Our view is Neutral on Eastman Chemical Co. (NYSE: EMN)

Eastman Chemical Co. (NYSE: EMN)   11/6/2012                            Last Price: $60.48

VIEW:  NEUTRAL

Established in 1920 to produce chemicals for Eastman Kodak, Eastman Chemical has grown into a global producer of chemicals, plastics, and fibers with manufacturing sites in seven countries. The company generates about 55% of its sales in the United States, with a strong presence in Asian markets. During the last several years, Eastman has sold noncore businesses, choosing to focus on higher-margin specialty product offerings.

Sector: Basic Materials                                                  Industry: Chemicals – Major Diversified

Highlights: 

Eastman Chemical Company is a global chemical company which manufactures and sells a broad portfolio of chemicals, plastics, and fibers. After its earnings announcement investors began to be bullish on Eastman Chemical’s shares. It jumped 14% within a day. The stock closed yesterday’s trading session at $60.48 giving a hefty return of 24% year to date. In the past year, the stock has hit a 52-week low of $35.40 and 52-week high of $61.48. Technical indicators for the stock are neutral for the short term and the company’s future outlook is stable but we can’t find the way it can growth from now on.

GROWTH AND BALANCE SHEET

The company posted EPS of $1.57, while consensus estimates were at $1.42 a share. The pro-forma combined sales revenue actually decreased by 3% due to lower selling prices. The pro-forma combined operating income was $397 million, a year-over-year growth of nearly 10.6%. In July, Eastman Chemical completed the acquisition of Solutia, a specialty chemicals company that broadens Eastman’s reach in the Asia Pacific region and increases Eastman’s access to the automotive and architectural industries. Also in 2011, Eastman entered into a joint venture to make acetate tow in China. The venture is expected to be operational in mid-2013. The total Debt/Equity of 165.62% is rather high, it is the most leveraged company in the industry. The company increased its full-year EPS guidance from 10% growth to at least 13%.

VALUATION

Eastman has taken another step to shift its product mix toward more attractive specialty products and away from more commodified basic chemicals, such as the chronically oversupplied plastics business Eastman sold in 2011.

EMN has a PEG ratio of 1.21, above the industry average. The P/E of 15.82 is above the industry average. The stock is currently trading above its fair value of $53. The beta of 1.83 implies high volatility of the stock with respect to the S&P 500. While EMN has a high quality dividend and a strong cash cushion, its relative operating performance is not strong enough to suggest an increase in the dividend.

RECOMMENDATION for next 6 months: We initiate our coverage with NEUTRAL. The company has demonstrated neutral technical signs, the earnings performance and future international expansion offers a positive feeling. Shares are up 44.79% for the 52 weeks as of the close of trading yesterday, we expect a price correction in the next two months. Our overall score for EMN is 5.00

For trading we suggest:

• Buy the January 13  put with a strike of 55.00 priced at $1.60 per contract
• Sell the January 13   put with a strike of 45 priced at $0.60 per contract
• Net Debit to start: $1.00
• Maximum risk: Net debit

NEWS and CALENDAR

12/12 / 01:00pm               Analyst and Investor Meeting

Thu November 1, 2012 – Eastman Ranks among Top Five U.S. Materials Companies in Newsweek’s 2012 Green Rankings

Tuesday October 9, 2012 – Eastman Chemical Cut to “Hold” at Gilford Securities

EMN Strengths

• Strong Reputation
• International diversification

EMN Weakness

• Competition
• Little pricing power
• Foreign Currency Exposure

Stock valuation model

The model rates stocks from 1 to 10, with 10 being the best using a system of advanced mathematics to determine a stock’s expected risk and return. I am using different fundamental and technical factors in order to rank a stock.

Intrinsic value of the stock

Investors should buy stocks selling at a discount to their intrinsic value, and then patiently wait for the fair value of their investments to be realized.

EMN’s intrinsic value is $53.00 the current price is $60.48, the stock trades above its fair value.

Financials

The financial health of the company the higher the better, we evaluate all the financial ratios of the company.

Sentiment

Investor’s sentiment for the stock

Analyst ratings

The model assigns a value according to analyst’s recommendation for the stock.

Earnings Consistency

We are searching for EPS numbers that are better than the previous year’s. One dip is allowed, but the following year’s earnings should be higher than the previous year. EMN’s annual EPS before extraordinary items for the last 5 years (from earliest to the most recent fiscal year) were 1.92, 2.27, 1.05, 2.88, 4.59, this type of earnings action is favorable.

Total Debt/Equity

The company must have a low Debt/Equity ratio, which indicates a strong balance sheet. The Debt/Equity ratio should not be greater than 20% or should be less than the average Debt/Equity for its industry

EMN’s Total Debt/Equity of 165.62% is not acceptable.

EPS This Quarter VS Same Quarter Last Year

The EPS growth for this quarter relative to the same quarter a year earlier is above the minimum 15% that this model likes to see for a “good” growth company. Stocks with improving earnings are worthy of your extra attention.

EMN’s EPS growth for this quarter relative to the same quarter a year earlier is -19.00% well below our target.

Annual Earnings Growth

This stock valuation model looks for annual earnings growth above 12%, but prefers higher than 20%.

EMN annual earnings growth rate over the past five years is 12.30%, above our target growth rate.

Current Price Level

Traders should keep an eye open for stocks that are trading within 10% of their 52-week highs, as it is likely to continue in its upward trend.

EMN’s 52 week high is $61.48 current price is $60.48, is only 2% below the 52 week high.

P/E Ratio

The Price/Earnings (P/E) ratio must be “moderate”, which in this stock model states is not greater than 15. Stocks with moderate P/Es are more defensive by nature.

The company has a P/E ratio of 15.82 above the average industry P/E ratio of 13.47 and is below the S&P 500 P/E ratio of 16.30

Insider Ownership

When there is strong insider ownership which we define as 12% or more, management is more likely to act in the best interest of the company, as their interests are right in line with that of the shareholders.

Insiders own 0.45% of Eastman Chemical stock. Management’s representation is not large enough. This does not satisfy the minimum requirement; companies that pass this test are more attractive to our valuation model.

Technical Analysis

The model is using several technical indicators (MACD, RSI, MFI, OBV, position Indicators) to forecast the trend of the stock for 6 and 12 months, and assign a value.

EMN stock has been showing support around $50.9 and resistance in the $60.60 range. Previous day’s closing price for EMN was slightly above its 50-day moving average. Our indicators give neutral signals for the short term and for the intermediate term on EMN.