The basic materials sector can be volatile. With both the demand and supply sides of commodities being constantly impacted by unpredictable external factors, companies in the space tend to produce fluctuating returns. In good times, these companies tend to record massive profits and pay out exciting dividends. During turbulent times, the opposite happens. However, Eastman Chemical (EMN) appears to have differentiated itself with its relatively stable results.
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Nonetheless, I’m neutral on the stock.
Eastman Chemical: A Solid Basic Materials Company
Despite the sector’s abnormalities, there are some companies trading basic materials that are diversified enough, both in terms of their offerings and their geographical footprint, that has allowed them to keep producing relatively stable financials and grow their capital returns over time.
One such company is Eastman Chemical, a specialty materials company serving its customers worldwide. The company supplies a broad range of products found in goods people use daily to multiple clients in various industries. These comprise transportation, building and construction materials, consumables, animal nutrition, and crop protection, among other markets.
Unlike its more volatile peers, the company has historically delivered rather steady cash flows while sustainably increasing its dividend. Specifically, the company has managed to grow its dividend for 13 consecutive years while slowly but gradually expanding the underlying business. This has been possible through management’s top-notch capital allocation, as they have been skillfully juggling between investing back into the business, managing debt levels, and rewarding shareholders.
Strong Q2 Results Despite a Turbulent Macro Environment
Eastman’s Q2 results demonstrated the company’s ability to keep producing stable results in a rather uncertain environment due to how diversified its operations are. While the company’s revenues were impacted by FX headwinds and the divested rubber activities, the company continued to capitalize on the elevated basic materials prices, delivering growth in both the top and bottom lines.
In particular, the company produced revenues and adjusted earnings per share of $2.78 billion and $2.83, implying growth of 4.9% and 15%, respectively. Revenue growth was pushed by 15% higher selling prices and a 2% increase in sales volume/mix, offset by headwinds of 2% and 10%, connected to FX and divestitures, respectively.
Higher selling prices were, in turn, caused by quite higher raw material, energy, and distribution prices and strong end-market demand driven by the ongoing recovery momentum stemming from the pandemic easing year-over-year. The current inflationary environment and geopolitical unrest following the war in Ukraine have also strengthened commodity prices, which Eastman has passed on to its clients.
Following increased pricing, the company was able to realize higher profit margins, hence the growth in adjusted earnings per share. Backed by a strong bottom line, which was in line with the company’s prior estimates, management reiterated its adjusted earnings-per-share outlook for Fiscal 2022. Thus, the company is still expecting the metric to land between $9.50 and $10.00 for the full year.
Management also reaffirmed its capital allocation priorities, which comprise paying the quarterly dividend, supporting organic growth, executing bolt-on acquisitions, and repurchasing shares.
Eastman’s Capital Returns are Strengthening
As mentioned, Eastman Chemical’s prudent capital management has allowed the company to gradually grow its dividend. After all, it’s one of management’s top priorities. In years of elevated profitability levels, the company has often chosen to repurchase shares to further increase shareholder value, as is currently the case. Let’s break these two capital return avenues down.
The Dividend
As mentioned earlier, Eastman Chemical counts 13 years of successive annual dividend increases. The company has also never slashed its dividend since the initial one it paid back in 1994. Eastman’s latest dividend hike last year was by a satisfactory 10.1%, to a quarterly rate of $0.76 per share.
Amid strong earnings growth, the dividend payout ratio remains healthy despite the rather aggressive dividend increase. Specifically, based on the midpoint of management’s guidance and the current annualized dividend of $3.04, the payout ratio presently stands at around 31%.
Therefore, I support that Eastman’s pace of dividend growth should remain quite vigorous, with enough space to meaningfully increase payouts in the coming years.
It’s also worth noting that since the company has already declared four consecutive $0.76 dividends, the next dividend announcement is quite likely to reveal another dividend hike. With the dividend yield currently at around 3.1% and robust dividend growth prospects, Eastman should make for a noteworthy pick for dividend growth investors.
Share Repurchases
At a lower rank but still important among management’s priorities are share repurchases. Eastman has executed substantial buybacks over the past decade, repurchasing roughly 19% of its outstanding shares since 2013. Buybacks play a notable role in boosting EPS as well.
Again, amid record profit levels, Eastman’s management stressed in its earnings report that it expects share repurchases for the full year to exceed $1 billion. With the company’s market cap currently at $11.6 billion, the company is set to retire a significant portion of its outstanding shares.
Further, stock buybacks can shield Eastman’s dividend safety in two ways. Firstly, by retiring shares, the company saves money on future dividends it would pay connected to these shares.
Secondly, if the business were to come under pressure, the company would most likely soften or suspend repurchases before touching the dividend. Thus, seeing strong buybacks provides another layer of safety for investors regarding the current payouts.
Is EMN a Good Stock to Buy?
Turning to Wall Street, Eastman Chemical has a Moderate Buy consensus rating based on seven Buys and seven Holds assigned in the past three months. At $113.29, the average Eastman Chemical price target implies 21.3% upside potential.
Conclusion: A Robust Capital-Return Machine
Despite the sector’s volatile nature, Eastman Chemical has managed to remain a stable capital-return machine, prioritizing shareholder value creation over the long term.
With shares trading at a rather attractive forward P/E of around 10, Eastman should continue to be an attractive dividend-growth pick that offers a decent margin of safety from a valuation standpoint as well.
