Description

ASH Long

(Current Price 76.47)

Summary

ASH is an excellent investment opportunity for investors with a 12-24m investment horizon. The high quality of ASH’s businesses has been obscured by poor cost management and mis-management of end-market developments. New CEO Guillermo Novo has the track record and experience to turn ASH around and drive strong returns to equity investors. We expect EBITDA margins in the Specialty Ingredients segment to improve from 23.4% in FY 2019 to north of 25% in FY 2021 which will result in ~100m of additional EBITDA. This should be achievable mostly through cost savings, if Guillermo is able to drive incremental topline growth beyond our ~2%/year assumption we will see additional upside to our numbers. We believe ASH’s mid-cycle EBITDA should be 630m. With an EV of roughly 6.2bn, ASH is trading sub 10x EV/EBITDA on a two year view. We believe ASH’s businesses should trade closer to 13.2x EV/EBITDA which implies a stock price of $103 and a 15% IRR over two years. 

Background

Ashland’s corporate history is long and twisted. In essence the company was a massive conglomerate that has gone through a long series of divestitures and acquisitions to end up as a medium sized specialty chemical company. 2019 saw the final non-specialty chemical business, Intermediates and Solvents, get sold. This completed the de-leveraging and for the first time in a decade meant that ASH had to focus on improving its existing business and not on setting up for the next deal. 

The current business (only one meaningful segment though that will change) is the Specialty Ingredients business. This business has delivered margins of 22-23% over the last few years and negligible organic growth. The underlying activities of this business are varied are varied and complex. 

The only unifying theme is that they produce additives that change the characteristics of end products that must perform to relatively exacting specifications. ASH’s products end up in things like toothpaste, pills and industrial paints that require high performance and consistency. 

Their personal care are pharma businesses are the highest quality pieces. They make additives that help drive label claims  (100% shinier hair!) for cosmetics and shampoo companies. They also make the binding ingredients for pills that must be customized for each drug in order to ensure the desired delivery characteristics. 

ASH’s lower quality activities are more competitive/less specialized. These are essentially the additives for end products with less-demanding performance specs. Things like thickeners for food  or additives for plastics end up in this bucket. 

ASH in 2017 targeted 25-27% EBITDA margins for this business. However, they have completely failed to deliver on this. Some of this was driven by the energy drawdown (ASH’s additives do end up in some fracking fluid), but the rest was poor cost management and generally poor management of the business. Their SG&A as a % of sales has remained in the high teens/low 20% while peers are in the low teens. They blame this on deal amortization running through the business, but the optics of it are annoying to investors. 

On the business side ASH as consistently been caught unaware at customer reformulations. A toothpaste customer in 2018 changed their formula which resulted in ASH losing a piece of business. This resulted in ASH having to move those volumes into lower quality businesses and has been a margin headwind. At the end of 2019 one of their acquired businesses Pharmachem (name totally misleading, the business is mostly lower quality nutrition, not pharma) had a substantial hit from a customer reformulation as well. Missteps of this kind are indicative of a management team that has no idea how to operate these businesses on an ongoing basis. Preventing this kind of missteps is why Guillermo was brought in as CEO. 

ASH’s poor performance and organic growth has resulted in one very public activist campaign (Cruiser) and pressure from Neuberger. Neuberger and Cruiser have worked with ASH to totally remake the board and install Guillermo Novo as CEO. Guillermo’s track record as CEO of Versum and as a manager of the electronics business at Air Products is very strong. We are highly confident ASH’s missteps are in the past. Guillermo understands what it takes to run specialty chemical businesses (had experience at Rohm & Hass) and understands the critical nature of setting achievable targets and delivering on them. 

The business is not fundamentally broken and the high-end pieces of it have continued to deliver. A resegmenting will highlight just how strong the good pieces of Ashland are and as Guillermo fixes the lower quality pieces we expect the business will begin to re-rate. 

Valuation

In order to come up with our multiple we divide the Specialty Ingredients business into three buckets of quality and assign a multiple to each one. These multiples then drive our price target. 

Our multiples come from comps with similar growth/margin characteristics of the businesses in each bucket. For the high bucket companies like Lonza and Croda are the right comps. For the mid bucket things like PPG/Akzo are good comps (not similar businesses at all but characteristics look kind of similar on financial basis. For the low end things like EMN are good comps. 

A more aggressive bull would argue that the high end multiple should be more like 16x (LONN SW and CRDA LN both well above 15x) and that the mid bucket multiple should also be higher. However, we can be conservative here and still see a solid return. 

The high bucket is mostly the pharma and personal care businesses. The Mid bucket is mostly coatings, specialty adhesives, and food and flavors. The lowest quality business is mostly construction, energy and commoditized nutrition. 

Catalysts/Path

With Guillermo in the driver’s seat we expect the path for ASH to be fairly smooth from here on out. Earnings will be closely managed and whatever targets that are set will be hit. 

It may be prudent to wait for the F1Q/C4Q print to initiate a position here as the weakness in 4Q will likely result in a re-base of 2020 numbers, the sell side is on top of this, but Guillermo may under cut those numbers in order to guarantee a string of beat/raise quarters. 

The resegmenting will be a catalyst as well, we expect the new segments to highlight the good pieces of the business and demonstrate that their historical performance has not been as bad as the bears think, thus justifying their valuations. The re-segmenting will likely happen on the F1Q/C4Q print. 

Risks

If Guillermo can’t steadily deliver on growth and margin improvement the multiples in our valuation will be too aggressive. We don’t see much downside even in that case, taking two turns off every multiple and 45m off the High bucket EBITDA only results in 2% downside to the current price. 

The Macro is a risk here, lower spending on personal care will have knock-on effects to ASH’s volumes and asset utilization (thus margins). 

Reformulations are another risk. A well managed specialty chemical business that is properly integrated with their customers should see reformulations coming and be able to mitigate them. Under previous leadership ASH was clearly not in that position. Guillermo has to improve the business to the point that ASH can do this. If this takes longer than expected we could see more disruptive quarters around unforeseen reformulations hurting volumes and margins. 

*I have no position in ASH in any capacity personal or professional

*I have no non-public information about ASH and there is no non-public information in this note

*Nothing in this note should be construed as investment advice or a recommendation to do anything at all with your money or money that you are in control of

Catalyst

Resegmenting on F4Q Results, Operational/cost improvement as new CEO improves the business over time