ASH - Ashland Stock: A Tougher 2023

2023-06-23 09:43:30 ET

Summary

• Ashland Inc. has seen a softer start to 2023.
• The company's performance has been rather stable in the first half of the year, while growth was anticipated.
• Investors have priced in these setbacks, with valuations coming down amidst lower expectations.
• With the long-term thesis intact, I am attracted to the pullback, looking to initiate an Ashland position if shares fall to the seventies.

In February, I looked at Ashland Inc. ( ASH ) , concluding that the company and its shares have risen from the ashes. This came after the company had undergone a great transformation in recent years, having moved from a cyclical and leveraged business to a simpler and higher-margin business.

While this transformation was much liked, these achievements were priced in, resulting in few triggers on the immediate horizon for ASH stock.

A Recap

Ashland hit my radar in 2016 when it floated a minority stake in Valvoline through an IPO on the back of activist pressure. Its shares traded around $118 per share at the time, with 62 million shares being granted a $7.3 billion equity valuation, although this excluded a large $4.6 billion net debt load.

The divestment of shares in Valvoline would reduce both debt and earnings power. Post this divestment, the company generated $3.7 billion in sales from specialty ingredients, with earnings reported at $1.79 per share (post a two-for-one split) as net debt was down to $2.2 billion. The company furthermore sold the composite business in a $1.1 billion deal to Ineos, causing sales to fall to $2.3 billion in 2020.

Amidst lower leverage and higher margins, the company posted earnings of $3.90 per share (again post the split). After announcing a bolt-on purchase in 2021, the company announced another large divestment, this time selling its performance adhesives business in a $1.65 billion deal to Arkema. Despite this sale, the company still posted sales of $2.1 billion in 2021, reporting earnings of $3.75 per share in the process.

Following this transition, the shares of the company have recovered to the $100 mark as investors have priced in positive developments. In November of last year, the company posted 2022 sales of $2.4 billion with earnings from continuing operations coming in at $3.20 per share, and adjusted earnings reported at $4.37 per share. Net debt of $600 million was largely similar to the adjusted EBITDA number, although that leverage excluded nearly half a billion in asbestos liabilities.

Moreover, the company guided for further advancements in 2023, with sales seen up to $2.5-$2.7 billion, and EBITDA up to $600-$650 million, up from $590 million in 2022. The $35 million incremental improvement in adjusted EBITDA (at the midpoint of the guidance) should work down to a $4.50-$5.00 per share number.

In February the company posted a mere 3% increase in first quarter sales to $525 million as an earnings number of $0.97 per share felt a bit soft, as the company saw risk to the full year guidance, with net debt ticking up to $800 million.

With the heavy lifting being done and the transformation being priced in, I thought that the resulting 20-22 times earnings multiple looked fair midst leverage coming in just above reported EBITDA, leaving few triggers to get upbeat especially after a softer first quarter.

Expectations Cool Down

Since I looked at Ashland Inc. shares in February, then still trading at $102, shares have come down quite a bit, now trading near their lows at $83 per share. Shares plunged early in May as the company released soft second quarter results with revenues of $603 million coming in a million dollar below the second quarter of last year.

Flattish sales in an inflationary environment resulted in some gross margin pressure with reported operating profits down from $100 million this quarter of last year to $83 million this quarter. Amidst some other income, the company posted an $1.67 per share number, but this was a bit inflated thanks to some one-time benefits. Adjusted earnings of $78 million came in at$1.43 per share, down seven cents on the year before.

Diving into the numbers: the company has seen a strong quarter from a sales and earnings perspective in the life science segment, offset by weakness in all other segments being personal care, special additives and intermediates. Lower sales and earnings meant that net debt ticked up to $929 million, in part due to continued share buybacks as well, with a $200 million program completed in the first quarter.

Amidst the softer results, the company cut the full year sales guidance to $2.3-$2.4 billion, a $250 million cutback in the full year guidance at the midpoint of the range. Adjusted EBITDA is now seen between $580-$610 million, a massive cutback from the initial guidance at a midpoint of $625 million, but largely consistent with the 2022 performance.

What Now?

The roughly $30 million setback in the adjusted EBITDA metric cuts pre-tax earnings by around half a dollar, but Ashland shares have seen a bit more of a pullback since February, down about 20%. This creates relative appeal, although the prospects of no earnings growth and temporary higher leverage are not the most exciting here, despite a current 1.6 times leverage ratio being rather modest.

To please investors and provide some share price support, Ashland hiked its dividend by nearly 15% to $0.385 per share on a quarterly basis, now supporting a 1.8% dividend yield. In the meantime the company reloaded on its $100 million buyback program in May as well.

While I am not too pleased with the Ashland Inc. operating performance in the most recent quarters, the valuation setback makes the investment thesis a bit more compelling here as well. That is not to be confused with the observation that shares are a screaming buy at these levels, but if Ashland shares dip into the $70s I will be looking to start initiating a position, with an intention to average down on dips.

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