When investors consider why companies such as Albemarle (NYSE:ALB), PPG (NYSE:PPG) and Huntsman (NYSE:HUN) go about the process of remaking themselves, a quick look at Ashland (NYSE:ASH) may offer some explanation. Once largely a refining and marketing company, Ashland has remade itself into a diversified specialty chemicals company. Now the question is whether this transformation can lead a company with perpetually poor free cash flow conversion and returns on capital to better results over the long term.

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Specialty Ingredients Hold Promise
One of the more interesting businesses for Ashland right now is the specialty ingredients segment. It contributed over one-third of the year's revenue at the end of June, and nearly 60% of its operating income. Alongside Dow Chemical (NYSE:DOW), Ashland is a leading producing of cellulose ethers, and also stacks up well with companies like BASF in categories such as solvents and PVP. Recently this business has benefited from tight supplies for guar, a product long used as a thickener in a variety of applications, but most recently also in hydraulic fracking. While the boom in guar isn't likely to last (it's derived from a bean and farmers will plant more), I like the diversification of this business. By producing chemicals used in applications such as toothpaste and controlled-release pharmaceuticals, Ashland gets a good portion of its revenue in this segment from personal care, pharmaceuticals and nutrition manufacturers.

Is the Water Business a Keeper?
Ashland has a reasonably large segment focused on chemicals used in specialized water applications, including paper-making and water treatment. Unfortunately, this business doesn't compare too well to rivals such as Ecolab (NYSE:ECL) and General Electric (NYSE:GE). It's not an especially lucrative operation for the company either - it contributes about 20% of sales, but about 7% of profits. Management is still looking for ways to turn this business around, but I have to wonder if a failure to deliver better results by 2014 or so will see this unit put on the block.

Input Costs Still Matter
One of the big attractions of specialty chemical businesses is that they offer better margins and less cyclicality than bulk commodity chemical businesses. Take the case of Ashland's Valvoline business - customers tend to stick with what they like, and that gives rivals like BP (NYSE:BP) (which owns Castrol) and Royal Dutch Shell (NYSE:RDS.A, RDS.B) (which owns Pennzoil) less incentive to compete on price. Likewise, the company's specialty ingredients business derives a lot of its needs from renewable sources. Nevertheless, the cost of basic inputs like oil still matter. If oil prices start moving back up, Ashland's margin improvement goals may be harder to reach. Likewise, ongoing sluggishness in markets such as construction and consumer staples could very well limit the company's ability to pass through costs.

The Bottom Line
Specialty chemical companies are largely getting multiples in a range of 5 times to 7 times on 2013 EBITDA estimates right now, and I have little problem with Ashland getting a multiple on the high end of that range. Taking an average of current sell-side EBITDA estimates for the year ending September 2013, that results in a target price of just over $90 (or $83 if using the lowest numbers in the range). While that looks relatively attractive in comparison to today's price around $70, it's worth noting that company insiders have been willing to start selling shares above $70 or so.

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

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