Description

Huntsman Corporation (HUN) falls into the category of significantly dislocated equities, with strong cash flows well-suited to weather the uncertain economic environment. HUN is a global specialty chemicals company with leading positions in three attractive specialty chemicals segments: Polyurethanes (55% of earnings) used in foams as well as coatings, adhesives, sealants, and elastomers; Performance Products (24% of earnings) used as a reactive agent, corrosion inhibitor and a precursor to unsaturated polyester resin; and Advanced Materials (21% of earnings) used in specialty materials for secularly attractive markets. like aerospace, electric vehicles, and electric power transmission and distribution.

Polyurethanes is considered one of the most attractive chemical markets due to its consolidated industry structure and above-average structural demand growth. Similarly, the competitive dynamic for the Performance Products segment is quite attractive given a concentrated industry structure with rational pricing.

Huntsman created this attractive portfolio through a multi-year corporate realignment during which it divested lower growth and commoditized segments. The process started with the exit of Titanium Dioxide via an initial public offering in 2017, continued with the sale of its commodity chemical intermediates and surfactants business in 2019, and was completed through a recently announced sale of its textiles business this past August.

Streamlining a business makes it easier for investors to understand. It also uncovers the superior return on invested capital of the remaining segments. This should have made HUN more valuable in the eyes of investors. However, instead of trading at a premium to commoditized peers, HUN trades at just below 5x EBITDA.

This is surprising when you consider that HUN sold the more commoditized businesses for close to 8x EBITDA and used the sale proceeds to deleverage the balance sheet and buy back stock. Today, adjusting for the sale of the textiles business, pro forma net debt to EBITDA stands below 0.5x, and the Company is on track to buy back $1 billion of stock in 2022, or ~ 20% of its outstanding shares. In addition, the equity pays a 3.2% dividend yield.

These attributes create a significant margin of safety and outsized return opportunity. There are two other dynamics that I find appealing. The first is that the majority of the Company's polyurethane capacity is located in the U.S. and Asia. This is a significant competitive advantage as 20% of global capacity sits in Europe with a disproportionate amount in Germany. Exacerbated by the war in Ukraine, European capacity is burdened with higher energy costs than the U.S. or Asia. Global pricing must be sufficiently high to cover the marginal cost of German producers or they will shut down capacity to avoid losses. This dynamic provides a pricing floor for HUN given its footprint is concentrated in areas which benefit from lower energy costs. Regardless of the outcome in Ukraine, energy costs in Europe will likely be structurally higher than before the war-arguably, HUN's assets should be worth more given the improvement in relative cost position.

In addition, I consistently hear from industry sources that polyurethanes is an area where strategic acquirers and private equity firms are targeting acquisitions. Indeed, Huntsman entered into an agreement to sell itself to a private equity firm in 2008, but the deal fell apart due to the Global Financial Crisis. Subsequently, a private equity firm tried to acquire competitor Covestro in 2020. Given a dramatic improvement in portfolio composition, an unlevered balance sheet, and the extremely dislocated valuation, there is significant optionality around M&A interest in HUN.

VALUATION

Finally, while investors have been concerned about incremental capacity additions previously announced by Covestro, given the pressures of the European energy situation they formally canceled expansion plans. This suggests that as the global economy emerges from the near-term economic slowdown, there will be little new global capacity coming online, paving the way for a strong upcycle in Huntsman's most significant business. My current view of normalized cash EPS is $4.65 and yields a target price for the stock of ~$56/share on a 12x multiple. The historical multiple is closer to 15x, which would give a target of ~$70 per share.

Catalyst

Continued execution

Investors looking for consistent cash flow and low leverage

Potential Takeout