2023-08-01 23:45:39 ET
Summary
- Olin Corporation is an undervalued chemicals company that is underappreciated by the market.
- The company has experienced a decline in earnings due to weak chemical market conditions, but still maintains a strong business model.
- Olin has significant upside potential with a long-term reversal growth rate of 20-40% beyond 2023, making it a compelling investment opportunity.
Dear readers/followers
To say I have a massive stake in Olin ( OLN ) would be wrong - but I am invested in the company, and have bought shares as the company has gone up and down, always loading up at least some common shares when we've seen price lows. Since my last article on the company, which, by the way, you can find here , the following has changed in my position, and the company has somewhat underperformed.
OLN Seeking ALpha (Seeking Alpha Olin article)
I maintain my overall position that Olin is not only undercovered, but underappreciated by the market overall. It's chemicals - which is a sector I'm fairly heavy in in a number of ways with names like BASF ( OTCQX:BASFY ), LyondellBasell ( LYB ), and Dow ( DOW ) being part of my portfolio to various names. Evonik Industries is another large addition that's now over 2.5% of my portfolio from this segment.
It's been over 3 months since an update on Olin - and here I'm going to provide you with one because I do see the company in a positive light here.
Olin - Still plenty to like here and an upside in the double digits.
I make no secret about the fact that I'm mainly looking for an annual 15-16% or above RoR. Whatever enables me to get this safely, and in a way I consider to be likely, I'll do. I've employed strategies such as options selling (both puts and calls), I've done straight common share investing, preference share investing, and even investing in debt, such as bonds to get what I want out of my portfolio.
What role does Olin play in such a strategy?
Olin is an undervalued basic materials business - chemicals. While Olin isn't my largest in any way, or most qualitative holding or potential investment, it's still a potential you can consider once you've "filled" your position in other companies in the same or adjacent sectors.
Now, it doesn't surprise me that the latest results aren't good on a YoY or sequential basis. Why is this?
Because chemicals overall is currently down in the dumps. That's one of the actual advantages of investing in this sector. When the sector or the correlated macro is down, you can pretty much bet on most businesses seeing that in their quarterlies. Because the market tends to overreact to such development, it's a good time to pick shares up cheap - as long as you pick quality companies to invest in.
Weak chemical market conditions saw the macros suffer from price declines in commodities like Chlorine. The company also noted a continued overcapacity in production for epoxy, as well as some unforeseeable impacts (plant operating issues, about $50M). All of this saw the company's 2Q23 results on an adjusted EBITDA basis drop.
OLN IR (OLN IR)
Also, that's not the end of the decline. The company expects 3Q23 EBITDA to be 10% lower to the 2Q, due to continued commercial pricing pressing in the ammunition segment, lower margins in resin and inventory reduction (the company is currently overstocked), as well a caustic price pressure and a reduced overall participation on the part of Olin. The plant issues for the VCM asset are unfortunately not yet over.
This leads to an updated FY23E trough-level guidance at the level of about $1.4B in adjusted EBITDA.
You can see from the trends above - and for basically every chemical company I review, that we're currently "cycling down", meaning we'll see lower results for the foreseeable future - at least 1-2 years, I'd say. This means that the valuation for these companies is going to continue to see a slight to medium decline.
This does not mean, however, that Olin is not delivering.
The way that Olin has structured its business means that when one segment is weaker, the other is typically stronger. Right now the caustic business is weak, while Chlorine is experiencing strength for Olin and seeing sequential improvements. The company is fully aware of the cyclical nature of its peaks and valleys, and expects at this time, the next peak to cycle up to over $3B in adjusted EBITDA, on the basis of strength in Epoxy, Chlor Alkali/Vinyl, and its Ammunition segment.
It's a very interesting mix, with military sales both on a domestic and international basis, with chemicals included. It's capital-light with plenty of JVs and a good share of inorganic growth opportunities. Even though the earnings and FCF are likely to decline, the company is still likely to deliver over $700M in continued free cash flow.
The company has over $1.5B available in liquidity and is now IG-rated by Fitch, albeit with a BBB-. However, Olin has almost no maturities until 2027 and recessionary leverage of 2.0x net debt/adjusted EBITDA. This also marks the second article where I can say the company is IG-rated, and it's actually close to achieving that in S&P as well, with a current BB+ rating.
This is the company's assumption for a recession-type scenario.
Despite its relatively small size, the impression I want to leave you with on the basis of profitability is of a company that's market/segment outperformed. The company's operating margin goes as high as 15%+ with a net margin of over 10%. That's better than many sector-leading chemical companies. So is the company's near 32%-RoE, and an ROIC of over 15%. The current debt/EBITDA as of this date is 1.78x (Source: GuruFocus).
The drawback is yield. Where most basic materials companies yield well above 4%, Olin only yields 1.4%, which is well below average for the sector.
Still, what I want to highlight with Olin is a very well-working company with an attractive, albeit Chlor-Alkali-heavy mix that manages over 10% net income margin.
This is a very well-working business model, and one, as I see it, well worth investing in. Even if the company is seeing a crash in earnings of over 50%, which is likely given current trends, I don't see the business going back to its lows or to the levels, we've seen for the past 20 years.
Since 2021, the company is a different business - and while I don't expect new records in 2024, I expect the trends, and the company's earnings, to reverse in kind.
When it comes to what you should look for with Olin, it's not that difficult. Look at macro and product margins. I expect continued pressure for the rest of the year, and I'll keep an eye on the facility issues that are currently on the table for VCM Freeport, Texas.
However, I want to clarify that I see a lot more positives than negatives for the next year here. The company calling a trough at around $1.4B EBITDA adjusted for the year - I'd make that maybe 1.3-1.35 to be on the safe side, given that there, according to management, is about a $100M problem with the facility.
The structure of the Chlor Alkali business will get better over time, and with epoxies/resins being restructured, things will get better (though we need to remember that China has just added 20% more global capacity in as little as 18 months). I do expect that it will take a few years for epoxies to get back to previous levels, so even with restructuring and other positives, I don't see much improvement here on an earnings basis in the near term, even if the company does better.
With Winchester/ammo, the company is seeing some challenging inventory trends - it's still above pre-COVID sales levels, but it's trending down, apparently seeing challenges in outdoor sports.
Let's look at valuation.
Olin Corporation - the Company's valuation remains compelling.
Olin is, to me, a relatively simple reversal play. Trends in Chlor Alkali/Vinyl and Epoxy/Resin segments are very hard to forecast. We can confirm this by looking at the forecast accuracy of the FactSet analysts following Olin.
I believe it's fair to say that this is a near-impossible sector to accurately predict with any certainty. So we need to take a through-cyclic approach and look at the company from a very long-term upside - how high and how low it typically goes in the cycles.
Olin has a significant upside. If we use the 5-year normalized P/E ratio of around 15x, which isn't at all unjustified based on a reversal growth rate of 20-40% beyond 2023, we get an overall upside of 108% Total RoR, or 35.35% annually.
This comes with both above-average risk and above-average uncertainty - no doubt about that. But given the relative long-term certainty about the cyclicality of these commodity trends, I view it as relatively good visibility - and Olin is no newcomer to this space at all. The company trades with storied peers like Sherwin-Williams ( SHW ), Sika AG, Westlake ( WLK ), Evonik ( OTCPK:EVKIY ), Nissan Chemical Corp, and Mitsubishi Chemical Corp, and I own several of these companies as well.
I expect growth on the basis of outperformance once the trend turns around. This seems unlikely to occur this year, but it's coming during the next year, as I see it.
Based on such an upside, I continue to view the company as both undervalued for the longer term and a "BUY". There's no doubt in my mind that Olin requires a strong stomach. There's also an argument to be made at this point for capturing alpha through the use of either cash-secured puts or buy-write CCs to lower the overall risk - I would try and target levels of buy-writes under $50, provided you then can get a 15%+ annualized RoR in such a play - but I still believe the best investment avenue for this company to be investing in the common share, if you have the patience and stomach.
My position remains small and likely to remain so for now, but it's a LONG, and I'm adding to it during weakness. I continue to view Olin as a positive play, and after 2Q23, I'm not shifting my PT of $65/share.
Thesis
- I'm sticking with my Olin thesis, which is bullish, and I stick to my PT for the company, which has been set for the past few articles. I consider the company to have performed very well.
- 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 that make this a potential "alpha" pick.
- I'm holding to my $65 PT, and reiterating "BUY", but remember that this company is likely to see some volatility going forward here - and that we've been as high as $64 back in February.
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 (italicized). 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.
With the credit rating upgrade, I now consider 5/5 fulfilled, but I do consider the company to be somewhat more of a speculative investment at this time.
For further details see:
Olin: I Still Believe It Is Poised For A Breakout