2023-09-10 04:41:35 ET
Summary
- I reiterate a hold rating due to a challenging outlook for FY23, particularly in the US residential market.
- 2Q23 results showed a significant drop in sales, EBITDA, and margins, with weak demand in construction and price pressures in commodity products.
- Valuation concerns arise as Huntsman stock continues to trade at high multiples, with a potential headwind to returns due to mean reversion.
Overview
My recommendation for Huntsman Corp. ( HUN ) stock is a hold rating, as I continue to see FY23 as a challenging year for the business. In particular, I believe HUN's key exposure to the US residential market will be a very tough one given the current macro circumstances. There are also a lot of uncertainties in the Performance Products segment that make it hard to model the earnings trajectories. Lastly, valuation continues to stay at a high premium compared to history, which I believe is not sustainable. Note that I previously assigned a hold rating to HUN, as I anticipate FY23 to be a challenging year for the company.
Recent results & updates
HUN's 2Q23 results were below expectations, confirming that FY23 is continuing to be a difficult year. A 26% drop in sales to $1.6 billion was reported for 2Q23 by the company. EBITDA fell 62% to $156 million, and EBITDA margins fell 910 basis points to 9.8%, while gross margins fell 680 basis points to 15.9%. EBITDA totaled $156 million, which was 3% lower than expected and 5% lower than the mid-point of management guidance. Weak demand in construction and industry, as well as price pressures in commodity products, were the primary causes of the shortfall. HUN still experiences destocking in consumer durables, construction, and general industrial sectors, a trend that has been affecting the company for some time. These challenges are likely to keep impacting the business for the foreseeable future. My analysis and forecast for HUN's 2Q23 two operating segments (collectively 82% of EBITDA) are provided below.
Polyurethanes saw a 10% annual and sequential decline in volume as customers destocked in response to a slowing construction market. This was partially offset by a 3% increase in Europe. About two-thirds of Polyurethanes' business in the Americas is related to the construction industry, with sixty percent of their portfolio focused on residential construction and forty percent on commercial building. The company's composite wood product sales were disappointing in 2Q23, but management anticipates a turnaround in the coming quarters. I'd like to present an alternative view. The future of the US construction industry is bleak, in my opinion. The US Census Bureau chart below is instructive in showing the underlying trend. HUN can easily relate to this because of their extensive involvement in the housing market. I expect the current weakness to persist for the rest of the year as a result of the persistent increase in mortgage rates, which drives up construction costs (along with the tight labor market) and ongoing supply disruption. Given that this segment represents 47% of total EBITDA, I believe the overall impact on HUN's performance is going to be a big one.
Worldconstructionetwork
In 2Q23, sales in the Performance Products division fell by 31%, the third consecutive quarterly decline of more than 30%. Demand for ethyleneamines and maleic anhydride, in particular, fell during the second quarter because of decreased demand in regions. But the fact that the drop in volume was only 2% from the previous period is encouraging. In this case, I believe that sequential volume growth isn't enough to make up for the segment's other flaws. With competitors entering the Amines and Maleic markets aggressively on the basis of price, and demand for these products remaining relatively flat, the future of this market appears to be fraught with uncertainty. The resulting 18% segment margin is significantly below management's long-term target of 20-25%. Some of HUN's growth initiatives (in the electric vehicle and semiconductor industries) also appear to be experiencing execution issues. These initiatives were anticipated to be earnings accretive in FY23, but that timeline has been pushed back to FY24. The combined uncertainty makes it extremely hard to model the earning trajectory of the business in the near-term, in my opinion. This is likely to put a cloud over HUN stock as this segment also represent a major part of the business (35% of total EBITDA)
Valuation and risk
Given the uncertainty of the near-term outlook, modeling the business earnings trajectory is like throwing darts in the dark. In my opinion, looking at HUN historical valuation is the best way to get a sense of valuation. As I mentioned previously, the stock's multiple has fluctuated between 7x and 13x over the past decade, with a 6-month reversion to the mean after each crossing above 10x (with the exception of COVID). Despite the weak FY23 and uncertainty in the near term, the stock continues to trade at extremely high multiples (both 1-year forward and 2-year forward). HUN currently trades at 16x forward PE, which I think is not sustainable. A mean reversion would mean a headwind to return of 40%.
Summary
In conclusion, I maintain a hold rating for HUN based on several key factors:
- Challenging FY23 Outlook: HUN faces a tough year ahead, particularly due to its exposure to the struggling U.S. residential market and uncertainties in the Performance Products segment, making earnings projections difficult.
- Disappointing 2Q23 Results: HUN's recent financial results reflected these challenges, with a significant drop in sales, EBITDA, and margins. Weak demand in construction and price pressures in commodity products have been notable issues.
- Valuation Concerns: Despite the uncertain outlook, HUN's stock continues to trade at high multiples, currently at 16x forward PE. Historical valuation trends suggest a potential headwind to returns due to mean reversion.
For further details see:
Huntsman Corp.: FY23 Continues To Be A Tough Year But Valuation Still Stays High