Investopedia's own Stephen Simpson believes
that Olin Corp
), the third-largest chlor alkali (i.e. chlorine, bleach and related products) manufacturer in North America, is fully valued
at current levels. He also suggests that Olin's stock tends to plateau once an economic recovery gains full traction. Translation: It has nowhere to go but down. While I understand his point of view, I believe this 120-year-old company makes an excellent long-term investment. Here are three reasons why. (For related reading, see Stock-Picking Strategies
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In February 2011, Olin acquired PolyOne's
) 50% interest in the Sunbelt chlor alkali partnership in Alabama for $132.3 million plus the assumption of PolyOne's guarantee of the partnership's debt. As a result of the purchase, it nows owns 100% of SunBelt. Why is this significant? Because the purchase price values the partnership at around 4.7 times 2010 EBITDA
. Now I'm no expert on the valuation of chemical businesses, but I'm willing to bet it's higher than 4.7 times earnings before interest, taxes and depreciation. Granted, PolyOne does have a three-year earnout
, which amounted to $4 million in the fourth quarter alone, so the real acquisition cost is likely closer to five times earnings.
As PolyOne CEO Stephen Newlin pointed out at the time of the deal, "For PolyOne, the sale of SunBelt represents another step in our transformation and portfolio repositioning as we intend to use the proceeds to accelerate specialty platform growth." In other words, they weren't interested in driving a hard bargain given they no longer wanted to be in that end of the chemical business. It was a win/win proposition. In 2012, SunBelt should contribute more than $84 million in EBITDA earnings, which represents 28% of the $300 million in EBITDA earnings for the entire company. Prices rise and fall, but deals like this don't come along very often. (To learn more, read A Clear Look At EBITDA.)
This is definitely the elephant in the room. In 2011, its freight cost per ECU (electrochemical unit) increased by 20%. Since 2006, those costs have more than doubled. In response to this, Olin is undertaking several initiatives to combat the freight issue. As Stephen Simpson points out in his article, transporting chlorine by pipeline is less costly. In that vein, it increased production at its Louisiana chlorine plant in 2010 while simultaneously reducing capacity at its Quebec plant to take advantage of the Louisiana plant's access to a pipeline.
In addition, it spent roughly $20 million in 2011 constructing low-salt, high-strength bleach facilities in Alabama, Nevada and New York. It plans to continue spending on those facilities in 2012, increasing its bleach capacity by 50% and reducing its transportation costs. Lastly, in its continuing effort to reduce freight costs, SunBelt has filed a freight rate case against two railroads. The decision might take up to 24 months, so it's definitely not a short-term fix. All it can really do is continue to find ways to chip away at its costs. I don't see it losing its resolve on this issue.
What do chlorine and ammunition have in common? Very little, I would think. However, Winchester has been a beloved part of the Olin family since 1931. While the Winchester business is less cyclical than the chlor alkali products, you still have to wonder why it remains a part of the company. In 2011, it generated a record $572 million in revenue. It's never made more than $68.6 million before taxes, which it did in 2009.
The company continues its restructuring of Winchester, which includes relocating its center fire ammunition manufacturing operations from Illinois to Mississippi. All of this is supposed to make it a more efficient, cost-effective business by 2016. This might seem like heresy to Olin employees, but now might be the perfect time to sell the business. Sturm Ruger (NYSE:RGR) currently trades at around 2.7 times sales. That's three times what Olin sells for. Alliant Techsystems (NYSE:ATK), a leading supplier of small caliber ammunition, sells for 0.42 times sales. The company likely could obtain at least $300 million for the business, probably more. It currently earns less than SunBelt on almost three times the assets. Management has the opportunity to unlock the true value of its chemical business by finding a strategic buyer for Winchester. By 2016, I believe they will.
The Bottom Line
Olin's current enterprise value (EV)
is approximately 6.03 times EBITDA. Dow Chemical
), one of its biggest competitors in the chlor alkali business, has an enterprise value of nearly 8.2 times EBITDA. With a dividend yield of 3.7% and very little downside, it might be fully valued. Then again, it might not. (To learn more about how to value a company, read Fundamental Analysis
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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.