I have not written on Huntsman (NYSE:HUN ) other than periodic comments, since last year since I published my article of top ideas, Bulletproof Portfolio Part I. The stock has performed well with the group, but arguably with HUN down nearly 20% since its recent high last month, it is so ridiculously cheap that I am compelled to encourage investors to once again, "pick up the free money." Huntsman is a Texas-based chemical manufacturer of unique organic and inorganic chemical products. Huntsman focuses its operations primarily on four segments, which the company characterizes as (1) Polyurethanes, (2) Performance Products, (3) Advanced Materials, and (4) Textile Effects. Huntsman's products are critical in many applications including but not limited to construction, automotive parts, personal care and hygiene, durable and non-durable consumer products, digital inks, electronics, medical, packaging, paints and coatings, power generation, refining, synthetic fiber, textile chemicals, and dye industries.
It is worth noting that chemicals are a critical component in housing and homebuilding, which continues to be a strong area of growth. Moreover, today UBS raised its forecast for the construction market significantly for both 2021 and 2022. While I am typically skeptical of sell-side research, this analyst (in my view) is among the best analysts in the area of construction. The UBS forecast for significantly higher growth in this segment is a clear positive for Huntsman. This increase in forecast alone would have justified a positive reaction in many of the chemical companies, and certainly for Huntsman.
Looking at Huntsman's four primary divisions, we provide a basic explanation for each of them and the end markets below.
Polyurethane - Huntsman is an “MDI-based maker of polyurethanes” (MDI stands for Methylene diphenyl diisocyanate), which is a versatile molecule that has an impact on the performance properties of the various products they make. This includes things such as foam insulation for appliances and in construction. It is also key as a binder for composite wood products and for making components such as sealants and adhesives for wood flooring laminates. Huntsman products target applications such as energy-saving insulation (think Green-friendly building products), lightweight components for performance materials utilized in auto manufacturing, the comfort foam found in bedding and other furniture pieces as well as protective coatings, adhesives, and elastomers for end markets such as footwear.
Performance Products - Think of these as chemicals needed for everyday items. The main product categories in this division are used to make products such as coatings & adhesives, fuels & lubricants, and in end-market products for construction, the treatment of energy and gas, and for epoxy curing (this is a chemical reaction that transforms liquid ingredients to a solid).
Advanced Materials - This division can be summed up as a specialty epoxy, acrylic, and polyurethane-based polymer resin systems and adhesive products in some revolutionary and innovative components replacing traditional materials in planes, autos, and for electrical power transmission. The products in this division are versatile with broad applications and can be used in coatings for numerous industries, construction materials, circuit boards, and numerous sports equipment applications.
Textile Effects - This division is in high demand for a variety of end markets. Clothing manufacturers such as Ralph Lauren use Huntsman Textile Effects to incorporate desirable characteristics in many of their clothing lines. (Ralph Lauren Working To Change How the Fashion Industry Dyes Cotton.) This product line includes water-saving and eco-friendly textile dyes and textile chemicals for the textile industry that enhance color and improve fabric performance. Examples of fabric improvement performance would be advertised clothing characteristics such as wrinkle resistance, fast-drying properties and repelling water/liquids, and preventing stains in clothing, but also in home and other technical textile applications.
Aside from the company operations, management has been consistent in streamlining the business units and executing well on improving an already solid balance sheet, paying down debt, increasing the dividend, and buying back stock. The dividend is up to $0.75 generating nearly a 3% dividend yield. And Huntsman management has been opportunistic in divesting units less valuable and acquiring synergistic companies that will help accelerate growth at HUN, and should receive a higher valuation. By divesting their upstream chemical intermediates and surfactants businesses for ~$2 billion last year, (Huntsman Completes $2 Billion Sale.) Huntsman strengthened their balance sheet and made incremental investments in its downstream businesses. In acquiring Icynene-Lapolla last year, Huntsman picked up an important "open-cell technology" in North American making SPF (spray polyurethane foam) insulation expanding their existing business. (Huntsman completes acquisition of Icynene-Lapolla).
The end markets are growing rapidly, and chemicals are essential to the global economy and certainly in the USA. As investors try to find a way to assuage their fears of inflation, new strains of COVID and other frightening headlines, they would be prudent to remember that chemical companies are excellent inflation plays. And HUN is about as cheap as it is likely to be near-term, and at current levels, it is very attractive TAKE-OUT BAIT. I suspect investment bankers and private equity players are doing the analysis and likely to conclude that HUN is a no-brainer at these levels (assuming it remains around here for a while).
For HUN, my Price Target is $64 which is an 8% normalized yield. If we use 5% then obviously one can ascribe a much higher price target. Investors should note that with HUN, in addition to good management, compelling end markets, and increasing earnings estimates, we also have high takeout optionality. Both strategic, as well as private equity players, are trying to buy Polyurethane companies. Apollo recently attempted to buy HUN competitor Covestro but was rejected as the board felt the offer did not sufficiently reflect the potential upside in the market. Apollo Weighs Deal for $10 Billion Plastics Firm Covestro. LyondellBasell (LYB) has made it clear that they are interested in polyurethane acquisitions. HUN is likely on the shortlist for any number of larger companies and private equity shops.
1. Adjusted for the acquisition Trinseo recently made, we calculate that TSE will generate $13 in free cash per share. Their business is now much more specialized so comps would indicate 15x multiple = $195 per share.
2. They have the best plastic recycled technology which gives the big guys yet another reason to acquire TSE, above and beyond the 65% discount to fair value.
3. Business is reaccelerating now that the supply chain bottlenecks are easing.
4. Estimates will move significantly higher this quarter as the company incorporates the acquired company in its new guidance.
While I still would encourage investors to buy chemical names such as OLN and Lanxess, TSE and HUN are at the top of my BUY NOW list for anyone with cash to allocate for maximum upside return. DOW is large, liquid, dirt cheap, and blue-chip, but the inefficiencies and poor analysis with the smaller companies are simply amazing and cause bigger dislocations - in some cases simply based on liquidity.
The chemical analysts and many within the investment community have simply been 100% wrong about TSE (and many value names), and have been proven to have excellent rearview vision, but with no insight into the likely future scenario of TSE performance. I will highlight the subpar analysis in the Goldman Sachs research note today on DOW but will remind investors of the dreadful analysis proffered by the sell-side in general on Trinseo. It would be easy to point to subpar analyses from brokerage firms on TSE as collectively they have recommended avoiding Trinseo at the troughs and typically capitulated to buy ratings at cyclical highs. But to highlight the point, recall the Morgan Stanley vocal SELL (short) call on TSE when the stock was in the teens and Morgan Stanley had a $10 price target. Debunking the short thesis in Trinseo. It is not my intention to be pejorative or hyper-critical, but rather to emphasize that when skeptics say "but this great firm has the opposite opinion" perhaps investors should not presume that a view on a stock from a high profile brokerage firm is the likely correct perspective.
We can point to a range of numbers and assumptions to establish a fair price objective suggesting a valuation for TSE at $150 on the very low-end and well over $200 that I could argue might even be conservative. The point is, the numbers are going to continue to go much higher, and for many quarters, possibly for multiple years. I believe either the stock will catch up or the company will likely be acquired. Dislocations of this magnitude seldom remain for prolonged periods. There is so much poor analysis in this sector and on TSE in general, but there are ample smart VCs and M&A professionals that ultimately, with TSE in the low-mid $60s, the valuation is absurdly cheap and cannot last. Situations like this simply are not sustainable. Buckle up; we are moving higher.
Dow just guided up materially again two weeks ago – at the Annual Bernstein Strategic Decisions Conference. This is great news for DOW shareholders. So over the last couple of months estimates for EBITDA have gone from $6.5 billion to $10 billion and we believe going much higher. We calculate that DOW's EBITDA will move to at least $14 billion. DOW stock still has substantial upside. Couple that with a ~4.5% dividend while you wait for investors to figure it out. And buybacks will now accelerate. This a safe, liquid blue-chip name with excellent upside.
My Price Target for DOW is $125 based on an 8% normalized cash yield. This is very conservative as a normalized yield should be closer to 5% which would put my price target closer to $200 per share. The bonds are yielding 4% and they have no upside. For a large and liquid quality name such as DOW? Investors should be loading up on this stock.
When people ask how such disconnects and great opportunities can exist in large and liquid public markets, one can only conclude that there is an abundance of inadequate analysis put forth from influential brokerage firms that truly might cause one to question the hiring and management processes at some of the big firms.
Bob Koort from Goldman Sachs, who in my perspective ranks among the less insightful chemical analysts on the street published a research note that still, somehow is surprising to me. The Goldman Sachs note published today (June 16, 2021) was a clearly bearish research piece on DOW. The reader should evaluate, what I believe, is the key quote from the report.
“The meaningful valuation multiple compression over the last few months suggests the risk/reward is becoming less attractive…..”
Wall Street analysts are supposed to assist investors to make decisions by providing insight and piecing together pieces of the puzzle, assessing valuation, and coming to a well-reasoned conclusion. But illogical phrases such as asserting that as the valuation has fallen, the stocks are becoming less attractive don't seem right. Where is the rationale? Where is the insight? How does this make any sense?
In addition to publishing such a generic bearish report with little analysis or insight, let’s objectively review what I see as some obvious key flaws in his report so that those investors inclined to follow big firm ratings and recommendations can fully consider what I consider to be concerning about such published research:
The Goldman Sachs report on DOW, in addition to being poorly reasoned and illogical, allocates zero report analysis on the other half of Dow's business that is NOT ethylene/polyethylene. This half of the business will accelerate (particularly silicones, siloxanes, coatings, and polyurethanes) substantially. So even if the half of DOW's business that Goldman Sachs writes about were to have a short-term blip, the rest of the business will more than offset it. I challenge readers to identify another large-cap stock with a ~4.5% dividend yield and 18% free cash flow yield at below-average earnings.
When investors ask themselves what could go wrong with these stock ideas, a few possible risks might seem obvious. If inflation (and interest rates) head much higher, this would likely be devastating to the overall economy, and the stock market, and while value names are likely to outperform, it is possible that we could see a rerating across the board, and selling prompting more selling, and with ETFs, program trading, etc., we could see all equities reset lower. Another potential risk could be poor management execution. With lengthy track records and industry expertise, it would seem unlikely, but executives at times make poor decisions, and even with strong boards of directors presumably available to push against executive misperformance, it can happen regardless. Lastly, if both the investor community and analysts following the space fail to recognize the value, the names could languish. In a free market, we think this is unlikely and unsustainable for a lengthy period of time, but to quote Keynes, "markets can remain irrational longer than you can remain solvent." Without elements of risk, we could not have the abnormal return opportunity we believe exists. We consider the risks to be low and that the risks have been appropriately calibrated, but we live in a volatile rapidly-changing world, and black swan events such as a pandemic are challenging if not impossible to forecast. The good news is - with economically essential products, accelerating demand, fundamentally cheap underlying values, it seems likely that if these names perform poorly, the entire market has likely reset, and already cheap and compelling values might become cheaper.
For such a prolonged period, Wall Street has had a deflationary cycle and been content to pile into growth and ignore value names. People simply are not willing to embrace a change in the paradigm. The recent cries from Wall Street have been, "inflation has peaked" so as it eases back, buy growth as interest rates and inflation will remain low. Selling of cyclical names has intensified in recent weeks. As the inflation data was stronger than expected last week, investors took that as their cue to buy growth and sell value, as they wanted to believe inflation had peaked. As I write this note, Powell is speaking at the FOMC meeting and has a more hawkish stance than perhaps investors were expecting, and will likely taper sooner. While wanting to keep the markets calm, it is clear inflation is here and is becoming a concern. As the 10-year moves up, I expect growth and the names within technology that have big valuations with no profits to be crushed, and investors to rotate into value names. Chemical stocks should be at the top of the list.
I would encourage investors to load up on TSE and HUN, and then DOW, OLN and Lanxess. Back-tracking to the typically weak calls and analysis from the sell-side, I should highlight that a perma-bear analyst at UBS finally capitulated and upgraded OLN this week. Kudos - and better late than never. While missing the first 5-fold move, OLN still has a long way to go and it makes sense to get on board. And it is refreshing to see UBS finally figure it out and climb on board rather than digging their heels in further. He will look less silly when OLN moves towards $100. The rest of the Wall Street chemical analysts who remain in the bear camp would do well to simply offer their clients a "mea cupla" and move to the bullish chemical cycle camp rather than waiting another year or two and capitulating at the top, as has frequently been the case historically. In addition to the chemical names, investors should own WestRock (WRK), Capri (CPRI), Sabre (SABR), Resideo Technologies (REZI), and other good value names. We will save the rest for another note.
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Disclosure: I am/we are long HUN, TSE, DOW, OLN, LNXSF, CPRI, REZI, SABR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.