Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. This is best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another company or by reviewing 5 Undervalued Companies for the Defensive Investor. By using the ModernGraham method one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. What follows is a specific look at how Eastman Chemical Co. (EMN) fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): Eastman Chemical Company (Eastman) is a global specialty chemicals company that produces a range of advanced materials, chemicals and fibers that are found in products people use every day. Eastman has over 40 manufacturing sites in 16 countries and equity interests in joint ventures that supply chemicals, plastics, and fibers products to customers throughout the world. Eastman has a portfolio of specialty businesses that hold positions and provide products that enhance performance in a variety of end markets such as transportation, building and construction, and consumables. Eastman management believes that the Company’s end-market diversity is a source of strength, as these markets are benefiting from longer-term global trends such as energy efficiency, a rising middle class in emerging economies, and increased health and wellness. On July 2, 2012, the Company completed its acquisition of Solutia Inc. (Solutia).
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 6/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 – PASS
- Earnings Stability – positive earnings per share for at least 10 straight years – PASS
- Dividend Record – has paid a dividend for at least 10 straight years – PASS
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period – PASS
- Moderate PEmg ratio – PEmg is less than 20 – PASS
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – FAIL
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 4/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – PASS
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – FAIL
- Earnings Stability – positive earnings per share for at least 5 years – PASS
- Dividend Record – currently pays a dividend – PASS
- Earnings growth – EPSmg greater than 5 years ago – PASS
|Value Based on 3% Growth||$81.76|
|Value Based on 0% Growth||$47.93|
|Market Implied Growth Rate||3.36%|
|Net Current Asset Value (NCAV)||-$35.08|
Balance Sheet – 3/31/2014
Earnings Per Share
Earnings Per Share – ModernGraham
Eastman Chemical Co. is suitable for both Defensive Investors and Enterprising Investors. The Defensive Investor’s only concern is with the high PB ratio, while the Enterprising Investor’s concern lies with the high level of debt relative to the net current assets. As a result, value investors following the ModernGraham approach based on Benjamin Graham’s methods should feel very comfortable proceeding with further research into the company and comparing it to other opportunities such as E I Du Pont de Nemours and Co. (DD) and Dow Chemical Corp. (DOW). As for a valuation, the company appears to be undervalued after growing its EPSmg (normalized earnings) from $2.06 in 2010 to an estimated $5.64 for 2014. This strong level of demonstrated growth surpasses the market’s implied estimate of 3.36% earnings growth and leads the ModernGraham valuation model to return an estimate of intrinsic value that is well above the market price.
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. What do you think? What value would you put on Eastman Chemical Co. (EMN)? Where do you see the company going in the future? Is there a company you like better? Leave a comment on our Facebook page or mention @ModernGraham on Twitter to discuss.
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Disclaimer: The author did not hold a position in Eastman Chemical Co. (EMN) or in any other company mentioned in the article at the time of publication and had no intention of changing that position within the next 72 hours.
Logo taken from wikipedia; this article is not affiliated with the company in any manner.