2023-09-18 11:54:04 ET
Summary
- Ashland Inc. has experienced a pullback in its share price due to weaker-than-expected earnings results.
- The company's financials suggest potential undervaluation, with a discounted stock price and a secure dividend payout, but my DCF model disproves this.
- Analysts rate Ashland as a "buy" with a potential upside of 23.49%, but caution is advised due to macroeconomic challenges.
- The firm's acquisition strategy may provide future value, especially in a time of high FCF to improve the business to be more resilient during cyclical declines.
Ashland Inc. ( ASH ) has demonstrated long-term growth over the past decade but has recently experienced a pullback on weaker-than-expected earnings results. Although the share price decline looks as if value is present, I believe that Ashland is still a hold due to being overvalued when assuming my DCF figures.
Business Overview
Ashland Inc. is a leading supplier of specialty chemicals and additives with operations in the Life Sciences, Personal Care, Specialty Additives, and Intermediates sectors. Pharmaceutical and nutritional treatments are the main topics of the Life Sciences sector. They provide natural ingredients for personal and home products in the personal care area. Foam control agents and surfactants are just two of the options offered by the specialty additives market segment. The 1,4-butanediol and its derivatives are produced by the Intermediates sector. Their goods are used in a variety of industries, including building, personal care, and pharmaceuticals.
Financials
Ashland is presently valued at $4.27 billion in the market, trading at $83.26, closely tracking its 52-week low of $79.42. The company's GAAP P/E ratio is at 19.18, suggesting that the stock is currently priced at a discounted rate in comparison to others in its industry. This hints at a potential undervaluation, as detailed in the valuation section of this article.
Moreover, the corporation allocates a dividend at a rate of 1.85%, demonstrating a secure payout ratio of 27.31%. This prudent dividend strategy enables the company to reinvest Free Cash Flow back into its fundamental operations, ensuring competitiveness, and concurrently providing shareholders with a satisfactory quarterly income. As the company continues to enhance its dividend and maintain consistent distributions within the context of a cyclical industry, the management of cash flows remains highly conservative. This cautious approach ensures a safety margin for expansion and operations.
Earnings
Ashland's Q3 2023 report revealed weaker performance than anticipated, with an earnings per share shortfall of $0.08 at $1.23 and a revenue miss by $0.55 million at $546 million, indicating a 15.2% decline year-over-year. This earnings shortfall underscores the impact of macroeconomic factors on Ashland's key clientele, grappling with inventory reductions and rising costs of essential materials due to inflationary pressures. In my assessment, although there's not likely to be significant movement in prevailing rates, persistent inflation poses a challenge for Ashland's growth. Moreover, when coupled with a cyclical downturn, it could potentially lead to a further decline in share prices. However, it's worth noting that sustained economic robustness may facilitate a relatively smooth transition from the current stock prices. With solid earnings estimates moving into 2024 and 2025, Ashland may witness a quick rebound if economic conditions stabilize and the firm can execute its strategies effectively.
Earnings Estimates (Seeking Alpha)
Performance Compared to the Broader Market
Over the past decade, Ashland has maintained performance with the S&P 500 when adjusting for dividends. In recent years, share price declines have resulted in underperformance but overall, this comparison demonstrates how the firm effectively invests cash flow in order to foster growth resulting in shareholder value.
Ashland Compared to the S&P 500 10Y (Created by author using Bar Charts)
Analyst Consensus
Over the past 3 months, analysts currently rate Ashland as a "buy" demonstrating potential for a high-growth opportunity. With a 1Y price target of $102.82, Ashland presents a potential 23.49% upside.
Balance Sheet
Ashland's balance sheet also looks solid due to the firm's ability to deleverage in recent years due to macro headwinds, allowing them to be more resilient in the current environment. This is exemplified by debt being reduced and interest coverage improving. Ashland also holds a current ratio of 3.53 and an Altman-Z-Score of 2.43 indicating the firm has adequate liquidity to remain solvent and as a major player in the chemicals industry.
Valuation
Prior to calculating a fair value for Ashland, finding its current Cost of Equity and WACC would be prudent to have a more granular firm value. First off, to find Ashland's Cost of equity, I utilized a risk-free rate of 4.34% which corresponds with the current U.S. 10-year treasury yield . Using this value, I was able to conclude that Ashland's Cost of Equity is 8.56% which represents the return investors would need to compensate risks presented.
Cost of Equity (Created by author using Alpha Spread)
Assuming my Cost of Equity calculation, I was able to calculate the firm's WACC to be 7.49%, which is under the average industry WACC of 9.89% .
WACC Calculation (Created by author using Alpha Spread)
Utilizing the earlier determined 8.56%, I incorporated an additional 1.44% risk premium to accommodate the prevalent macroeconomic challenges and the inherent cyclicality of the chemicals industry, which heightens risk for potential investors. By employing a 10% discount rate within a 5-year Equity Model DCF based on net income, I derived a fair value approximation of $69.17. This suggests an overvaluation of approximately 17%. My revenue and margin assumptions align with existing analyst projections, illustrating an anticipated rapid rebound in 2024 and 2025 as expected.
5Y Equity Model DCF Using Net Income (Created by author using Alpha Spread)
Even though Ashland was previously perceived as overvalued, my sensitivity analysis indicates that excluding the 1.44% risk premium would align its valuation with current market prices. This suggests the potential for a robust investment choice if an investor's comfort level is such that the risk premium isn't deemed necessary. In my view, the margin of safety I incorporated offers ample resilience in the present macroeconomic landscape, characterized by elevated rates and persistent inflation, which in turn makes predicting future decisions by the Federal Reserve and consumer purchasing power somewhat unpredictable.
Strategic Acquisitions Resulting in Compounding Growth
To improve its portfolio, increase its market presence, and strengthen its position as a leading global provider of specialty chemicals, Ashland Inc. uses a targeted acquisition approach. Based on strategic fit with its long-term business goals and development areas, the organization chooses suitable acquisition candidates. They look to buy businesses that provide access to new markets, offer cutting-edge technologies, or complement their current product offerings. In order to achieve a seamless integration process following the acquisition, Ashland also carefully evaluates the target company's financial sustainability and cultural fit.
The acquisition of Pharmachem Laboratories in 2017 by Ashland, a major supplier of ingredients to the international health and wellness industries, serves as an example of this acquisition strategy. By making this acquisition, Ashland increased the scope of its product offerings in fast-growing industries including nutraceuticals and personal care. Ashland was able to better service consumers and expand their market reach because of Pharmachem's unique formulation knowledge and creative solutions. This tactical acquisition highlights Ashland's dedication to enhancing its product lineup and expanding its clientele for long-term success.
From a financial standpoint, this acquisition has played a crucial role in broadening Ashland's cash flow streams. This diversification has, in turn, provided stability to dividend safety and mitigated the cyclicality often seen in the firm's revenues. Consequently, Ashland is now positioned to enhance its cash flows, leading to a more substantial return on investment. This strategic move has not only facilitated entry into high-growth market segments but also bolstered the firm's overall stability. Anticipating a consistent influx of high cash flows, I foresee similar acquisitions in the future. These strategic moves will fortify and expand the business, ensuring resilience in the face of potential downturns.
Risks
Regulatory and Compliance Risks: Ashland is required to adhere to a number of rules, regulations, and standards as it works in a heavily regulated sector. Regulatory, environmental, or compliance requirements changes may result in higher expenses and more difficult operational conditions.
Supply Chain Disruptions: Ashland obtains its basic materials via a lengthy supply chain. Natural catastrophes, geopolitical unrest, trade restrictions, and other unforeseen occurrences can cause supply chain disruptions that have an impact on both production and profitability.
Conclusion
In conclusion, my view on Ashland is to maintain a hold position. Despite the company having a robust core business, a sound balance sheet, and a well-crafted acquisition approach, it appears overvalued based on my DCF analysis. Hence, a reassessment is advisable in the coming months as we gain a clearer understanding of the prevailing macroeconomic landscape.
For further details see:
Ashland Inc.: Slightly Overvalued Even After Recent Pullback