2023-08-28 17:00:55 ET
Summary
- Huntsman Corporation faces a lack of demand across all geographies, leading to uncertainty.
- The commercial construction market may take years to recover, particularly in cities like San Francisco, and China is not keen on providing stimulus to boost its economy.
- The company's revenue and margins have declined, and it is facing intense competition, putting pressure on profitability.
- The stock offers a good dividend with much growth potential.
- The stock looks overvalued. Investors may look to buy on weakness and closer to its historical valuation.
Huntsman Corporation ( HUN ) has had a rollercoaster ride over the past few years. It saw its revenue and profits soar in 2022, only to vanish within a few quarters. The company’s near-term future remains uncertain, with a lack of demand across all geographies. Given these prospects, the company trades at a premium to its historical average and peers. The stock offers an excellent dividend, which is safe for now. Investors may want to wait for a much lower valuation before buying this cyclical materials company, however.
Demand has vanished
The company operates under three segments : Polyurethanes, Performance Products, and Advanced Materials. The company mentioned that it sees inventory destocking nearing a bottom, especially in the new home construction market. This market is served by its Polyurethane segments and creates building insulation and construction. The company is beginning to see demand follow more seasonal trends. However, the company noted the commercial construction market may take a while to recover.
Given the state of cities like San Francisco, the commercial construction market may take years to recover. Downtown San Francisco has a vacancy rate of 31% with no signs of a quick recovery. The overall U.S. office vacancy rate hit a 30-year high of 18.2% in Q2 2023. Although, according to CBRE , it is not indicative of the overall health of the performance of most buildings. Either way, there is no rush to build new commercial buildings in the U.S. The Chinese economy is dismal, and the government has been reluctant to spur growth with stimulus spending. The automotive sector, beginning to come off of semiconductor shortages, is probably heading towards a labor strike, which could bring production to a standstill. United Auto Workers union members recently authorized its leaders to have the option to call for strikes during ongoing contract negotiations.
Huntsman Corporation saw y/y double-digit revenue growth in 2021, but the demand is faltering, and the company is giving back all its growth with y/y double-digit declines in revenue (Exhibit 1) . The company’s gross margins have dropped from 23.4% achieved in March 2022 to 15.9% during the June quarter. The operating margins have dropped considerably to low single-digits. The company pointed to aggressive pricing by competitors as another factor impacting its revenue and margins. The company suffered from lower y/y sales volumes in all three segments. Lower selling prices also affected its poor performance in its Polyurethanes and Performance Products segments. The Advanced Materials segments, which serve aerospace, electric vehicles, and consumer electronics, among other markets, benefitted from higher prices.
Exhibit 1:
Huntsman Corporation Quarterly Revenue and Margins (%) (Seeking Alpha, Author Compilation)
Given this business backdrop, revenue may continue under pressure in the rest of 2023 and the first half of 2024. But the y/y comparisons should be favorable in 2024. Much may also depend on the interest rates. If interest rates go lower, it may spur more activity in the real estate market, further driving new home sales.
The company’s EBITDA margins have suffered with this deterioration in sales. The company has averaged a 12.2% annual EBITDA margin since 2013. Over the past four quarters, the company has averaged just a 6.9% EBITDA margin. Huntsman Corporation ranked among materials companies poorly on EBITDA margins over the past two quarters (Exhibit 2) . Although most materials companies on this list registered double-digit EBITDA margins, Huntsman Corporation registered single-digit margins. Intense competition may be putting pressure on pricing, thus pressuring its profitability.
Exhibit 2:
EBITDA Margins of Materials Companies (Seeking Alpha, Author Compilation)
Great dividend with much growth potential
The stock offers an excellent 3.5% dividend yield . Its payout ratio is high due to the deterioration in its cash flows. But, the company has cash reserves to cover its dividends. The company has $500 million in cash while it pays just $167 million in dividend payments. The company has grown its dividend by 9.3% CAGR over the past five years.
The company has repurchased its shares, thus reducing the share count from 242.4 million in 2013 to 180.3 million as of June 2023. The company has spent $1.9 billion on share repurchases since 2013 (Exhibit 4) . The reduced share count improves earnings per share and helps the company increase the dividend payout to the outstanding shares. The company carries a total debt of $1.57 billion and net debt (after cash) of $1 billion (Exhibit 3) . The company’s net debt to EBITDA ratio is 2x based on its $500 million in EBITDA over the past twelve months.
Exhibit 3:
Huntsman Corporation Debt (Seeking Alpha, Author Compilation)
Exhibit 4:
Huntsman Corporation Share Repurchases (Seeking Alpha, Author Compilation)
The current strong momentum may not continue
The materials sector has performed poorly over the past year, with the Vanguard Materials ETF rising by just 1.8% compared to the 4.9% return of the S&P 500 Index ( SP500 ) and the NASDAQ 100 Index ( NDX ) returning 13%. Huntsman Corporation has dropped 10.7% over the past year, underperforming all the major indexes. However, the stock has staged a comeback over the past three months with a return of 7.3%. This rally may not last, given that the company has endured 15 down revisions to its EPS over the past three months and no up revisions.
Huntsman is overvalued on multiple measures
The company is trading at a forward GAAP PE of 23x—the companies in the Vanguard Materials ETF ( VAW ) trade at an average PE of 17.5x. Huntsman Corporation is trading at an EV to EBITDA multiple of 11.4x compared to its five-year average of 9.2x. The Chemours Company ( CC ) and Eastman Chemical ( EMN ) trade at a lower forward EV to EBITDA multiple of 7x and 8.9x, respectively. A discounted cash flow model estimates the per-share equity value at $40.26 (Exhibit 5) . This model assumes a 3% growth rate, a 6.7% free cash flow margin, its average over the past decade, and a discount rate of 8%. But, the company has averaged a free cash flow margin of 3.7% since December 2020, a substantial drop in cash flow compared to the past decade. If a 3.7% free cash flow margin is used, the equity value drops to about $17.
Exhibit 5:
Huntsman Corporation Discounted Cash Flow Model (Seeking Alpha, Author Calculations)
Huntsman Corporation faces demand challenges and entrenched competition across its sectors and geographies. Demand may not recover for the rest of 2023. The current strength in the stock may be short-lived. The stock looks overvalued based on valuation measures and a discounted cash flow model. The company has work to do to recover its margins. The company offers a good dividend for existing shareholders and can grow the dividend. So, it may be best for existing investors to continue holding the stock, especially if they have a lower cost basis than the current price. New investors may have to wait for the stock to trade closer to its historic multiple before buying.
For further details see:
Huntsman Corporation: Much Uncertainty Remains