|Shares Out. (in M):||78||P/E||17.7x||14.3x|
|Market Cap (in $M):||8,400||P/FCF||13.9x||12.1x|
|Net Debt (in $M):||2,750||EBIT||766||837|
|TEV (in $M):||11,150||TEV/EBIT||14.6x||13.3x|
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Ashland stock is a very compelling, event-driven long investment opportunity. First, the return potential is quite strong with ~40% upside from current levels. Second, the risk/reward profile is very attractive with a downside price of $100 and a target price of $150, equating to $8 down and $42 up from current levels, a ~5:1 ratio. Third, the overall "set up" for the stock to perform well over the next 6-9 months is excellent. Additional detail on the set up of the stock is provided below, but the headlines are:
Fourth and finally, there is an element of "differentiated view / variant perception" here in that the market appears to be missing the fact that Ashland will have a very sizeable amount of excess cash on its balance sheet even after all of these share repurchase programs are completed. This cash can be used for even more share repurchases or accretive M&A, either of which could drive the stock even higher than $150.
Ashland is a specialty chemical company which, pro forma for the 8/1/14 sale of the Company's Water Technologies business, now has three reportable segments described below. Of note, Ashland recently "realigned" some of its business portions, switching some from being included in Specialty Ingredients to Performance Materials and vice versa. For a description of this realignment, see Note O in the Company's 3Q14 10-Q filing. Also of note, the "realigned" financials for each of the business segments can be found on the Company's website by going to the "Investors" section, clicking on "Reports and Filings" and then "Financial Information". The PDF file is listed under "New Business Alignment" and is called "Related Financial Information".
Favorable Set Up for the Stock
Here's why the set up for the stock to perform well over the next 6-9 months is so favorable:
Below is some fundamental commentary on each of Ashland's business segments as well the rationale for the financial projections for them.
In addition, here’s some commentary regarding other fundamental aspects of Ashland’s business:
Based on the fundamental analysis above, below are summary financials for the Company:
|Specialty Ingredients||$ 2,478.0||$ 2,471.6||$ 2,571.2||$ 2,674.8|
|Total||$ 6,091.0||$ 6,095.6||$ 6,275.9||$ 6,463.4|
|Depreciation and Amortization||348.0||348.0|
|Net Income||$ 537.1||$ 629.4|
|FD Shares Out||71.0||68.3|
|FD EPS||$ 7.57||$ 9.21|
|EBITDA||$ 1,184.8||$ 1,283.7|
|Net Cash Interest Expense||(156.9)||(139.0)|
|FCF||$ 635.1||$ 727.4|
|FCF / Share||$ 8.95||$ 10.64|
|BALANCE SHEET ANALYSIS|
|Current Cash Balance||$ 570.0|
|After-Tax Proceeds from Sale of Water Technologies||1,400.0|
|After-Tax Proceeds from Sale of ASK Chemicals JV||100.0|
|Remaining Share Repurchases to be completed by YE2015||(1,270.0)|
|Approximate 1Q16 Ending Cash Balance||$ 1,435.1|
Note that the fully diluted share count being used is based on the following share repurchase schedule and the conservative assumption that the Company is buying back stock at $125/share.
|Q3 2014||Q4 2014||Q1 2015||Q2 2015||Q3 2015||Q4 2015||2015||2016|
|SHARE COUNT ANLAYSIS|
|Beginning Basic Shares Outstanding||78.1||71.2||70.6||69.9||69.2|
|Shares Issued / (Repurchased)||(6.8)||(0.7)||(0.7)||(0.7)||(2.2)|
|Ending Basic Shares Outstanding||78.1||71.2||70.6||69.9||69.2||67.1|
|Avg. Basic Share Balance||74.6||70.9||70.2||69.6||68.2||69.7||67.1|
|Shares Issued / (Repurchased)||(6.8)||(0.7)||(0.7)||(0.7)||(2.2)|
|Aggregate Dollar Amount||($ 750.0)||($ 83.5)||($ 83.5)||($ 83.5)||($ 270.0)|
|Avg. Price Per Share||$ 110.00||$ 125.00||$ 125.00||$ 125.00||$ 125.00|
|FD Shares Out||71.0||68.3|
Over the next 12 months, I believe Ashland’s stock should reach $150/share. This is based on four methodologies included below.
PE Multiple – Based on my projections above, Ashland will generate $9.21 in 2016E EPS. Currently, US specialty chemical comps trade at 16.8x 2015E EPS and 14.7x 2016E EPS. As Ashland is a high quality company, I think it’s fair and reasonable to project that it will eventually trade to 16.0x 2016E EPS. This equates to a $147/share price.
EV/EBITDA – Also based on my projections above, Ashland will generate $1.28 billion in 2016E EBITDA and will have $1.4 billion in cash on its balance sheet by 1Q16. Assuming no debt paydown, the Company will also have the same $3.3 billion in debt on its balance sheet that it has now. Currently, US specialty chemical comps trade at 9.5x 2015E EV/EBITDA and 8.7x 2016E EV/EBITDA. I think it’s very reasonable to project that Ashland will eventually trade to 9.5x 2016E EV/EBITDA and have 68.3mm FD shares out. This equates to a $150/share price.
FCF Yield – Based on my projections above, Ashland will generate $10.64 in 2016E FCF/share. If Ashland trades a 7% FCF yield, which I think is very reasonable for a high quality specialty chemical company, this equates to a $150/share price.
SOTP – Based on the 2016E projections above and applying a 10.0x EV/EBITDA multiple for Specialty Ingredients (an “above peer” specialty chemical multiple), a 7.0x EV/EBITDA multiple for the Performance Materials (an “well below average” specialty chemical multiple), and a 11.0x EV/EBITDA multiple for Valvoline (closer to a branded consumer product multiple), Ashland should eventually trade to a combined enterprise value of $12.7 billion. This equates to a blended EV/EBITDA multiple of 9.9x 2016E EBITDA. Projecting $1.4 billion in cash, $3.3 billion in debt, and 68.3mm FD shares out, this equates to $158/share price.
Please note that in all of these calculations, any potential negative valuation impact from Ashland’s pension liability has not been included. As of 9/30/13, Ashland’s total pension and employee benefit plans were underfunded by $1.1 billion. However, conversations with management have indicated that the underfunded status of the pension will be much smaller when they file their 2014 10-K in a few months. While management did not provide any specifics, they indicated that the funded status of their pension plans has changed due to (i) the remeasurement of their liabilities from their restructuring actions, (ii) a changes in the discount rate used to measure their liability, and (iii) and changes in their plan assets. Again, it’s unclear what the current funding status of their plans is. Obviously, alter the valuation as you see fit by included whatever pension liability you feel is appropriate.
Additional Upside through Excess Cash
While a $150 price target is healthy and presents ~40% upside from current levels, I believe the upside to Ashland’s share price could actually be much greater if the Company deploys the excess cash it has on its balance sheet. This is valuable imbedded optionality.
Based on the financial projections I included above, Ashland should have $1.4 billion in cash on its balance sheet at the end of its 1Q16. By this time, the Company will have completed its $1.35 billion share repurchase program. Also based on my projections, the Company should generate $727 million in free cash flow in 2016, more than enough to fund the paydown of the $600 million in 3.00% notes which are due in March 2016. Conversations with management indicate that Ashland could easily run its business with $400 million in cash on its balance sheet. So, Ashland will have considerable excess cash ($1.0 billion) to deploy even after it completes its share repurchase program through calendar 2015. In my opinion, the market doesn’t seem to be appreciating this. This is why I believe I have a “variant perception / differentiated view” on how attractive Ashland’s stock really is.
My net income projection for 2016 is $629 million. With a projected 68.3mm shares out, my “base case” 2016E EPS is $9.21. If the Company buys back another $1.0 billion worth of stock at a very conservative average price of $150, Ashland could drop its share count by another 6.7 million shares to 61.6 million. On net income of $629, that’s a 2016E EPS of $10.21. Applying a 16.0x PE multiple on that and Ashland’s stock could trade to $163, up >50% from current levels.
Looking at it another way, my projections indicate the Company can generate $727 million in FCF in 2016. On a reduced share count of 61.6mm, that’s $11.80/share. At a 7% FCF yield, that equates to $168/share.
Ashland could also use the cash for accretive M&A which could also increase the Company’s per share value.
I think the biggest risk to the Ashland story in the near-term is the upcoming change in management. Ashland’s CEO Jim O’Brien has announced that he will be retiring on December 31, 2014. Ashland’s board has formed a special committee and has been interviewing candidates for the position, both from inside as well as outside the Company. The selection process is obviously expected to be completed well before yearend so an appropriate transition can occur. These processes always entail risk as you don’t know who the new candidate will be, how smoothly the transition will occur, with the new CEO take the Company in a different direction, etc. Unfortunately, there’s no mitigant to this risk.
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