term trend, which is the degree of improvement in the spread between propylene, an output of the company’s ethylene crackers at Longview, Texas, and propane, the principal feedstock for those crackers. We call this the “C3” spread and others sometimes refer to it at as the “PTP” spread. Polymer-grade propylene (PGP) averaged ~$0.61/lb for the month of January thanks to mid-month spikes supported by various outages. DowDuPont’s propane dehydrogenation (PDH) went down on …
• Eastman is recovering from an operational disruption at Kingsport that weighed on 4Q results. The company is exiting a messy 4Q17, when EBIT was hit by $115mn from an explosion at Kingsport, TN in early October 2017 that disrupted the company’s ability to gasify coal. The good news is...
• Capital deployment: look for ongoing share repurchases with door open for bolt-on deals. As shown in Figure 3, Eastman has done two major acquisitions over the last six years: Solutia in mid-2012 and Taminco in late 2014. Over the past three years, portfolio activity has diminished with greater focus on organic growth, de-leveraging, and share repurchases, while allowing for the occasional bolt-on deal. Looking ahead...
• Key incremental takeaways from the 4Q conference call: (1) the 2018 EPS cadence is front-end loaded with 1H18 EPS expected to exceed 2H18 EPS; (2) EMN foresees FCF >$1.1bn in 2018 vs. our revised estimate of $1.18bn; (3) Kingsport “incident” costs now look lower by $25-50mn; FCF impact is negative $50-70mn in 2018 inclusive of the rebuild of working capital; (4) tax reform results in...
• We affirm our Buy on EMN shares and raise our target by $3 to $111. Our revised target suggests upside potential of 14% including a dividend yield of 2.3%. Eastman offers top quartile 2018 FCF yield at 8.3% coupled with a well below-average P/E multiple at 11.7x our estimate of 2018 EPS, a 28% 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 $124. Using our relative valuation framework, our P/E multiple implies a fair value of $112 while our EV/EBITDA implies a fair value of $96 per EMN share.
(Please see full report for details)
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LyondellBasell Industries (LYB: Hold, $113 PT)
4Q EPS Beats as Lower Tax Covers for EAI Softness
• Lyondell 4Q EPS beats on tax. 4Q adjusted EPS for LYB, excluding $2.07 of tax benefits and ~$0.03 of charges related to European pension settlement, looks to have settled at $2.76A vs. our $2.72E and the Street at $2.57. A lower than expected tax rate of 20% was well below the 27% that we had forecast, resulting in a net tailwind of $0.25. Core adjusted EBITDA of $1.75bn missed the $1.85bn that we had penciled in, but came in just ahead of the $1.73bn consensus. On a segment basis, Olefins & Polyolefins (O&P) - Americas and Refining outperformed our estimates, while Intermediates & Derivatives (I&D) finished in line, and O&P – EAI fell well short, even after adding back the $20mn in pension settlement charges. The company appears to have paused repurchase activity following the 3rd quarter, with the 10mn shares repurchased on the year reflecting no additional buyback in 4Q. Net leverage declined by $625mn q-q and nearly $1.6bn in 2017 to 0.8x EBITDA.
• Outlook reads cautiously optimistic. While North American polyolefin margins increased sequentially in 4Q, price, and subsequently margins, contracted over December and January as capacity has returned following Harvey-related outages. That said, the rally in crude and delays in the start-up of new capacity may help stave off further pressure from here. It is the latter two issues which have management viewing the 2018 outlook more favorably than they had in the middle of 2017.
• Weakness at O&P EAI trumps modest beat in Americas. O&P Americas EBITDA of $784mn came in $5mn ahead of our $779mn, though managed a more sizeable outperformance vs. the Street’s $740mn. Integrated PE margins benefited from better market prices, higher co-product values, and lower feedstock costs. Ethylene production looks to have rebounded successfully following the 3Q Harvey related outages. Across the pond however, O&P-EAI EBITDA of $376mn (adjusted for $20mn of pension settlement charges) was considerably weaker than our $521mn estimate and the Street’s $488mn. Higher feedstock costs drove a sequential unit margin decline of $0.06/lb, which was roughly double the decrement we were modeling. An outage at the company’s Wesseling, Germany cracker was expected to result in a $40mn headwind to EBITDA in 4Q. It is possible that costs ran over, and we look forward to the call for more details on this issue. Looking ahead, Lyondell has declared force majeure at its PE facility in Matagorda, TX and has likely run at lower operating rates throughout the Gulf in January due to the severe cold. At a higher level though, the rally in global crude prices may provide support to PE markets which have weakened from 4Q peak levels. This would support earnings in O&P Americas, though could continue to be problematic for EAI margins.
• I&D reports modest beat. I&D segment EBITDA of $410mn came in just ahead of our $406mn as a stronger top line made up for the sequential margin pressure. Following the strong quarter reported by Celanese in Acetyls we had reason to believe our numbers could be more conservative into the print. However, margins of 18.4% were 210bps below our estimate and down 100bps sequentially. As we look into 1Q, results should continue to improve on the back of strength in styrene and acetyls as well as sequential improvements in MTBE margin (C-Factor).
• Refining profitability rebounds following Harvey outage. In EPS terms, Refining segment EBITDA was $0.05 better than the $78mn we had penciled in, though it looks like LIFO benefits did drive some of the performance. Total throughput of 245kbpd increased 2% sequentially, though throughput remains below the 2Q17 watermark of 265kbpd following Hurricane Harvey-related outages. Looking forward to 1Q, we anticipate a continued ramp in refining operating rates and see Maya 2-1-1 spreads remaining at healthy levels.
• We rate shares of LYB Hold with a price target of $113. Our price target suggests limited upside, including a dividend yield of 3.1%. 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 3.0x discount to the group average multiple and reflects a stock price of $115, while our normalized P/E methodology reflects a warranted stock price of $110 based on our normalized EPS estimate and a multiple equal to a 30% discount to the sector average multiple.
(Please see full report for details)
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LyondellBasell Industries (LYB: Hold, $116 PT)
Sea Change in Cash Deployment
• Lyondell’s earnings profile remains solid but cash deployment is shifting dramatically. We exit Lyondell’s quarter with the view that the familiar FCF return story that investors have enjoyed over the last 6 years has come to an end. This is not the consequence of industry oversupply or other cyclical forces, despite our concerns about the amount of new polyethylene (PE) resin capacity coming to market over the next two years. In fact, the oil price rally over the last 4 months will help to “ease the pain” that we had anticipated with Brent crude closer to $50. Instead, Lyondell’s strategic preference is the primary reason for the paradigm shift. Whereas our earnings estimates are moving north, based on an improved outlook in domestic PE margins and a lower tax rate, FCF is headed south, and not only for the winter. Lyondell is embarking on an ambitious four-year program with capital expenditures to average $3bn per annum, more than double the company’s historic run rate. Don’t get us wrong – the returns on Lyondell’s PO/TBA and Hyperzone HDPE projects are likely to be attractive, particularly in the wake of recent US tax reform. Our point is simply that FCF yields could be halved vs. the “good old days”. Overall, we view Lyondell’s valuation as reasonable. However, increasing supply of ethylene/PE likely to restrain earnings upside and FCF coming under pressure, we believe it will be increasingly difficult to justify higher multiples. Meanwhile, M&A has been quiet, but remains on the table.
• Top 10 takeaways: (1) 4Q17 adjusted EPS of $2.76A (ex $2.07 in tax benefits and $0.03 in pension charges) exceeded our $2.72E and consensus of $2.57; (2) a lower than expected tax rate added $0.25 to EPS; (3) EBITDA of $1.74bn missed our $1.85bn with the primary variance being the O&P-EAI segment, which came in $145mn, or $0.27 light vs. our estimate; (4) no shares were repurchased during the quarter due to pre-determined levels set in a 10b5-1 plan, but buybacks will likely resume and the company will seek approval for an additional 10% program at the May AGM; (5) the pro forma tax rate following passage of the US tax bill is estimated at 21% vs. the VRP estimate of 24.1%, a boost to EPS of $0.40; (6) a planned maintenance turnaround at Channelview will reduce earnings by...
• Changes to our model: Following the 4Q17 conference call we are taking our 2018 EBITDA estimate up to $6.85bn from $6.7bn. The primary drivers of the elevated core profitability are higher expectations from the O&P Americas and I&D segments given better North American PE margins following the recent rally in Brent crude oil as well as improved profit outlooks for acetyls, styrene, and MTBE. Partially offsetting these positive revisions are lower expectations from O&P – EAI as the crude rally has increased regional feedstock costs in Europe and thereby pressured margins in the region. Our EPS estimate for 2018 also rises to $10.50 from $9.95. Of this $0.55 increase, $0.40 comes from a lower than expected tax rate, with the remaining $0.15 the net effect of higher EBITDA estimates and a higher interest expense.
• We rate shares of LYB Hold and increase our price target by $3 to $116. Our revised price target suggests a return of 7%, including a dividend yield of 3.2%. 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 2.5x 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 $119 based on our normalized EPS estimate and a multiple equal to a 30% discount to the sector average multiple.
(Please see full report for details)
Investor Day Preview; Innovation in Focus
• We see four key topics of interest to investors. Ahead of Eastman’s upcoming Innovation Day in New York on 6 February, we outline and discuss herein four salient topics of interest to investors: (1) selected innovation efforts and growth prospects among Eastman’s specialty chemical markets; (2) fundamental prospects in commodity chemical markets where Eastman participates and potential for any strategic action related thereto; (3) capital deployment; and (4) financial considerations related to Kingsport, TN where Eastman suffered an operational disruption in early October 2017. Exiting the company’s conference call on Friday, we also affirm our Buy on EMN shares and increase our price target by $3 to $111, which suggests upside potential of 14%.
• Innovation will be front and center. After all, the event is dubbed “Innovation Day”. Generally speaking, Eastman is not perceived by many investors to be an especially innovative chemical company, yet the company has enjoyed important successes in the recent past (e.g. Tritan) and is rightly proud of its R&D efforts. In recent years, the company has doubled spending on its top 10 innovation programs and likewise doubled its concentration in application development to 40% of the resources from 20%, while keeping overall R&D investment flat. So, the opportunity for Eastman will be…
• The “C3” spread has improved markedly as propylene prices hit a 3-year high in January. While investor days are meant to focus on medium- to long-term considerations, we are intrigued by at least one short-term trend, which is the degree of improvement in the spread between propylene, an output of the company’s ethylene crackers at Longview, Texas, and propane, the principal feedstock for those crackers. We call this the “C3” spread and others sometimes refer to it at as the “PTP” spread. Polymer-grade propylene (PGP) averaged ~$0.61/lb for the month of January thanks to mid-month spikes supported by various outages. DowDuPont’s propane dehydrogenation (PDH) went down on …
• Eastman is recovering from an operational disruption at Kingsport that weighed on 4Q results. The company is exiting a messy 4Q17, when EBIT was hit by $115mn from an explosion at Kingsport, TN in early October 2017 that disrupted the company’s ability to gasify coal. The good news is...
• Capital deployment: look for ongoing share repurchases with door open for bolt-on deals. As shown in Figure 3, Eastman has done two major acquisitions over the last six years: Solutia in mid-2012 and Taminco in late 2014. Over the past three years, portfolio activity has diminished with greater focus on organic growth, de-leveraging, and share repurchases, while allowing for the occasional bolt-on deal. Looking ahead...
• Key incremental takeaways from the 4Q conference call: (1) the 2018 EPS cadence is front-end loaded with 1H18 EPS expected to exceed 2H18 EPS; (2) EMN foresees FCF >$1.1bn in 2018 vs. our revised estimate of $1.18bn; (3) Kingsport “incident” costs now look lower by $25-50mn; FCF impact is negative $50-70mn in 2018 inclusive of the rebuild of working capital; (4) tax reform results in...
• We affirm our Buy on EMN shares and raise our target by $3 to $111. Our revised target suggests upside potential of 14% including a dividend yield of 2.3%. Eastman offers top quartile 2018 FCF yield at 8.3% coupled with a well below-average P/E multiple at 11.7x our estimate of 2018 EPS, a 28% 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 $124. Using our relative valuation framework, our P/E multiple implies a fair value of $112 while our EV/EBITDA implies a fair value of $96 per EMN share.
(Please see full report for details)
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LyondellBasell Industries (LYB: Hold, $113 PT)
4Q EPS Beats as Lower Tax Covers for EAI Softness
• Lyondell 4Q EPS beats on tax. 4Q adjusted EPS for LYB, excluding $2.07 of tax benefits and ~$0.03 of charges related to European pension settlement, looks to have settled at $2.76A vs. our $2.72E and the Street at $2.57. A lower than expected tax rate of 20% was well below the 27% that we had forecast, resulting in a net tailwind of $0.25. Core adjusted EBITDA of $1.75bn missed the $1.85bn that we had penciled in, but came in just ahead of the $1.73bn consensus. On a segment basis, Olefins & Polyolefins (O&P) - Americas and Refining outperformed our estimates, while Intermediates & Derivatives (I&D) finished in line, and O&P – EAI fell well short, even after adding back the $20mn in pension settlement charges. The company appears to have paused repurchase activity following the 3rd quarter, with the 10mn shares repurchased on the year reflecting no additional buyback in 4Q. Net leverage declined by $625mn q-q and nearly $1.6bn in 2017 to 0.8x EBITDA.
• Outlook reads cautiously optimistic. While North American polyolefin margins increased sequentially in 4Q, price, and subsequently margins, contracted over December and January as capacity has returned following Harvey-related outages. That said, the rally in crude and delays in the start-up of new capacity may help stave off further pressure from here. It is the latter two issues which have management viewing the 2018 outlook more favorably than they had in the middle of 2017.
• Weakness at O&P EAI trumps modest beat in Americas. O&P Americas EBITDA of $784mn came in $5mn ahead of our $779mn, though managed a more sizeable outperformance vs. the Street’s $740mn. Integrated PE margins benefited from better market prices, higher co-product values, and lower feedstock costs. Ethylene production looks to have rebounded successfully following the 3Q Harvey related outages. Across the pond however, O&P-EAI EBITDA of $376mn (adjusted for $20mn of pension settlement charges) was considerably weaker than our $521mn estimate and the Street’s $488mn. Higher feedstock costs drove a sequential unit margin decline of $0.06/lb, which was roughly double the decrement we were modeling. An outage at the company’s Wesseling, Germany cracker was expected to result in a $40mn headwind to EBITDA in 4Q. It is possible that costs ran over, and we look forward to the call for more details on this issue. Looking ahead, Lyondell has declared force majeure at its PE facility in Matagorda, TX and has likely run at lower operating rates throughout the Gulf in January due to the severe cold. At a higher level though, the rally in global crude prices may provide support to PE markets which have weakened from 4Q peak levels. This would support earnings in O&P Americas, though could continue to be problematic for EAI margins.
• I&D reports modest beat. I&D segment EBITDA of $410mn came in just ahead of our $406mn as a stronger top line made up for the sequential margin pressure. Following the strong quarter reported by Celanese in Acetyls we had reason to believe our numbers could be more conservative into the print. However, margins of 18.4% were 210bps below our estimate and down 100bps sequentially. As we look into 1Q, results should continue to improve on the back of strength in styrene and acetyls as well as sequential improvements in MTBE margin (C-Factor).
• Refining profitability rebounds following Harvey outage. In EPS terms, Refining segment EBITDA was $0.05 better than the $78mn we had penciled in, though it looks like LIFO benefits did drive some of the performance. Total throughput of 245kbpd increased 2% sequentially, though throughput remains below the 2Q17 watermark of 265kbpd following Hurricane Harvey-related outages. Looking forward to 1Q, we anticipate a continued ramp in refining operating rates and see Maya 2-1-1 spreads remaining at healthy levels.
• We rate shares of LYB Hold with a price target of $113. Our price target suggests limited upside, including a dividend yield of 3.1%. 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 3.0x discount to the group average multiple and reflects a stock price of $115, while our normalized P/E methodology reflects a warranted stock price of $110 based on our normalized EPS estimate and a multiple equal to a 30% discount to the sector average multiple.
(Please see full report for details)
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LyondellBasell Industries (LYB: Hold, $116 PT)
Sea Change in Cash Deployment
• Lyondell’s earnings profile remains solid but cash deployment is shifting dramatically. We exit Lyondell’s quarter with the view that the familiar FCF return story that investors have enjoyed over the last 6 years has come to an end. This is not the consequence of industry oversupply or other cyclical forces, despite our concerns about the amount of new polyethylene (PE) resin capacity coming to market over the next two years. In fact, the oil price rally over the last 4 months will help to “ease the pain” that we had anticipated with Brent crude closer to $50. Instead, Lyondell’s strategic preference is the primary reason for the paradigm shift. Whereas our earnings estimates are moving north, based on an improved outlook in domestic PE margins and a lower tax rate, FCF is headed south, and not only for the winter. Lyondell is embarking on an ambitious four-year program with capital expenditures to average $3bn per annum, more than double the company’s historic run rate. Don’t get us wrong – the returns on Lyondell’s PO/TBA and Hyperzone HDPE projects are likely to be attractive, particularly in the wake of recent US tax reform. Our point is simply that FCF yields could be halved vs. the “good old days”. Overall, we view Lyondell’s valuation as reasonable. However, increasing supply of ethylene/PE likely to restrain earnings upside and FCF coming under pressure, we believe it will be increasingly difficult to justify higher multiples. Meanwhile, M&A has been quiet, but remains on the table.
• Top 10 takeaways: (1) 4Q17 adjusted EPS of $2.76A (ex $2.07 in tax benefits and $0.03 in pension charges) exceeded our $2.72E and consensus of $2.57; (2) a lower than expected tax rate added $0.25 to EPS; (3) EBITDA of $1.74bn missed our $1.85bn with the primary variance being the O&P-EAI segment, which came in $145mn, or $0.27 light vs. our estimate; (4) no shares were repurchased during the quarter due to pre-determined levels set in a 10b5-1 plan, but buybacks will likely resume and the company will seek approval for an additional 10% program at the May AGM; (5) the pro forma tax rate following passage of the US tax bill is estimated at 21% vs. the VRP estimate of 24.1%, a boost to EPS of $0.40; (6) a planned maintenance turnaround at Channelview will reduce earnings by...
• Changes to our model: Following the 4Q17 conference call we are taking our 2018 EBITDA estimate up to $6.85bn from $6.7bn. The primary drivers of the elevated core profitability are higher expectations from the O&P Americas and I&D segments given better North American PE margins following the recent rally in Brent crude oil as well as improved profit outlooks for acetyls, styrene, and MTBE. Partially offsetting these positive revisions are lower expectations from O&P – EAI as the crude rally has increased regional feedstock costs in Europe and thereby pressured margins in the region. Our EPS estimate for 2018 also rises to $10.50 from $9.95. Of this $0.55 increase, $0.40 comes from a lower than expected tax rate, with the remaining $0.15 the net effect of higher EBITDA estimates and a higher interest expense.
• We rate shares of LYB Hold and increase our price target by $3 to $116. Our revised price target suggests a return of 7%, including a dividend yield of 3.2%. 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 2.5x 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 $119 based on our normalized EPS estimate and a multiple equal to a 30% discount to the sector average multiple.
(Please see full report for details)