Investment Summary

Huntsman Corporation (HUN) is a global chemicals producer that will benefit from near-term company specific catalysts as well as macro tailwinds.  We like HUN for the following reasons:  1) HUN’s largest segment – Polyurethanes – is a strong, growing business that provides exposure to improving US housing and construction cycles which rely on the MDI chemical; 2) Recent trough purchase of Rockwood TiO2 assets provides for significant synergies with HUN’s TiO2/Pigments segment, cyclical upside to global construction and a catalyst in the form of a partial IPO; 3) Successful restructuring plans have already provided $180mm in run-rate benefits with another $60mm planned; 4) Prior skepticism of management has made HUN an unloved name in the otherwise very strong chemicals space; 5) Change in leadership over time is expected as Founder Jon Huntsman Sr., the 76-yr old Chairman who built the company, gives way to CEO Peter Huntsman, who is focused more on creating shareholder value; 6) Play on global GDP growth which may have upside to Bloomberg Street estimates of ~3% (2015/2016); and 7) Low risk of a US or Euro-zone recession in 2014 provide limited fundamental downside to HUN’s core business.  HUN’s current multiple (8 – 9x 2015 P/E and < 6x 2015 EBITDA) underappreciates the company’s transition and growth prospects, while our sum of the parts valuation results in a price target of $42 (~70% upside).  

Business Description

HUN is a differentiated chemicals producer with five major segments across diversified end markets.

• Polyurethanes segment produces MDI (methylene diphenyl diisocyanate), PO (propylene oxide) and other chemicals used to produce rigid and flexible foam, coatings, adhesives and sealants for construction, auto, appliance, furniture and other industries.  The MDI chemical is the key source of growth as demand growth exceeds industry capacity growth and benefits from US housing growth and incremental product per house.
  • 44% of 2013 sales; 53% of 2013 Adj. EBITDA
• Performance Products segment produces amines, surfactants and other chemicals used in detergents, personal products, fuel additives, auto and other industries
  • 27% of 2013 sales; 29% of 2013 Adj. EBITDA
• Advanced Materials segment produces epoxy resins, resin compounds and curing agents used in aerospace and industrial adhesives and composites
• 11% of 2013 sales; 9% of 2013 Adj. EBITDA
• Textile Effects segment produces textile chemicals and dyes used in apparel, home and technical textiles.  Historically HUN’s weakest segment, Textiles is beginning to show positive results of a turn-around plus management has indicated their willingness to sell it if trends don’t improve significantly
• 7% of 2013 sales; 1% of 2013 Adj. EBITDA
• Pigments segment produces titanium dioxide used in paints and coatings.  The most volatile segment which Huntsman intends to combine with Rockwood’s TiO2 assets and separate in a partial IPO
• 11% of 2013 sales; 8% of 2013 Adj. EBITDA

Thesis

HUN has several tailwinds and expected catalysts that are likely to drive revenue growth, EBITDA margin expansion and trading multiple expansion over the next few years.

• Revenue growth drivers
  • Capacity expansion (as disclosed in HUN’s March 2014 Investor Day presentation) adds $275mm EBITDA – (see the EBITDA bridge below)
    • Polyurethane capacity growth projects to add $160mm in EBITDA by 2017
    • Performance Products capacity growth projects to add $50mm EBITDA by 2016 
    • Advanced Materials capacity growth projects add $30mm EBITDA in 2017
    • Pigments capacity growth projects add $25mm EBITDA by 2014
    • Textile capacity growth projects add $10mm EBITDA by 2014
      • These projects are in addition to a number of recent bolt-on acquisitions expected to add $75mm in near-term EBITDA
• Demand drivers
  • MDI demand growth of ~8% per year versus industry capacity growth of 4% per year fuels Polyurethanes segment EBITDA growth
    • Insulation and housing segment growth even higher as buildings focus on limiting energy use with MDI-based insulation, housing cycle ramps up and new houses use more MDI on per unit basis for housing structure and interior furnishings
    • Asia is the fastest growing MDI market – multiple projects by competitors planned to expand MDI capacity in the region, however slow Chinese licensing and strict environmental regulation has limited supply growth
  • Performance products division sells amines into high growth end markets (5 – 8%)  
  • Amines and US surfactants capacity utilization at or above 90%
  • Advanced Materials fast-growing sub-segments in auto and aerospace (30% of segment EBITDA) end-markets (expected 11-12% growth)
  • Recent textiles growth at 3x industry growth of 2 – 3% due to innovative product line
  • Pigments long-term demand growth at GDP, though recently at cycle low

• Restructuring benefits
  • $180mm in annual benefits achieved by 2013; $60mm incremental, annual benefits by 2015 (for total of $240mm in annual benefits vs. 2011) – also shown in the EBITDA bridge
    • No benefits from Pigments segment are included in these figures though annual pigments synergies of $130mm are expected following the closure of the Rockwood asset deal (described below)
• Rockwood Assets purchase and subsequent IPO
  • In September 2013, HUN announced a deal to acquire Rockwood’s (ROC) Performance Additives and TiO2 business for $1.1bn in cash and the assumption of $225mm in pension liabilities
    • HUN described the assets as having normalized EBITDA of $200mm and expected $130mm in run-rate synergies by year-end 2015 – for a synergy-adjusted purchase multiple of 4x normalized EBITDA
      • HUN purchased these assets during a trough earnings period for the segment
      • The Pigments synergies of $130mm appear achievable – they include cutting combined SGA by ~25% ($45mm), fixed costs by 6% ($40mm), 2% of purchasing synergies ($30mm) and $15mm in revenue synergies and efficiencies.  HUN projects the cost of these synergies at $130mm
      • Pigments has not been part of HUN’s restructuring plan so it’s likely there are plenty of opportunities for cost-cutting  
    • HUN plans to combine the ROC assets with its existing Pigments division to create a ~$500mm EBITDA, $3bn revenue segment that HUN plans to take public in a partial IPO within 2 years – though we think it will occur within one year    
      • HUN hopes to reduce the volatility and increase the multiple of the non-pigments company by doing the IPO of the volatile low multiple pigments business. 
        • We think they will eventually spin Pigments if the multiple does not expand
    • The deal is currently undergoing a Phase II review with EU anti-trust authorities – the global TiO2 market is not overly concentrated and the combo of HUN and ROC will provide ~15% of TiO2 capacity (significantly less than the 20% share of DuPont)
      • Experts suggest there may be niche product lines that may become overly concentrated and require limited divestitures however it is unlikely that an EC action would be a deal killer
• EBITDA bridge from 2013 – 2016E shows growth from $1.2bn to HUN’s target of $2bn
  • This represent growth of 66% or an 18% annualized rate over 3 years

Summary Financials and Projections (assuming ROC deal closes in 2H 2014)

The key assumptions in the above projections – which reflect management’s 3 year target but do not reflect peak segment margins - include the Rockwood deal closing without material divestitures, continued US and global GDP growth in the ~3% range, an improvement in the TiO2 sector (from trough levels) and the achievement of synergy and restructuring targets.  Importantly, to date HUN has realized more improvements than initially targeted under its $240mm restructuring plan begun in 2012/13, and none of these self-help initiatives impacted the Pigments division. 

Valuation

Given the mix of differentiated segments with varying growth prospects and relative attractiveness, the best way to value Huntsman is to create a SOTP using peers with similar businesses.  Our price target is based on 2016 segment EBITDAs capitalized relative to peer multiples (in most cases at a 10 – 15% discount to those peers current year forward multiples).  The result is an aggregate multiple of 7.6x EBITDA (which compares to HUN’s trading range over past 5 years of approximately 5 – 8x forward EBITDA).  We believe that a multiple near the top of this trading range – and still at a discount to peers – is not ambitious given the improved fundamentals, on-going restructuring efforts and imminent separation of HUN’s lowest multiple segment (TiO2).     

As seen below, the year-end 2015 price target of $46 (based on 2016E results) is discounted back to a year-end 2014 fair value target.  The resulting target price is $42.  The $42 target is less than 12x our 2016 EPS estimate and 14x our 2015 estimate – which is not a stretch multiple.  

Risks

• Economic slowdown
  • If US or global GDP significantly slowed or entered a recession, this would undermine our thesis of strong fundamental improvement – however this is a low risk in 2014
• ROC deal fails to close
• Commodity price volatility (in the wrong direction)
• HUN’s major cost exposure includes butane and ethane inputs
• We believe each 10c per gallon increase in ethane price results in a 5c hit to EPS or $17mm hit to EBITDA
• Ethane spot prices did spike in Q1 up to ~40c per gallon from year-end ~28c, but have since returned back to 29c
• MTBE, TiO2 end markets
  • MTBE – HUN sells ~260mm gal / yr; spot pricing YTD is almost flat with last year (after being down in January)
  • TiO2 – customer inventory levels have normalized and supplier inventories have come down (HUN’s most recent estimate of the the industry is at 75d of inventory, while they are at 65d which they see as in-line with historical averages)
    • A 10% move in TiO2 prices would result in a -$174mm hit to EBITDA (on 2013 base)
      • Underlying demand appears stable but there continues to be some slack in operating rates (est ~80%)
• FCF Yield underwhelming – cash restructuring costs, pension contributions
  • The Rockwood deal should result in the last major restructuring charge, and HUN projects a significant decline in pension contributions from $171mm last year to ~$75mm in 2 years
• With the exception of the ROC merger and TiO2 IPO, many of our catalysts are soft, which means that it may take more than one year for the market to appreciate pro forma Huntsman’s potential and reach our price target 

• ROC deal closes (2H 2014)
• TiO2 industry normalizes
• MDI growth exceeds expectations
• Textile division generates material EBITDA or is sold