Summary
Olin is a buy based on solid fundamentals and a low valuation. Its current P/E is 8.5 when its historical average is 15. The management is skilled and knowledgeable about its cyclical business and will see a rebound in 2024 and beyond. The bad news is priced into the share price and earnings will start growing.
Understanding OLN as a business
Olin is a global leader in chlor alkali production. Chlor alkali products include chlorine and caustic sodas. These products have a wide range of applications and are used in a variety of industrial processes. The products are used in plastics production, detergents, and paper pulp. Olin supplies other manufacturers with the base chemicals for the other companies products. This segment represents 77% of Olin’s profits and is by far the largest segment of their business.
Another segment of Olin’s business is that they produce epoxy products. Their epoxy products are used in the automotive, aerospace, construction, electronics, and coatings. These products are used as surface treatment for materials in those industries’ processes. The epoxy business is approximately 8% of their profits.
The third segment of Olin’s business is the firearm and ammunition production. They own the brand Winchester firearms. They sell these firearms to sporting good retailers, distributors, law enforcement, and the military. The Winchester division of their business accounts for 15% of their total profits.
The main moat that Olin has is that the chemical industry is a capital intensive business that competition can’t quickly join the market. It takes time and money to build chemical plants and isn’t economically feasible until it’s at large scale production. This is different from many of the software and technology companies that need to deal with competition coming overnight.
A risk factor for this business is that they participate in heavily regulated industries. The EPA heavily regulates the large scale chemicals business to ensure the environment is protected against spills and releases. Firearms are heavily regulated in the US and are hated by the US government. Along with the regulations the firearm business also has quite a few competitors in the space.
Valuation Metrics
Using the Finviz stock screener we can look at the metrics that are important to us in understanding the valuation of Olin.
Olin is valued at $6 Billion by market cap. The P/E ratio is 8.56 based on its earning per share of $5.89. The $6 Billion market cap gives the stock room to grow and provide the return we are looking to achieve. The earnings has grown by 68% yoy over the past 5 years and is looking to continue for the next year at a 40% growth. Analysts are projecting 5% growth in earnings for the next 5 years. Another thing to consider with this company is that they have nearly $40 in cash per share and pay a 1.5% dividend. At this price you are paying $10 a share for the business subtracting the cash on hand per share.
FAST Graphs Analysis
FAST Graphs is a great tool to look at how a company’s earnings compare with the current valuation of the company.
The black line represents the share price and the orange line represents the earnings of the company at a 15 P/E. From this graph we can see that the earnings of the company have skyrocketed recently and are falling again. Analysts are projecting that earnings will bottom out at $4 a share and recover. The price didn’t follow earnings run up and the projected fall of earnings seems to be priced into the share price.
Bull Thesis
Olin’s current valuation is based on a large drop in earnings and that drop in earnings is already priced in. Management is aware of the challenges from the macro environment and they are positioning accordingly. The share price is not reflecting the fundamentals of the underlying business and is a rebound candidate. Olin’s management is saying trough earnings in the down cycle will be at $1.4 billion and has the potential to grow at 15% yoy for the years following 2023. The current P/E of 8.5 is well below the 15 year avg P/E of 15 and there is little reason to think that there should be a return to the mean.
The company is cash rich and is committed to doing share buybacks which shows that the management believes in its business. This should help the shareholder return value on their investment. Olin also offers a dividend of 1.4% that is well covered that adds a layer of safety to the investment.
The war in eastern Europe has been going on for a while and the need for more ammunition will continue to grow. The United States is throwing billions of dollars into this war machine and the ammunition part of Olin’s business stands to gain from that.
Bear Thesis
The chemical industry is cyclical and is cycling down. The earnings are going to fall further than expected due to macro challenges. The epoxy industry is still over supplied and China has built a large capacity of epoxy manufacturing plants that increases the supply even more.
One of the operating plants for Olin is having operating issues and its a $100M issue that still isn’t resolved per the latest earnings report. Along with that trouble the CEO is stepping down and transitioning away from the company. These two issues are going to lead to worse performance and further decline.
Buy Rating
The final rating Basil Leaf Capital gives Olin is a buy rating. We think that for its current valuation it is at a good value based on the opportunity for a rebound and is a good price to get into for future growth. We think that the bad news of the company has been priced in and that is why it is trading at a P/E of 8. The company is managed well, and its diversified products lead it to success in a variety of market conditions. Management is well aware of its cyclical business and has reasonable predictions based on its insider knowledge. The large amount of cash on hand for the business is a positive and will help the company if macro conditions do get worse before they get better.