The easy days are long over for companies that represent leveraged plays on economic growth. There may still be a feeling of general malaise and disappointment in the economic recovery, but the numbers are what they are and economic activity is strongly up off the bottoms. That represents a problem for Olin Corp (NYSE:OLN), as this chemical manufacturer has enjoyed a solid recovery from the depths of the recession, but now has to find a way to maintain the momentum.
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A Mixed Fourth Quarter
All in all, Olin's performance for the fourth quarter was fairly mixed. Revenue rose about 16% as the company offset lower volume in chloralkali and caustic potash with higher netbacks. The company's operating rate was a disappointing 70%, though, and well below industry averages for the quarter.
Profitability was a mixed bag as well. Adjusted operating income did rise 30% from last year, and the company is certainly getting some benefit from higher caustic soda prices. Still, the company is seeing significantly higher rail freight rates and that's a concern. (For related reading, see Understanding The Income Statement.)
Will Industrial Activity Lift Chemical Demand?
The third-largest caustic soda producer in the country, Olin would certainly like to see more pronounced strength in the U.S. economy. Caustic soda gets a lot of attention as an input in alumina production, but the reality is that alumina is actually a relatively small consumer of the product - sectors like pulp or paper and organic chemicals are actually much larger consumers.
Chlorine is the other byproduct of chloralkali production, and Olin is the largest merchant producer of chlorine ((companies like Dow (NYSE:DOW) actually make more but use more of it internally)). Unfortunately, chlorine prices have been weak as demand for downstream products like polyvinyl chloride (used in a lot of building products) has been soft.
Making matters worse, compared to companies like Dow, Occidental Petroleum (NYSE:OXY) and PPG (NYSE:PPG), Olin has much more reliance on rail shipment of chlorine versus pipeline. That has exposed the company to double-digit rate increases that are weighing on profitability.
Winchester Always a Wildcard
Olin's Winchester ammunition business is doing reasonably well right now. The trouble is that this business is surprisingly variable. Not only are companies like Olin and Alliant Techsystems (NYSE:ATK) looking at lower military ammunition demand as overseas operations wind down, but the consumer market is strangely cyclical.
To wit, there was a spike in demand starting with Obama's election victory as rumors spread that the new administration would somehow curtail gun ownership. With demand apparently so subject to emotion, it's always a bit of a wildcard.
The Bottom Line
Fellow chemical company Westlake (NYSE:WLK) has brought a bit more attention to the sector recently with its hostile bid for Georgia Gulf (NYSE:GGC). Unfortunately, it doesn't change the basic realities of the market - one of the biggest being the extent to which companies like Olin can enforce price increases.
Trading at around six times 2012 estimated EBITDA, Olin shares look fully valued today. While this can be a very good stock to ride out of recessions, once the recovery growth rates start to flag, the stock tends to flatten. With better mid-cycle ideas out there, investors can let this one go by. (For related reading, see A Clear Look At EBITDA.)
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.