Eastman Chemical: Good Company, Expensive Stock

While Kodak (NYSE: EK) is fading away, its former chemical subsidiary, Eastman Chemical (NYSE: EMN) -- it operates 16 manufacturing sites in nine countries that make chemicals, plastics and fibers products -- is doing great. Should you add Eastman Chemical to your portfolio?

In the 1980s, I did consulting work for both companies. At the time, they were all part of the same corporation -- but in January 1994, Eastman Chemical, based in Kongsport, Tenn., was spun out from its Rochester, N.Y.-based parent, and its stock has had a nice run -- up 126% since January 2004.

And it has done particularly well since March 2009. Since that low point, the stock has surged 344% from $23 to $102. By contrast, Kodak stock has lost 92% of its value since that spinoff -- falling from $46 to $3.58.

Here are two reasons to buy Eastman Chemical stock:

• Eastman's first quarter performance was great. Its earnings from continuing operations were $2.52 per share, and revenue was up 28% percent to $1.76 billion. Eastman beat expectations of analysts surveyed by Thomson Reuters I/B/E/S for earnings by 30% and revenue by 15%. And Eastman raised its 2011 EPS forecast to $9 -- 11% above analysts' expectations before its first quarter report.
• Recent buying by hedge funds. According to SeekingAlpha, five recent buyers of Eastman stock (and the amounts they bought) include First Eagle Investment Management LLC ($59 million), Kingdon Capital Management LLC ($17 million), Zweig-DiMenna Associates ($13 million), SAC Capital Advisors LP ($8 million) and Balyasny Asset Management LLC ($3.5 million).

Here are two reasons not to buy Eastman Chemical stock:

• Eastman stock is not cheap. Eastman trades at a price-to-earnings-to-growth (PEG) ratio of 2.13 (where 1.0 is considered fairly valued). Eastman’s P/E is 14.9 on earnings expected to climb 7% to $10.01 a share in 2012. Its 2011 earnings growth is expected to be a far better 34%. So if Eastman can continue that growth rate into 2012, its valuation would be reasonable.
• Progress in trying to earn more than its capital cost. Eastman does not earn enough in after-tax operating profit to offset its cost of capital. But it is getting closer. After all, it’s producing positive EVA Momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales. In 2010, Eastman’s EVA momentum was up 5%, based on 2009 revenue of $4.4 billion, and EVA that improved from negative $382 million in 2009 to negative $162 million in 2010.

While Eastman Chemicals is much more successful than its former parent, it looks expensive to me and would be worth buying should July feature a debt-ceiling-negotiation-related sell-off that drives down its stock price to a more reasonable level.