Thursday, June 16, 2011

With Family Scion To Run For President, Should You Buy Stock in Huntsman Corp.?

Former U.S. Ambassador to China, Jon Huntsman is poised to announce his run for the presidency in 2012. Thanks to his family's chemical company, Huntsman (NYSE: HUN), he has never wanted for campaign funds. And with a growing portion of that company's jobs going to China, what's good for Huntsman shareholders may not be good for his presidential bid. Should you hold your nose and buy its stock?

The $4.2 billion market capitalization, Huntsman makes chemicals around the world -- its most famous products are its polystyrene-dozen-egg container and the Big Mac clamshell. Headquartered on 500 Huntsman Way in Salt Lake City, Jon Huntsman (the former Ambassador's father), and the company's Executive Chairman, likes having his name on things. For example, the University of Pennsylvania's Wharton School named its now-main building, Jon M. Huntsman Hall, after him for giving most of the $140 million needed to build it.

Huntsman's China revenues rose in the years the Ambassador served the man whose office he aspires to occupy. According to Bloomberg's analysis, Huntsman's revenue in China increased 57%  from 2009 to 2010 -- 9.5% of corporate revenue, almost two decades after the company first started doing business there. 

The Ambassador's brother, Peter, is CEO. As Bloomberg reported, on June 8th, Peter boasted, “We now employ more people between China and India than we do in North America, which is really quite phenomenal when you consider that about 90 percent of our associates 10 years ago were in North America.”

At $17.58, Huntsman stock trades 24% below its February 2005 IPO price of $23. And on May 26, its Huntsman International unit agreed to pay $33 million to settle a lawsuit alleging it conspired to fix the price of urethane chemicals sold in the U.S. from 1999 through 2004, according to Bloomberg.

That does not resolve all of Huntsman's legal problems. According to its 2010 10K, the U.S. is investigating the company for potential violations of the U.S. Foreign Corrupt Practices Act -- records at the facility showed that employees of Huntsman's Indian joint venture paid Indian officials as much as $11,000 in the nine months in 2009 and early 2010.

Has all this background noise affected Huntsman's recent financial performance? Not at all. In the first quarter, Huntsman blew through expectations. Its net income of $62 million, or 26 cents per share, was a big improvement over its net loss of $172 million, or 73 cents per share, in the first quarter of 2010. Its adjusted EPS of $0.47 was 100% better than the 24 cents per share expected by analysts polled byThomson Reuters I/B/E/S. Not only that, but its revenues were up 28% to $2.68 billion -- 12.6% ahead of expectations.

The interesting reason for this boffo financial performance is a lesson in Economics 101. In many parts of its business, Huntsman is operating at full capacity and demand is strong. As a result, Huntsman is able to raise its prices more than the rise in the cost of its raw materials. As Gleacher & Co analyst Edlain Rodriguez explained to Reuters, "They did extremely well. Their facilities are running at full capacity. They're able to raise prices to offset costs and demand is extremely strong."

But in 2009 and 2010 Huntsman's cash flows fell far short of its cost of capital. In the last year, Huntsman has been creating negative so-called Economic Value Added (EVA). Bennett Stewart coined the term -- it's a number calculated as follows: EVA = Net Operating Profit After Tax - (Total Assets - Current Liabilities) x the Weighted Average Cost of Capital).

The best companies create value in excess of their cost of capital -- generating a positive EVA. But using the EVA measure, Huntsman is destroying value -- albeit at a less dramatic rate in 2010 than it was in 2009. Its 2010 EVA was negative $550 million, down 44% from its 2009 EVA of negative $986 million.

Huntsman could be in an awkward situation when it comes to repaying its debts. After all, at the end of 2010 it had $3.6 billion in long-term debt, double its $1.8 billion in equity -- making it far more leveraged than its industry (the chemical industry's debt to equity ratio is 0.9). And it must repay $519 million of that debt in 2011 -- fortunately, it had $966 million in cash at the end of 2010.

Is the market pricing all of Huntsman's financial risks and opportunities correctly? To think about that, we can look at its price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.

Huntsman stock is reasonably priced -- trading at a PEG of 0.97. Its P/E is 18.9 and its earnings are forecast to grow 19.5% to $2.10 in 2012.

If Huntsman can keep doing better than expected, it may be worth a look. But I would avoid this equity at least until the dust has settled from the expected opposition research that will use publicity about the negative aspects of Huntsman's business operations to undermine the Ambassador's presidential hopes.


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