Free Annual Reports
Troubled Waters in Georgia Gulf (GGC)
As an investor, I've always been attracted to messy situations, for they often present profitable investing opportunities.
Not surprisingly, then, I find myself attracted to Georgia Gulf Corp. (NYSE: GGC), an integrated manufacturer of chemicals and aromatics.
To be sure, Georgia Gulf is in a messy situation. Especially if you are a long-term shareholder, the company must seem like an absolute disaster.
Over the past two years, Georgia Gulf's share price has tumbled from $50 to $17 and change.
One noteworthy reason for the stock drop is a general lethargy in Georgia Gulf's businesses.
The chemical business is diverse, though it can be bifurcated into two principal segments: commodity and specialty.
Georgia Gulf receives 70% of its revenue from the former, which services cyclical industries such as automotive, housing, packaging, textile, and steel. Needless to say, it's tough to make money when most of your customers aren't.
The other 30% of Georgia Gulf's revenue is generated from aromatics -- cumene, phenol and acetone. The segment has posed challenges because of costs incurred to ramp up a 2006 increase in domestic and Asian capacity.
The October 2006 purchase of Canada's Royal Group Technologies -- a major producer of vinyl building and construction products -- has posed additional challenges. The acquisition set Georgia Gulf back $1.56 billion, including assumption of debt.
Moreover, it sullied Georgia Gulf's formerly pristine balance sheet by pushing long-term debt up to $1.2 billion and the debt-to-equity ratio to 80%, prompting Moody's (NYSE: MCO) to place Georgia Gulf under review for a possible downgrade.
That said, the growing pains associated with the Royal Group purchase should prove temporary. On the revenue side, the acquisition immediately doubles Georgia Gulf's sales to about $3.5 billion annually. Further down the income statement, Georgia Gulf expects to achieve $64 million in profit improvements.
Longer term, the Royal acquisition makes Georgia Gulf a more integrated vinyl company, which should help reduce its exposure to wide swings in resin margins. And while Royal Group increases Georgia Gulf's exposure to the construction industry, more than half of Royal's sales are related to maintenance applications, not new construction.
A few months ago there were some murmurings about a possible buyout of Georgia Gulf by Dow Chemical (NYSE: DOW), but nothing came of it. Similar chattering had been made concerning BASF (NYSE: BF) and Huntsman (NYSE: HUN), but to no avail.
At currently depressed prices, Georgia Gulf could reasonably be expected to generate a few sniffs from other chemical or private-equity firms looking to buy a decent company on the cheap.
And cheap, Georgia Gulf is. A low-range average P/E ratio of 12.5 applied to an estimated 2007 EPS of $2.00 produces a current value of $25 a share. Almost the same value is achieved using a dividend discount calculation based on a consistent 3% annual EPS growth (roughly the inflation rate) into perpetuity and an 11% discount rate.
A more interesting (and more favorable) value is achieved using operating cash flow per share instead of EPS. Georgia Gulf has historically produced twice the cash flow per share than EPS. Based on the aforementioned parameters and beginning cash flow per share of $4.00, I arrive at a share value of $51.
Not surprisingly, then, I find myself attracted to Georgia Gulf Corp. (NYSE: GGC), an integrated manufacturer of chemicals and aromatics.
To be sure, Georgia Gulf is in a messy situation. Especially if you are a long-term shareholder, the company must seem like an absolute disaster.
Over the past two years, Georgia Gulf's share price has tumbled from $50 to $17 and change.
One noteworthy reason for the stock drop is a general lethargy in Georgia Gulf's businesses.
The chemical business is diverse, though it can be bifurcated into two principal segments: commodity and specialty.
Georgia Gulf receives 70% of its revenue from the former, which services cyclical industries such as automotive, housing, packaging, textile, and steel. Needless to say, it's tough to make money when most of your customers aren't.
The other 30% of Georgia Gulf's revenue is generated from aromatics -- cumene, phenol and acetone. The segment has posed challenges because of costs incurred to ramp up a 2006 increase in domestic and Asian capacity.
Moreover, it sullied Georgia Gulf's formerly pristine balance sheet by pushing long-term debt up to $1.2 billion and the debt-to-equity ratio to 80%, prompting Moody's (NYSE: MCO) to place Georgia Gulf under review for a possible downgrade.
That said, the growing pains associated with the Royal Group purchase should prove temporary. On the revenue side, the acquisition immediately doubles Georgia Gulf's sales to about $3.5 billion annually. Further down the income statement, Georgia Gulf expects to achieve $64 million in profit improvements.
Longer term, the Royal acquisition makes Georgia Gulf a more integrated vinyl company, which should help reduce its exposure to wide swings in resin margins. And while Royal Group increases Georgia Gulf's exposure to the construction industry, more than half of Royal's sales are related to maintenance applications, not new construction.
A few months ago there were some murmurings about a possible buyout of Georgia Gulf by Dow Chemical (NYSE: DOW), but nothing came of it. Similar chattering had been made concerning BASF (NYSE: BF) and Huntsman (NYSE: HUN), but to no avail.
At currently depressed prices, Georgia Gulf could reasonably be expected to generate a few sniffs from other chemical or private-equity firms looking to buy a decent company on the cheap.
And cheap, Georgia Gulf is. A low-range average P/E ratio of 12.5 applied to an estimated 2007 EPS of $2.00 produces a current value of $25 a share. Almost the same value is achieved using a dividend discount calculation based on a consistent 3% annual EPS growth (roughly the inflation rate) into perpetuity and an 11% discount rate.
A more interesting (and more favorable) value is achieved using operating cash flow per share instead of EPS. Georgia Gulf has historically produced twice the cash flow per share than EPS. Based on the aforementioned parameters and beginning cash flow per share of $4.00, I arrive at a share value of $51.
by
Stephen Brown
Stephen P. Brown is a Chartered Financial Analyst, former equity analyst, investor, and freelance financial writer living in Brighton, Colorado. His work has been published in Barron's, CFA Magazine, Wealth Manager Magazine and The Denver Post.
Free Annual Reports
