Anyone who follows the electric car saga is likely familiar with lithium, the chemical compound used to make rechargeable batteries, for cars or otherwise. Two companies control the production of lithium in the Untied States: FMC (NYSE:FMC) and Rockwood Holdings (NYSE:ROC).
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Rockwood was 75%-owned by KKR (NYSE:KKR) until 2005, when it took the company public at $20 a share. Most of the $400 million raised in the IPO went to repay funds borrowed by KKR to buy Rockwood in the first place. Recently, KKR recently sold half of its 16 million remaining shares for $53.77 each. Since buying the company in 2000, it has invested approximately $561.7 million of its own capital into Rockwood and in return, generated $738 million in realized profits and another $400 million in unrealized gains for an average annual return of 11%. The S&P 500 over the last decade was flat.
There's no question KKR knows how to make money. But is Rockwood a good bet right now? Look closely and you'll see that PolyOne (NYSE:POL), a company of similar size, is actually the better stock to own. (To learn more, read Steady Growth Stocks Win The Race.)
Revenues and Profits
Rockwood's the bigger of the two with $3.2 billion in revenue in 2010 compared to $2.6 billion for PolyOne. In terms of operating profits, Rockwood's are $358 million, slightly more than double PolyOne. Clearly, Rockwood has the better income statement so why is PolyOne the better stock? In one simple word: value.
Successful investors want to buy good assets at reasonable prices. Rockwood's current P/E is 16.8; double PolyOne's at 8.5, calculated using the earnings per share figure from both fiscal year-ends. Using the trailing twelve-month EPS, Rockwood's P/E drops to 10.7 versus 5.5 for PolyOne.
Rockwood shareholders will probably argue that its future is much brighter given the potential demand for lithium and its other products, and therefore deserves a multiple premium. This might be true but I'm not in the game of conjecture. If you are just interested in cold, hard facts, KKR will likely unload its remaining shares while the share price sits near an all-time high. The fact that it sold eight million shares in May at just under $54 tells me it KKR doesn't believe it has another leg up in the near-term. (To read more, check out Revenue Projections Show Profit Potential.)
Like many private equity-run businesses, financing is a key ingredient at Rockwood Holdings with $1.6 billion in net debt compared to $21 million for PolyOne. It will take Rockwood management almost five years (based on 2010 operating income) to repay its entire debt burden compared to less than two months for PolyOne. When push comes to shove, PolyOne gets a much better return on its invested capital than Rockwood does and lithium or no lithium, until Rockwood substantially reduces its overall debt, PolyOne is always going to make better use of its capital. (For more information, check out Will Corporate Debt Drag Your Stock Down?)
PolyOne and Peers
|Rockwood Holdings (NYSE:ROC)||1.81||1.19||8.26|
|Arch Chemicals (NYSE:ARJ)||2.15||0.66||8.01|
Out of four peers, including Rockwood, only Ferro's valuation is lower. Ferro's stock dropped over 15% on the announcement of a good first quarter. If the economy continues to improve, expect more good things from the manufacturer of performance coatings.
As for PolyOne, its first quarter got an extra lift from the sale of its 50% Sun Belt joint venture for a $128.2 million gain. Excluding this sale, its earnings per share grew 67% year-over-year to $0.30. Most importantly, all four of its operating segments achieved double-digit increases in both revenues and operating income. Business is going so well it also initiated a dividend in the first quarter, its first since 2002, and repurchased one million of its shares at an average cost of $13.64. Management expects to use much of the cash from the Sun Belt divestiture for future tuck-in acquisitions and operating capital so a surprise special dividend seems unlikely.
Its stock price is currently only 3.2 times cash per share; compared to 19 times for Rockwood Holdings. If you back out PolyOne's cash and forget about any acquisitions, it has a forward P/E of just 3.6. It's very tempting indeed. (For more, see Peer Comparison Uncovers Undervalued Stocks.)
The Bottom Line
KKR might have made out like bandits on the Rockwood Holdings deal but that doesn't mean you will too. Forget about the producer of lithium and go for the lower margin, conservatively financed alternative in PolyOne. You'll be glad you did. (To help you invest, check out Value Investing + Relative Strength = Higher Returns.)
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