Relative performance can be a tricky metric to use when assessing whether a particular company's stock is getting its due in the market; significant factors like debt, margins and management's competence all make a difference. Nevertheless, the valuation on Huntsman (NYSE:HUN) puzzles me a bit, especially in relation to other chemical companies such as Albemarle (NYSE:ALB), Ashland (NSYE:ASH), Dow (NYSE:DOW) and BASF (OTC:BASFY). Although Huntsman has not fully executed a transition to a specialty chemicals company and there is a lot of debt here, this could be an interesting name to watch.
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Straddling Commodity and Specialty
The differences and distinctions between a commodity and specialty chemicals can be pretty subjective. That said, I think it's fair to say that Huntsman is a company still in transition between the two. In MDI foam, for instance, the company enjoys low production costs and has managed to couple somewhat commoditized applications like insulation with higher-value products for customers like Nike (NYSE:NKE) and BMW.
Likewise, while Huntsman enjoys good share in markets like polyetheramines, carbonates, and morpholine (where companies like BASF and Dow also have a presence), and these products are important in a host of consumer and industrial products, there's still a commodity aspect to the businesses. That said, Huntsman has been active over the past years in existing commodity businesses and steering itself into differentiated markets where success is not just about whomever can produce at the lowest cost.
SEE: Taking A Closer Look At Chemical Companies
Trends Still Favor Composites
One of the clear trends in the chemical industry over the past few decades has been substitution. Anybody familiar with old cars will notice how much heavier they used to be. Over time, automakers switched to lighter, stronger steel alloys, aluminum and plastics to shed weight, lower costs and improve performance. Then, in the 1990s, specialty chemical companies like Hexcel (NYSE:HXL) and Cytec (NYSE:CYT) saw carbon fiber catch on in applications like aerospace.
Now Huntsman is in place to benefit from this ongoing trend towards substituting metals with resins, epoxies and various other composites. Take the case of Boeing (NYSE:BA) - the 787 Dreamliner is just 45% metal (20% aluminum, 15% titanium, and 10% steel), but 50% composites. This isn't exclusive to Boeing, and I believe Huntsman has long-term opportunities here as aerospace, automobile and commercial vehicle OEMs continue to find better trade-offs on weight, performance and cost.
No Smooth Sailing Yet
There's always going to be a general risk that large rivals like BASF or Dow fight for market share with price, but Huntsman's move into more differentiated products should reduce that risk. In the near-term, I'd be more concerned about debt, titanium dioxide, overseas markets and overall investor confidence. Huntsman carries a pretty hefty load, about 2.3 times trailing EBITDA. Because of the debt, Huntsman spends more than 2% of its revenue on interest payments; 2% doesn't sound like a lot, but we're not taking about a company with huge operating margins.
While debt is a known risk, the state of the titanium dioxide business and key overseas markets are less certain. Titanium dioxide is a large part of Huntsman's pigments business, and cautious statements from other players like Tronox (NYSE:TROX) have investors worried that this business will start weighing on results in 2013. Huntsman also has sizable overseas exposure, with both Europe and China representing significant percentages of sales. Although Huntsman has said the China business isn't doing badly (the MDI facilities are running all-out, for instance), there's still a risk of the economy slowing further.
The Bottom Line
Huntsman is not Albemarle or DuPont (NYSE:DD) and shouldn't be valued as a peer. Nevertheless, I do think the company is not getting much benefit of the doubt right now. While Huntsman has historically traded at an EV/EBITDA multiple around 8.5 times, the current multiple (5.3 times) is well below that. What's more, while this may not be a banner time for chemical stocks, most of Huntsman's comparables are trading in a range of six to eight times trailing EBITDA. If you agree that Huntsman's exposures to China and Southern Europe, high debt load, and mixture of commodity and specialty businesses merit a significant valuation discount, I suppose the shares are more or less fairly valued today. If you have more confidence in the company's long-term plan, however, and believe the global economy will avoid another nasty recession, these shares might just be a bargain today.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.