Summary
- I last wrote about Olin Corporation back in April, taking a careful "BUY" stance. While the thesis hasn't generated decent RoR, it's outperformed the S&P.
- I take a second look at Olin - the recognizable ups and downs give rise to potential buying opportunities, provided that the business remains stable and appealing.
- I believe the business to be appealing - here is my updated thesis for Olin Corporation.
Dear Readers,
It's time to take another look at Olin Corporation ( OLN ). The subscriber request 5.5 months ago turned into a small "LONG" position for me and provided we see another dip like the one we saw in June and prior to my own first investment, I may be interested in expanding my current stake.
Let me show you why that is.
Updating on Olin Corporation
It shouldn't be a surprise to anyone at this point that I like chemical companies - with over 4% of my portfolio in companies like BASF ( OTCQX:BASFY ) and over 10% of the total in various basic materials and chemical investments, my stance on the long-term appeal of these businesses should be clear as crystal. As many investors say - put your money where your mouth is.
And certainly, most often, do.
In my last article, I made a case for why even a below-IG rated chemical company with a sub-par yield of 1.5% could be interesting. Given that the yield has been the same for years and years, we also can't argue for much in the way of actual dividend growth - Olin hasn't shifted or bumped those levels for several years.
But it doesn't lack history, with its 120-year tradition, nor does it lack size, employing over 6,400 people with revenues in the billions.
Like with most chemical companies, we look first at what Olin actually delivers and what it's used for. Olin produces c hlorine, sodium hydroxide, copper alloys, epoxies, and vinyls. The company also does ammunition and rifles in the Winchester segment, basically as sort of a VAP. These aforementioned chemicals are co-produced commercially through the electrolysis of salt. Chlorine is a basic commodity used in the production of vinyls, urethanes, epoxy, water treatment, and organic/inorganic chemicals.
A major appliance for Chlorine is the production of Ethylene Dichloride, or EDC, and Vinyl Chloride Monomer, or VCM. The company is one of the largest global sources of EDC, marketing its own produced output and also buying secondary EDC for reselling. EDC and VCM are so-called chemical precursors for Polyvinyl Chloride, or PVC, a material that you're familiar with and is one of the most common applications in pipe fittings, automotive parts, and other sources.
Its ammunition business also doesn't come from nothing, as Olin's historical business was in part supplying coal mines and quarries with explosives - so Olin can be said to have been in that business for 120 years.
It's a global producer with facilities in Germany - of course working against the company at this time due to electricity prices and similar issues.
Olin doesn't lack for backlog or orders - and the company sees significantly improved EBITDA despite all-time low epoxy sales volumes, which basically confirms the company's targeted business model, as it "works" in a downturn.
Olin IR (Olin IR)
Olin expects to be able to generate EBITDA of upwards of $2.7B for the year, plenty of cash to distribute both for dividends, eventual buybacks, reinvesting into the business and other targets. Olin bought back 5% of shares outstanding back in 2Q22, all of it from free cash flow, and was able to generate record-level EBITDA in non-epoxy segments.
Olin IR (Olin IR)
The issues in the company's epoxy segments are related to curtailments, and these continue. This has forced the company to focus on value over volume, not necessarily a bad thing. The company is also ready for more curtailments - and given the current situation in Germany and Europe, this seems very likely.
The company is essentially resetting the EBITDA floor, with an estimated $1.5-2B in Adjusted EBITDA - in the case of an actual recession. This translates into a levered free cash flow of up to $1.2B - again, in a recession. Not really a "bad" thing.
The fundamental investment cases for Olin have not shifted one hair since my last article.
What are they exactly?
- The company is virtually in a market-leading position in every business it has.
- It has superb trends across cycles.
- The free cash flow yield, on a levered basis, comes out to over 20% - which is amazing.
- The market, due to a mix of low yield, low credit rating and low DGR , has a recorded trend of significantly undervaluing Olin, meaning triple-digit return potential if bought at the right price.
The company even gives us their own investment/reinvestment strategy
The company intends to use its 2022E Free cash flow for a mix of buybacks, dividends, $200M of debt repayment and trying to execute on some M&As.
Also, the Winchester segment delivered extremely stable, growing performance, despite these current trends.
I've modeled my forecasts based on the company's own 2022E modeling assumptions, which call for 30% debt at variable rates, continuing restructuring costs and otherwise similar trends to the 2021 fiscal.
The company's primary focus has been the breaking of its cyclical behavior. Despite market demand, the company has no intention of increasing production capacity but will continue to grow by using existing and external capacity while lifting the value of its products, This will, according to the company's targets, flatten out earnings but making them more predictable - and this has also been happening. The company forecasts a 2022 EBITDA above the 2021 level. The drivers for the company's markets remain almost universally positive.
The bullish case for Olin remains based on a shift from a cyclical thematic to a structural thematic, which the company is currently trying to achieve. The mix with which it's attempting this is solid fundamentals, solid execution of capital, and executing on what the company considers its contrarian model.
The Winchester model is a very good example of this. The company is successfully growing the Winchester brand, seeing record amounts of recreational shooters, up to 57 million participants, and addressing 220 million adults and youths for future growth.
The company has also started licensing the brand.
So, the company continues to do well - and despite the low yield, the sub-par credit rating, and the no dividend growth, I do expect the company to continue to be a good investment.
And one that I want more of.
Olin - The updated valuation
Olin is still at interesting levels. The company has already announced that it now targets $10/share EPS levels, which would imply a vastly different valuation from the EPS levels we've seen in the company for the past 10 years.
The more often we see the positive quarterly results we're seeing from Olin, the less ambiguous the results, forecast trends, and uncertainties get. Simply put - with every positive or decent quarter, my confidence in the company rises.
Even on a 10-13x forward P/E, the company will, based on current forecasts, rise, and deliver RoR well into the double digits. Forecasting it at a level below 9.5x wouldn't be feasible, and the potential RoR here looks like this.
There are also several positive potential catalysts that could cause the valuation to rise here. The shift from a BB+ to BBB- would be a certain one - as the company would then reach an investment-grade credit rating. The company instituting some sort of dividend growth would be another potential catalyst.
The bearish argument almost writes itself. While the current trend remains good, there's no telling how far or how long this will go on. Company fundamentals, including a low yield and a substandard, junk-rated credit rating don't give a whole lot of confidence here.
But my positive view on the company remains. The bullish scenario in the case of a 12-14X P/e normalization on the basis of new earnings is an annualized RoR of more than 25%, with around 100% 3-4-year RoR.
The lowest forecast level essentially looks at today's valuation, while expecting things to normalize to lower levels, resulting in a relatively flat RoR over time. However, as I said, if the company retains its new EPS level and slight growth rate, I do expect Olin to start normalizing to these higher levels.
With the company's fundamentals, any investment in Olin needs to be made at a cheap valuation. That's also why I didn't buy it before it was very cheap. However, I have good experiences with investment in underestimated, smaller companies without or with lower credit ratings, and making a whole lot of money over time. Exchange Income ( OTCPK:EIFZF ) is a good example of this.
I consider the company to be attractive. I would still hold Olin to a different tact and perhaps expect a normalized EPS level of around $6-$7 for the long-term based on demand normalization in context with the company's plan not to increase its capacity. This would imply a valuation closer to $60-$70 per share. I normalize this at around $65/share, which becomes my initial PT for the company.
You will note that the company remains below this target. The S&P Global analyst target averages come to $68.79 from a range of $57 to $102. Even the lowest possible overall price target is above the current share price. 11 out of 14 analysts have a "BUY" or "Outperform" rating here.
The thesis here seems clear to me, based on these results.
Thesis
- I'm shifting my fundamental thesis on Olin from one of more caution, to one of more bullishness. I'm now willing, after recent results and forecasts, to shift my view to a "BUY".
- There are at least 2 not-unrealistic catalysts for an upside here, beginning with a bump in credit, to a bump in dividends - and even without this, there are things to like about Olin.
- I'm holding to my $65 PT, but I'm firming up my "BUY" here.
Remember, I'm all about:
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them (Bolded). But in this case, note that the fundamentally safe is with a * due to the BB+ rating.
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.*
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
For further details see:
Olin Corporation: Finding The Valuation A 'Buy'