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Eastman Chemical Mixes Strong Growth Formula

Posted
6/14/2013 2:10:00 PM
By: Investor's Business Daily
Referenced Stocks:CE;EMN;XOM

When it comes to developing a formula for growth, who better thanEastman Chemical ( EMN ) to come up with the right mix of ingredients?

Through a series of divestitures and acquisitions over the past several years, Eastman has reduced its exposure to cyclical commodity chemical markets and increased its emphasis on the faster-growing, more stable specialty chemicals businesses. The company has also expanded its reach geographically in the Asia Pacific region and other emerging markets.

Its efforts have paid off. Eastman has sparked a favorable reaction on Wall Street as it's shown consistent earnings growth while transforming into more of a specialty chemicals producer.

"Investors usually award a higher valuation to specialty chemicals producers than commodity chemicals producers," said S&P Capital IQ equity analyst Stuart Benway.

The reason: There's more consistency in profits in specialty chemicals, while in a highly cyclical business like commodity chemicals there can be wide swings in profits, he says.

Eastman boasts a strong portfolio of specialty businesses that hold leading positions and provide products that enhance performance in a variety of end markets such as transportation, building and construction, and consumables. They include specialty chemicals, such as an additive that reduces tire wear, materials that prevent auto glass from shattering and a fiber used in manufacturing cigarettes and yarn.

Consistent Growth

The big draw for investors is Eastman's earnings growth, which has been "fairly strong and fairly consistent," says Benway.

Sales and earnings have climbed by at least 25% for three straight quarters. In the most recent first quarter, earnings popped 33% to $1.62 a share. Sales shot up 27% to $2.3 billion.

Despite ongoing economic uncertainty, Eastman's end markets, particularly the transportation and building and construction markets, benefited from continued economic growth in Asia and modest economic growth in the U.S., says a company filing with the SEC.

Operating earnings rose to $393 million from $339 million the prior year. The increase came amid lower raw material and energy costs, which more than offset lower selling prices.

A big lift came from the $4.8 billion acquisition of performance and specialty chemicals producer Solutia in July. Solutia supplies specialty films and additives into the automotive, building and construction, and renewable energy markets.

Solutia brought a lot to the table. It added more than $2 billion in annual sales, says Benway, and expanded Eastman's presence in emerging markets.

The buy accelerated Eastman's growth efforts in Asia Pacific. With Solutia in the mix, Eastman expects to have a compound annual growth rate in Asia Pacific approaching 10% for the next several years.

At the time of the buy, Eastman identified annual cost synergies of roughly $100 million it expected to achieve by 2013.

Eastman also expects to realize tax benefits from Solutia's historical net operating losses and other tax advantages that it expects to contribute to free cash flow of roughly $1.0 billion through 2013.

On the product front, the buy added a handful of specialty businesses to Eastman Chemical's portfolio. Solutia's rubber chemicals used by the tire industry are the firm's most attractive asset, wrote Morningstar analyst Jeffrey Stafford in a report.

"Rubber chemicals look to fit alongside acetate tow as Eastman's most profitable business lines going forward," he said. "In acetate tow, a main component of cigarette filters, Eastman benefits from a low-cost production method using coal as a feedstock. In general, this business is relatively immune to cyclical downturns and should help stabilize earnings over time."

Among Solutia's products for the tire industry is Crystex insoluble sulfur, an additive that slows the wear on tires.

Another Solutia product is Saflex, a material used in commercial glass and auto windshields that limits shattered glass damage.

Eastman has made other acquisitions over the years, including the 2011 purchase of Scandiflex do Brasil S.A. Industrias Quimicas, a maker of plasticizers. Plasticizers are additives that increase the plasticity or fluidity of a material. The buy helped expand Eastman's presence in Latin America and expanded its product portfolio.

It's also divested more than $3 billion in sales from underperforming business lines over the past several years, notes Stafford. That included the 2011 sale of its Performance Polymers PET business, related assets, and technology to DAK Americas.

Eastman is the former supplier of chemicals to the now-defunct camera company Eastman Kodak.

It generates roughly half of sales outside the U.S. and Canada. It's a top player in many of its markets. It's the second-largest acetate tow manufacturer in the world. Competitors in the fibers market for acetate tow include Celanese Corp. ( CE )and Mitsubishi Rayon Co. Ltd.

The company forecasts global growth in demand for filter tow of 1% to 2% annually over the next several years with Asia accounting for more than 50% of the growth, wrote Benway in a report.

Eastman is the world's largest non-phthalate plasticizer manufacturer and the second-largest resin manufacturer. Eastman's major competitors in this segment include large multinational companies such as BASF andExxon Mobil ( XOM ).

Coal Gasification

Stafford says Eastman's coal gasification production technique provides a low-cost base for many of its products.

"Competitors have been reluctant to replicate this process because of high upfront costs," he said.

Meanwhile, Eastman's prospects are bright, despite head winds.

"We expect our leadership positions in key end markets, the diversity of the end markets we serve, and our broad geographic footprint to continue to position us well for strong earnings growth," said CEO Jim Rogers when reporting first-quarter results April 25. "However, global economic uncertainty continues with particular weakness in Europe, and raw material and energy costs remain volatile."

Still with the integration of the Solutia buy on track and continued momentum in its end markets, he maintained his 2013 full-year earnings per share guidance of between $6.30 and $6.40.

Analysts polled by Thomson Reuters see 2013 earnings rising 18% to $6.35 a share. They expect an 11% rise in 2014 and in 2015.

Separately, in May, Mark Costa was named chief executive effective Jan. 1, 2014. Costa, who had been executive vice president, was also named president effective immediately. He replaces Rogers, who will continue to serve in his post as chairman after Costa takes the helm.