Description

Eastman Chemical is a company exposed to some fairly unexciting markets. Yet while top-line growth prospects for EMN are not exciting, there is a tremendous restructuring story which should play out over the next 12 months. The company got itself into a difficult position making ill-timed and ill-conceived acquisitions in the 1990s. However with new blood at the helm, I believe the current CEO is ready to right this ship and there are some very specific actions to be taken which will unlock value in short order.

This is actually a fairly simple value play, so I’m not going to spend too much time discussing the extraneous details of the story, however I’ll briefly go through what the company does. It is divided into two divisions: Voridian and Eastman. The Voridian segment has two division I)Fibers division which makes specialty fibers primarily used in tobacco filters. It doesn't sound great, but despite its zero growth, it operates at double digit EBIT margins and is the prime producer in the country for this product. It is a key cash generator for the company. II)Polymers segment which produces PET used in plastic bottles. EMN is more vertically integrated than competitors in this business and therefore enjoys good margins here as well. To be sure, the global market for PET is way oversupplied and will likely take years to work that off, but relative to competitors, EMN has a fairly good cost structure.

The Eastman Division is divided into three segments: I)Specialty plastics which focuses on products that can be used as substitutes for PVC (used in plumbing), Acrylic and other materials. EMN can manufacture almost equivalent performance products for lower costs. II)PCI which is focused on high growth specialty chemicals. This division has been a laggard for the company. III)CASPI(Coatings, Adhesives, Specialty Polymers and Ink) - within this division, there are three tiers of profitability with the first tier generating double-digit EBIT margins, the second tier being EBIT neutral, and the third tier generating losses of anywhere between $75-100 million annually. CASPI is an amalgamation of companies purchased over previous years under different management leadership.

In addition to all of this, EMN owns 25 million shares of Genencor, a biotech company which trades around $15 per share. This equates to $5 per share of value for EMN ($15*25million)/77million EMN shares outstanding. I am not tax effecting this for reasons which I will explain below. At recent conferences, management has given body language that they will make a decision as to whether to liquidate this position shortly.

The other part of the value-unlocking story is the CASPI division. The bottom tier of the businesses encased in this segment lose around $75 million annually. One way or another, management has committed to eliminating this loss, either through selling it or even shutting it down. Adding this back to earnings would bump annual EPS by around $0.80 from the current base of around $2.00. I believe the company wants to orchestrate a coincident sale of Genencor and the bottom tier of CASPI, which will likely sell for a sizeable book loss, in order to minimize the tax impact. Lastly, management believes it has additional restructuring opportunities in the PCI segment. By the middle of next year, people could be looking at annual EPS potential of $3 per share.

The stock currently trades at $34.60. I believe putting a 13 multiple on earnings of $3, and adding in the $5 for the Genencor stake results in a $44 stock. I think much of that gain will come the day of the announcement of a sale of Genencor and CASPI. The added attraction of the story is that EMN pays a safe 5.1% dividend while you wait. The underlying business holds little attraction to me, however I think management is on the cusp of making the announcements of the actions it will take regarding the aforementioned issues.

Catalyst

1)Sale of Genencor
2)Sale of part of CASPI
3)Restructuring of PCI