Over the last year, 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 a peak last week, the sector had increased in value by nearly double by early January, 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 many of the raw materials that make up 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 federal stimulus in the year – with more expected to come next month – and continued accommodative monetary policy from the Federal Reserve. Vaccine administration has apparently begun to gain additional traction over the last several weeks, but in the last week frigid temperatures across the country have experts predicting that the pace of vaccination is likely to slow down as people stay hunkered down at home. In states like Texas, which are generally unaccustomed to extreme cold temperatures, the last week or so has left power grids overwhelmed and millions without heat or electricity, creating a new short-term but nonetheless real element of uncertainty. Even so, most analysts are pointing to the second half of 2021 and beyond as the place where most U.S. activity will see a return to some semblance of the “old normal” that existed prior to the pandemic. That is a forecast that bodes well for the entire economy, and certainly for Materials stocks as well.
Huntsman Corp (HUN) is a good example of the sector’s performance over the last few months – as well as the tipping point that I think it could be sitting at right now. From its bear market low in March at around $12, the stock more than doubled in price by the end of 2020, and even drove to a new set of highs in just the last week or so at around $29.50. Helping to drive the stock near to its pre-pandemic highs along with sector strength earlier in the year 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 last couple of quarters of 2020, however revealed a pattern of declining Free Cash flow and narrowing overall profitability severe enough to shift the value argument significantly against the stock’s upward trend. With a new earnings report provided a week ago, and current fundamentals factored in, let’s take a look at where HUN’s “fair value” price should be now.
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 $6.3 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased nearly 76%, while revenues were flat, but positive, by 0.66%. In the last quarter, earnings were 59.4% higher while revenues increased by 10.46%. HUN’s operating profile also appears not only to have reversed its previous decline, but also to be strengthening. In the last year, Net Income was 17.18% of Revenues, and increased to 20.62% in the last quarter. It is worth noting that six months ago, HUN’s quarterly Net Income/Revenue was -4.97%, which can be taken as a strong indication of stabilization and sizable improvement in operating profitability.
Free Cash Flow: HUN’s free cash flow is $4 million. This is marks a major, even alarming decline over the last couple of quarters, when Free Cash Flow was $375 million, and $588 million at the beginning of the year. The current number translates to a Free Cash Flow Yield of .06%. It is also noteworthy that HUN’s Free Cash Flow saw a peak at $1.2 billion in June 2018, and has declined steadily from that point; it helps to put the shorter-term decline into perspective and should add to the cautious outlook moving into the rest of the year.
Debt to Equity: HUN has a debt/equity ratio of .46. This is a conservative number that has also decreased since the beginning of 2020 from .77. HUN’s balance sheet provides a strong counterbalance to the cautionary measurements just outlined. Total cash in the last quarter was about $1.59 billion, while long-term debt is $1.52 billion.
Dividend: HUN pays an annual dividend of $.65 per share, which translates to an annual yield that of about 2.27% at the stock’s current price.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth. My normal preference is to work with a combination of Price/Book and Price/Cash Flow analysis; however given the company’s current Free Cash Flow number, a practical Price/Cash Flow becomes impossible. That means that the most practical historical analysis comes from the Price/Book ratio, where HUN’s increasing Book Value per share – currently at $16.86, which is a useful improvement from $15.07 in mid-2020 – suggests that HUN’s “fair value’ target is at around $30.43. That isn’t far from the stock’s current price, offering just about 8% current upside. It also puts a useful bargain price at around $24.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The diagonal red line on the chart above traces the stock’s upward trend from a mid-March low at around $12 to its high point around $29.50 just a few days ago. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock’s rally since March has been impressive, with the stock’s momentum flattening out over the last month. Current resistance is at $29.50, and immediate support should be at around $28 per share. A push above $29.50 could have upside to about $33.50, based on the distance from the last resistance break at the beginning of January to its current high. A drop below $28 should see the stock drop to about $25.50 before finding new support.
Near-term Keys: HUN’s current upward trend is intriguing, and might offer tempting fodder for a short-term trader right now. The truth is that the stock doesn’t offer a compelling, or even useful value proposition right now, which means that the best trading opportunities lie in short term trades; you could use a break above resistance at $29.50 as an opportunity to consider buying the stock or working with call options, using a target at around $33.50 as a useful exit point. A drop below $28 should be taken as a strong indication to consider shorting the stock or working with put options, with a near-term profits target at around $25.50 if bearish momentum picks up. HUN is a company with a terrific balance sheet, which works in its long-term favor; but its narrowing Free Cash Flow is threatening to dip into negative territory, which is a big red flag for now. Improving Net Income is an encouraging sign, and if that improvement can continue it should start to pull Free Cash Flow with it; until then I think long-term investors should take a cautious approach with HUN.