HUN is down almost -8% in the last two days. How much downside risk is there?

Through the summer, one of the best sectors of the stock market’s rally back to, and even above pre-pandemic levels has been the Materials sector. Beginning in mid-May to the end of the last week, the sector had increased in value by more than 71% as measured by the S&P 500 Materials Sector SPDR (XLB).

This is a sector that I like to pay attention to as a barometer for the underlying relative health of the economy, because the companies that comprise it produce or mine the building blocks used to create most of the finished goods we use every day. The sector includes industries that cover chemicals and plastics, construction materials, paper, forest, and packaging products, as well as metals and minerals – which means that in some form, this sector touches practically every other segment of the economy in one more or another.

As a reflection of broad economic health, it isn’t that surprising that a lot of the momentum that helped to drive the sector higher came on the back of favorable economic indicators as state and global economics began to to reopen, facilitated by aggressive fiscal stimulus from the federal government and continued accommodative monetary policy from the Federal Reserve. The last couple of weeks have reintroduced uncertainty in the broad economic picture, as Congress debates on the need for a second wave of stimulus have failed to see any kind of productive progress and trade uncertainty between the U.S. and China has begun once again to enter the conversation.

A heightened state of market volatility can drive you nuts if you’re trying to make rational, objective decisions about how to put your money to work for you. That’s because the signals and triggers you’ve learned to use to identify signs of breakouts, continuations, and reversals start to break down; a “breakout” signal may end up really being a “fake out” signal, putting you exactly where you don’t want to be at exactly the wrong time. That creates second-guessing and doubt, which increases stress and emotional decision making. It really makes things more difficult than they need to be!

Conditions like we are experiencing now, and that make short-term trading strategies generally harder, are one of the reasons that I’ve come to use those technical indications of trends and short-term swings back and forth as just one piece of a broader puzzle to help me identify stocks that offer useful value. It isn’t that the volatility goes away; but when I can leaven the emotion that a stock’s current price action might encourage with a solid dose of reality about a company’s business based on current fundamental data along with whether the stock should still be worth more than its current trading price, it helps to make the process a little less emotional and more manageable.

Huntsman Corp (HUN) is a good example of the sector’s performance over the last few months – as well as the tipping point that it could be sitting at right now. From its bear market low in March at around $12, the stock nearly doubled in price by last Thursday, but in the last two days has dropped more than -8% as market and economic uncertainty has finally reached the Materials sector. Helping to drive the stock near to its pre-pandemic highs along with sector strength were strong indications the company had managed to improve their operating profile since the beginning of the year, which also helped them increase their financial liquidity and boost the stock’s intrinsic value. The question, of course, is whether those strengths still apply today. Has the stock’s rally has pushed the stock past the point of useful value, and if it has, at what price level should you consider using the stock as a smart bargain investment?

Fundamental and Value Profile

Huntsman Corporation is a manufacturer of differentiated organic chemical products and of inorganic chemical products. The Company operates all of its businesses through its subsidiary, Huntsman International LLC (Huntsman International). The Company operates through five segments: Polyurethanes, Performance Products, Advanced Materials, Textile Effects, and Pigments and Additives. Its Polyurethanes, Performance Products, Advanced Materials and Textile Effects segments produce differentiated organic chemical products and its Pigments and Additives segment produces inorganic chemical products. The Company’s products are used in a range of applications, including those in the adhesives, aerospace, automotive, construction products, personal care and hygiene, durable and non-durable consumer products, digital inks, electronics, medical, packaging, paints and coatings, power generation, refining, synthetic fiber, textile chemicals and dye industries. HUN’s current market cap is $4.9 billion.

Earnings and Sales Growth: Over the last twelve months, earnings declined more than -122%, while revenues dropped about -43%. In the last quarter, earnings were -148% lower while revenues shrunk by nearly -22%. The negative earnings and revenues pattern isn’t too surprising given the recessive economic conditions that have existed since the beginning of the pandemic. The real story, however comes in the company’s margin profile, which had begun to solidify and improve in the first quarter of the year, but appears to have reversed in the last quarter. In the last year, Net Income was 15.78% of Revenues, but fell to -4.97% in the last quarter. This could be a temporary reflection of the broader economics that have come to play this year, but for now is a red flag that should make an investor cautious.

Free Cash Flow: HUN’s free cash flow is generally healthy at $375 million. This is marks a decline from the quarter prior, when Free Cash Flow was $588 million. That translates to a Free Cash Flow Yield of 7.38%. It is noteworthy that Free Cash Flow remains well below its peak at $1.2 billion in June 2018; it helps to put the shorter-term decline into perspective and should add to the cautious outlook moving into the rest of 2020.

Debt to Equity: HUN has a debt/equity ratio of .46. This is a conservative number that has also decreased in the last two quarters from .77. HUN’s balance sheet provides a strong counterbalance to the cautionary measurements just outlined. Total cash in the last quarter was about $1.25 billion, while long-term debt is $1.9 billion.

Dividend: HUN pays an annual dividend of $.65 per share, which translates to an annual yield that of about 2.82% at the stock’s current price.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $16.50 per share. That means the stock is overvalued by -25%. That also puts the stock’s bargain price at around $13.20 per share – just a bit above its March, bear market lows.

Technical Profile

Here’s a look at the stock’s latest technical chart.

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Current Price Action/Trends and Pivots: The diagonal red line on the chart above traces the stock’s slide from late December around $25 to its low point around $12 in March. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock’s rally since March saw it push above the 88.2% retracement line last week before sliding back in the last two trading sessions. Immediate resistance is around $24, with nearest support most likely back around $20 where the 61.8% retracement line rests. The upward trend since March should provide a good basis to see the stock try to stabilize around support; however a drop below $20 should be considered a trend reversal indicator and provide even more downside that could see the stock drop even more. Technically speaking, the stock has limited upside, as a break above $24 should see additional resistance form around $25; however if bullish momentum accelerates around that point, the stock could see another push to about $29.

Near-term Keys: HUN’s current upward trend is intriguing, and might offer tempting fodder for a short-term trader right now. I think a bullish forecast on HUN is over-optimistic right now, but any kind of stabilization between the stock’s current price and $20 could shift that short-term perspective quickly, and even offer a reasonable signal to consider buying the stock or working with call options, using a target at around $24 as a useful exit point. A drop below $20 should be taken as a strong indication to consider shorting the stock or working with put options, with useful profits targets on a bearish trade sitting at $18.50 and $17 per share. HUN is a company with a terrific balance sheet, which works in its long-term favor; but it is also very overvalued, and has some critical fundamental weaknesses including deteriorating Net Income and declining Free Cash Flow. Those are primary reasons that HUN shouldn’t be considered as a useful long-term opportunity unless and until those weaknesses show signs of material, stable improvement.

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