Tickers in this Article: OMG, DOW, EMN, ALB
Part of what makes commodity-driven stock investments so frustrating is that they so often rise much further than common sense says they should in the good times and likewise fall so far in the tougher times. Right now, OM Group (NYSE:OMG) is seeing tougher conditions in Europe, lingering impacts from the Thai flooding and a market that has soured on commodities in general, due to fears of shrinking growth in Chinese imports. While this stock looks cheap, investors cannot afford to ignore the risks that things will get worse before they get better.

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A Disappointing Fourth Quarter
OM Group didn't help their case with the fourth quarter results. Revenue was up 50%, but that was a byproduct of the VAC acquisition. Organic revenue seems to have dropped about 8%, with advanced materials down 7%, specialty chemicals revenue was down 9%, while battery revenue fell 13%.

Profitability was also nothing too special. Gross margin slid a bid and operating profit was down 37% as reported. Even adding back acquisition-related charges and expenses doesn't really improve the picture all that much, and profits in specialty chemicals fell by almost 50%, with a similar drop in advanced materials. To know more about income statements, read Understanding The Income Statement.

A Perfect Storm, at Least for Early 2012
Right now, OM Group is taking fire on multiple fronts. As companies like General Dynamics (NYSE:GD), Raytheon (NYSE:RTN) and Boeing (NYSE:BA) look at lower defense orders, cobalt prices have been weak. Despite management's attempts to reduce OM Group's reliance on cobalt, that transition takes time.

The company also happened to buy VAC right as Europe started to cool down substantially. Although large European industrials have been relatively positive on the likelihood of an improving European economy later in 2012, VAC's exposure to segments like European automakers and renewable energy is a risk.

Last and not least, there are signs and portents that consumer electronics have bottomed out, but the strong recovery is not yet in place. Making matters worse, it's anybody's guess as to whether the company can start displacing Rohm & Hass ((owned by Dow Chemical (NYSE:DOW)), Solutia ((being acquired by Eastman Chemical (NYSE:EMN)) and Albemarle (NYSE:ALB) are really start making this diversification pay off.

The Bottom Line
OM Group should be in better shape today than it has been in some time. Unfortunately, worries about defense spending and Chinese demand have pressured cobalt prices and the company's diversification efforts haven't really added sustainable value yet. Said differently, the company has spent a lot of shareholders' capital without a lot of show for it.

I do believe it's short-sighted to assume that will always be the case. Admittedly, management needs to prove that it can build value in the acquired businesses, but Dow and Eastman didn't make their respective purchases because this is a terrible market. What's more, while VAC may be too reliant on Europe today, getting into the advanced magnets business makes sense on a long-term basis for OM Group.

For better or worse, even a lower-than-average multiple on OM Group's forward EBITDA suggests that the shares are undervalued. Clearly there is a risk that EBITDA estimates will fall further, but that is the risk that goes hand-in-hand with commodity stock investing. Patient investors may still see value here, but anybody buying OM Group today needs to be ready to see things get worse before they get better. For additional reading, check out 5 Must-Have Metrics For Value Investors.

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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