DOW - Cabot Corporation Can Grow With America

2023-05-25 07:53:28 ET

Summary

• Cabot Corporation produces products that are essential ingredients to a wide selection in the manufacturing processes of finished goods. Management is sticking to the knitting, and efficiencies are paying off.
• Cabot's growth will be moderate but in promising industries that we expect will underpin increased revenue and stronger earnings.
• The share price at $70 or under is potentially a worthwhile investment for retail value investors with a forecast for shares to move up perhaps 20%, as economies grow.

Building Value

Cabot Corporation (CBT) is a materials company in the commodity chemicals industry. The stock climbed slowly but steadily. Peaks and valleys mark it but CBT is apace with the Dow Jones Industrial Average ( DJI ). In our opinion, Cabot Corp is a potential value opportunity at or below $70.

When we last wrote about Cabot Corp last year, the share price was ~$67 each. The company's recent Q3 '22 earnings report was uplifting at a time of unsettling fears about global and national economic growth. We think the next earnings report will be released around August 6.

The stock has momentum and lots of advocates. The consensus among Wall Street analysts is Cabot Corp is a Strong Buy opportunity. The Seeking Alpha Quant Rating vitally leans toward a Buy assessment. SA rates the stock a Hold giving greater weight to a low valuation Factor Grade. Concomitantly, grades for growth and profitability improved.

Price-to-book TTM and FWD are the only two underlying metrics of 19 comprising the valuation grade that are near-to-failing. 5 other metrics are average; the dividend yield FWD is at 2.28%.

We consider the dividend safe and acceptable; its growth and consistency are noteworthy. The payout ratio is ~26%; the dividend is covered by earnings and cash flows. The next dividend payment date is June 8, '23. We expect the company to maintain the dividend yield close to the industry average yield of 2.4%. The company ranks 16 out of 32 in its industry and 180 out of 377 in its sector.

Company Priorities

The 141 years-old Cabot Corporation sells the chemicals, additives, and materials used to produce industrial and consumer products. Engineered elastomer composites and specialty carbons are in inks, coatings, cables, plastics, adhesives, toners, batteries, and display applications. Its carbons reinforce rubber for tires, hoses, and belts. Cabot acquired 7 companies in the chemicals and machinery sectors; 3 in the last 5 years.

In the SA transcript of the Q2 '23 shareholder call, management highlights "the long-term resilience of the replacement tire market." They are focusing on expanding battery materials sales. Battery materials volume grew 45% in the last quarter. Cabot Corp sells "to nine of the top-ten global battery manufacturers." Management forecasts greater battery materials growth when EV sales fully recover.

Tires/rubber products, batteries, and solar power are the future for Cabot. In April, Cabot Corp announced the purchase of a solar farm next to its carbon black manufacturing facility in Japan. The goal is to reduce its energy consumption and to export and sell solar power to the electric grid. By the way, four types of batteries are used to store solar energy, so this path has revenue-generating implications in addition to cost-cutting advantages:

One of Cabot's 2025 global sustainability goals is to export twice the amount of energy that it imports. To help achieve this goal, Cabot recovers, uses and exports energy from its manufacturing processes to reduce its own emissions as well as reduce the net emissions of nearby businesses and communities and aid in the global transition to a lower carbon future. To further its efforts, Cabot looks to incorporate renewable energy sources into its network.

Q2 '23 Results

The share price topped $83 in early May '23, then tumbled to +$69 per the second quarter results. Some important results were:

• Cabot's Reinforcement Materials segment EBIT in Q2 of $122M million was a 21% increase Y/Y.
• Cash Flows from Operations was $162M from which the company spent $37M on dividends and $16m on the repurchasing of shares.
• Revenue in Q2 '22 was $1.09B but $1.03B in Q2 '23 attributed to the slow global economic recovery, especially in China.
• EPS was $1.69 and $1.33, respectively.

Anticipating a better economic environment into 2023 and 2024, earnings estimates are for 9.75% growth in FY '24 and +8.3% the next fiscal year. We expect FY '23 earnings ending in September will probably be reported flat in the +1% to +1.5% range. NASDAQ.com offers this quarterly earnings forecast:

Right Track

Investors have confidence in Cabot Corporation's management. CBT shares are holding their own apace with the DJI increases. There are not a lot of risks we believe will create severe downward pressure on the share price at this time. Other companies' stocks in similar sectors and the same industry have tumbled. For instance, over the past year, MEOH is -13%, BAK shares fell 49%, and DOW is -23%, so investors need to undertake due diligence.

Short interest for Cabot shares is a mere 1.57% despite the pressures companies in Cabot's industry are facing. The PE stands at 11.22 and FY '23 earnings for the year, SA estimates, will be $6.35. We forecast the average price might hover around $72 for a while.

We forecast an average price target in the high $80s over the next 12 months. We factor in marked improvements forecast for Asia-Pacific's and China's economic growth (where Cabot has significant investments); these economies might grow as much as +6.4%. Growth is also anticipated in the solar and EV industries.

Additionally, we find a strong consensus among analysts forecasting a 21% to 25% price increase. We concur considering Cabot's earnings growth can potentially reach an average annual growth rate of 30% and revenue growth at an average rate of 6.4% per year. Cabot's return on equity is 29%. NASDAQ.com forecasts the Cabot EPS to hit on the high side of estimates at $6.50 in FY '23, $7.35 in FY '24, and $8.25 in FY '25. According to SA, Cabot's 3-year price performance (+104.44%) is among the three top peer performers.

The company reported better than analysts' expected earnings in all 9 of the last 9 quarters. More sell trades were made by insiders and funds in the last year but the numbers are small and reveal no trend. On the other hand, 14 funds owned Cabot stock in Q1 '22, while 22 reportedly own the stock going into Q2 '23.

One analyst calculates the company's return on capital employed by Cabot of 21% is a great return and ~2xs better than the ROCE industry average; the ROCE over the last 5 years for Cabot is 41% expending about the same amount of capital. This demonstrates management's commitment to efficient and effective operations. Cabot's quarterly free cash flow ending March 31, '23 was $135, much better than anytime over the last 9 quarters.

Takeaway

The products Cabot Corporation produces are essential ingredients to a wide selection in the manufacturing processes of finished goods. Management is sticking to the knitting, i.e., their expansions and growth is in areas akin to the core business, as evidenced by the acquisitions, the plucky move into the solar energy field, and their commitment to the EV revolution. We believe investors have confidence in the dividend's safety and hold expectations of future increases.

In the current macro environment, industrial stocks might deserve a cautious Hold assessment. Despite the fearmongering, over the long-term, we urge retail investors to keep in mind the positives about Cabot Corporation when mulling Warren Buffett's closing statement at his annual meeting: "Our investment income is going to be a lot larger this year than last year, and that's built in."

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