By Awais Iqbal –
June 30, 2013
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Awais is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The fate of the chemical industry is fundamentally tied to the financial strength of the U.S. economy. The chemical processing industry is projected to witness healthy growth backed by a noteworthy increase in the number of projects that are likely to start construction in the United States. Industrial information has recognized 231 projects worth a total investment value of more than $11 billion that have been granted the funding approval to commence construction in 2013. Although the numbers may fluctuate during the year, it exhibits a much more positive outlook for the industry as a whole than in years gone by.
Nevertheless, chemical-industry executives still confront myriad strategic challenges as they develop new formulas for growth to help them support a path to success.
The point of this report is to scrutinize PolyOne (NYSE: POL) against its peers, namely LyondellBasell Industries NV (NYSE: LYB), Dow Chemical (NYSE: DOW) and E. I. du Pont de Nemours (NYSE: DD). The companies have been picked to evaluate their overvaluation based on their P/E compared to the chemical industry, in the midst of its bright future outlook.
Financial performance analysis
PolyOne was among the top players to register double-digit top-line growth. Sales increased by 4.5% in fiscal 2012 and 9.2% in fiscal 2011, primarily owing to an increase of 6.9% from the acquisition of ColorMatrix and a 12% increase coming from the improved sales mix and increased market pricing linked with raw material inflation, 1.3% from foreign exchange gains, and 1.7% from acquisitions.
Nonetheless, PolyOne lagged behind rivals Dow Chemical and du Pont in the race of net margin growth. Dow undertook assertive actions – driving a full range of cost and cash-flow measures by launching $2.5 billion of cost-control actions. It also repaid $613 million in debt, achieved noteworthy milestones with enterprise growth projects and continuous progress towards total quality management with the focus on zero accidents, evidenced by a 36 percent improvement.
PolyOne’s net income margin growth was at loggerheads with its peers mainly due to higher average borrowing levels in fiscal 2012, arising due to the senior secured term loan entered into on December 21, 2011, in combination with the ColorMatrix acquisition.
The net income growth from continuing operations was in fact even lower, as the company had recognized a gain on the sale of investments in SunBelt in fiscal years 2012 and 2011.
The EPS declared by PolyOne was also down at 0.8 for the same aforementioned reasons.
Current ratio portrays a corporation’s capability to pay off its liabilities as they fall due. PolyOne is managing its working capital in an ideal manner. With a current ratio nearing 2, the company has an adequate safety margin above its legal liabilities, to absorb any volatility. Quick ratio is a more distilled measure to assess PolyOne’s liquidity position. A ratio of 1 is considered to be superlative in this industry, the case for PolyOne. Though LyondellBasell has the highest current and quick ratio, it may not be an ideal situation as the corporation had too many funds tied up in its working capital, which could be put to better use. Even though du Pont has a healthy current ratio, its below-average quick ratio shows that it has its funds mainly blocked in inventory.
Valuation based on comparables
Under the mutiples-based comparable approach, a company’s value is estimated based on the relative valuation metrics used in the respective industry. This approach is based on the law of one price. It is a better measure as the value is estimated using actual market data. This method provides a market estimate of fair stock price. It allocates more weight to multiples that represent the economic truth regarding the company’s inside story.
Compared against the current market price of each stock, PolyOne is currently overvalued relative to the market. The current market figures indicate that the company is expected to register negative returns of 17.83% in the future. However, Dow Chemical exhibits a positive potential of 10.16% return as it converges to its intrinsic value.
Using the aforementioned analysis, the stock price of PolyOne is already higher than its intrinsic value. The company is expecting to capitalize on its recent launches of Next-Generation Wilflex™ Oasis water-based inks to boost customers’ operational efficiency and high performance heat stabilizer for high consistency silicone applications. In the face of the chemical industry’s future growth prospects, here my opinion would differ from the comparable valuation results as I expect the PolyOne to register further growth in the future as the chemical industry expands and the company reaps the return on its new launches. I would recommend going long on PolyOne.