Monday, July 11, 2011

Is Nalco A Good Buy?

Arch Chemicals (NYSE: ARJ) -- the $1.6 billion maker of chemicals to kill microbes in consumer products -- is getting acquired. Does this mean that competitor, Nalco Holding Company (NYSE: NLC) could also be an acquisition candidate? If not, should you buy its stock?

Arch Chemicals' stock is up 11.3% on the news that Swiss specialty chemicals and biotechnology company Lonza Group Ltd. will buy Arch Chemicals for $1.2 billion in cash. This news got me thinking about other companies in the industry who might be candidates for other companies seeking a foothold in this attractive market segment.

Nalco is not in exactly the same segments as Arch but it has a similar focus on cleaning chemicals. Specifically, Nalco sells $4.3 billion worth of chemicals and technology used in water treatment, pollution control, energy conservation, oil production and refining, steelmaking, papermaking, and mining.

There are three reasons for modest optimism on Nalco's stock:
  • Long-term financial strength -- though debt level is worrying. Nalco has grown steadily. Its $4.4 billion in revenues have increased at an average rate of 5.1% over the last five years and its net income of $288 million has risen at a 32.6% annual rate over that period. And its cash grew at a 36.4% annual rate between 2006 ($37 million) and 2010 ($128 million). Nalco still has too much debt. Although it's declining from $3.1 billion in 2006 to $2.8 billion in 2010, Nalco's debt/equity ratio of 3.21 is almost three times the industry average of 1.1.
  • Strong, but disappointing first quarter earnings. Nalco first quarter earnings were $0.26 per share -- 16% percent below the $0.31 eleven analysts polled by Thomson Reuters expected. But the good news was that Nalco's first quarter sales grew 11% to $1.06 billion from $956.6 million in the 2010 quarter and ahead of 13 analysts' estimate of $1.03 billion for the quarter. Nalco left unchanged its 2011 EPS guidance of $1.65 -- 2% below analysts' estimates of $1.69
  • Under-earning its capital cost-- but that's improving. Nalco earned less after-tax operating profit than its cost of capital but since it's improving, Nalco's EVA momentum was 4%, based on 2009 revenue of $3.7 billion, and EVA that improved from negative $253 million in 2009 to negative $117 million in 2010, using an 11% weighted average cost of capital.
As for the possibility of Nalco being acquired -- it already was back in 1999. On June 27 of that year, Nalco closed a deal to be acquired by Suez Lyonnaise des Eaux, a $32 billion company with 200,000 employees worldwide. But on November 11, 2004, Nalco returned to the New York Stock Exchange as an independent company.

Even without the possibility of being acquired, Nalco is a bargain priced stock. Nalco's price to earnings to growth (PEG) ratio of 0.53 makes it very under-valued (a PEG of 1.0 is considered fairly priced). Nalco's P/E is 14.1 and its earnings are expected to grow 26.8% to $2.08 in 2012.

Even if Nalco remains independent, its very low valuation makes its stock worth considering.


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