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Nicholas Coppola, CFA
May 15, 2019
We recently added Huntsman Corporation (HUN) to portfolios at what we believe to be a bargain price at just ~7.0x next twelve months expected earnings. As a matter of background, Huntsman is a global manufacturer of chemical products. Their products go into seemingly everything, and as a result, their revenues and profits are broadly diversified across industries and geographies. To give you a sense of this diversification, the long list of end-markets Huntsman serves include insulation, energy, fuel additives, industrial applications, intermediate chemicals, construction materials, adhesives, coatings, elastomers, paints, agrochemicals, aerospace, automotive, marine, home furnishings, and household products. To make this a bit more concrete, Huntsman contributes their products to certain types of insulation in buildings, certain parts in the automotive industry (i.e., seats, steering wheels, dashboards), the wood binding in composite wood products, chemicals responsible for the cleaning properties in laundry detergents, materials in running sneakers, additives in crop protection products, adhesives and composites used in aerospace manufacturing, fiberglass reinforced resins used in boat manufacturing and a variety of inputs to the textile industry (i.e., technologies that make dress shirts wrinkle-free or athletic shirts manage moisture). By geography, last year’s sales were ~36% in US & Canada, ~24% in Europe, ~26% in Asia Pacific, and ~14% in rest of world.
Aside from an attractive price and diversified end-markets, Huntsman is expected to benefit from long-term trends including 1) global economic growth, 2) material substitution, and 3) a continued shift to differentiated/downstream products vs. commodity products. In regards to global economic growth, a growing population with greater wealth should consume more of the products Huntsman provides. For example, more residential and commercial construction required to serve a larger population with higher incomes should translate to more insulation, particularly as the world focuses on conserving energy as a result of both economic and environmental considerations. Similarly, a growing global middle class with improved diets should require the agricultural industry to use more crop protection products. This same group of people should also travel more, driving growth in the commercial jetliner manufacturing business. And the list clearly goes on. We also believe there are currently under-appreciated material substitution trends underway. For example, the MDI that Huntsman manufactures is replacing the fiberglass in insulation due to better thermal properties as well as the phenol formaldehyde used as a binder in composite wood products. And in the auto and aerospace industries, there is an increased focus on light-weight solutions to improve fuel efficiency that should lead to growth in Huntsman’s advanced materials business. Importantly, Huntsman has also been transitioning into more differentiated/downstream chemicals which, in our view, bodes well for future results. Note that in delivering differentiated products, Huntsman offers technical solutions tailored to their customers’ needs rather than bulk/commodity chemicals. This should contribute to a wider competitive moat, stronger margins driven by a greater value-add for their customers, and reduced cyclicality with less dependence on global capacity utilization.
As always, we ask ourselves why this opportunity exists. In other words, why is the stock so cheap? First, we recognize that many investors are concerned about the macro-economy, and the commodity portion of their business is facing tough comparisons after an unusually strong performance last year due to spike margins on the heels of industry outages. In regards to the economic cycle, while we are encouraged by the increased focus on differentiated products, this business is still inherently cyclical, just less so, as volumes ramp up and down with the demand for their customers end products, albeit with less volatility in pricing and margins relative to commoditized products. There’s also fear regarding the trade war with China and/or Brexit impacting results. While we share similar concerns, we are also somewhat encouraged that Huntsman has manufacturing facilities all over the world that should help to blunt some of the impact (i.e., polyurethanes sold to the Chinese market that are manufactured locally in China and thus not subject to tariffs). And importantly, with the stock trading at ~7.0x next twelve months consensus earnings, we think there is more risk already baked in than currently justified, especially given our expectations for the longer-term growth trajectory.
And in regards to valuation, peer chemical companies trade at an average of ~9.0x next twelve months expected earnings. In our view, as investors better understand Huntsman’s long-term growth story and the impact of a greater mix of differentiated products, the stock should re-rate to a higher multiple. If Huntsman were to trade in-line with peers at ~9.0x next twelve months earnings, intrinsic value would be closer to ~$26, implying ~33% upside from our purchase price. Turning to our discounted cash flow analysis, our price target moves even higher, and we can make the case for additional upside. As is typical, while we recognize there are a variety of risks to the investment (i.e., a slow-down in global economic growth, trade wars, lower pricing in commodity chemicals, higher raw material costs), we think the risk/reward profile is skewed positively.
We thank you for your continued trust, and please let us know if you have any questions about Huntsman or your larger portfolio.
Nicholas Coppola, CFA
Senior Portfolio Manager