If you think Huntsman's (NYSE: HUN ) lackluster second-quarter numbers are a precursor of worse times ahead, you may want to pause and dig deeper before jumping to conclusions that could influence your investing decisions.
Sure, a massive 62% drop in year-over-year net profit on a flattish top line is enough to spook investors, but there's more to Huntsman's earnings report than meets the eye. The company's ailing businesses are reviving and its growth plans are solid. What's more, Huntsman is making just the right moves that could prove the diversified company one of the best plays on an upturn. Here's why you should have Huntsman's stock on your radar.
It wasn't unexpected, really!
Huntsman's second-quarter performance would have looked better had it not been for the sharp 18% drop in revenue, year over year, from its struggling pigments business. But investors, who kept abreast of the situation in the titanium dioxide, or TiO2, pigment market shouldn't be surprised.
The TiO2 industry suffers from high inventory, which has put tremendous pressure on pigment prices. This scenario has played out for months, even quarters, and the pigment producers aren't out of the woods yet. Just last month, DuPont (NYSE: DD ) , the world's largest TiO2 producer, reported a staggering 56% drop in the operating earnings from its performance chemicals business, which largely constitutes TiO2 pigment. The reason, as in Huntsman's case, was lower selling prices.
So what is Huntsman doing to keep its pigments business afloat in these difficult times? Several things, actually.
Three wise moves
Huntsman was one of the first TiO2 producers to increase pigment prices recently, which should help the company salvage some growth on the top line. Sales volumes are already picking up – Huntsman reported a 9% year-over-year increase in its second-quarter sales volumes from the pigments business while DuPont registered a 12% jump in TiO2 volumes in the last quarter.
While increasing prices, Huntsman has also started substituting costly feedstock with cheaper sulfate ore to produce TiO2. With input costs showing no signs of easing, several TiO2 producers have been forced to look for alternatives. Tronox (NYSE: TROX ) went to the extent of buying out the mineral sands (titanium ore deposits) business from titanium ore feedstock producer Exxaro Resources last year. Tronox's mineral sands division reported a 39% rise in year-over-year revenue during the first quarter, and the company is now positioned to source its entire TiO2 feedstock requirement internally.
More importantly, Huntsman has an even bigger plan for its TiO2 business in the long run. The volatility in earnings might even encourage the company to exit the business altogether in the future. According to Bloomberg, Huntsman may join hands with a competitor to merge its TiO2 assets and spin it off as a separate company. A possible suitor could be Tronox, which is keen on acquisitions to expand its TiO2 business.
In short, Huntsman investors should know that their company isn't going to sit back and watch its pigments business dwindle. It will likely come up with a concrete plan, and soon.
The big threat, and the bigger opportunity
Meanwhile, investors should focus on how Huntsman is growing its largest business, polyurethanes. It accounted for 43% of the company's total revenue during the second quarter.
While Q2 revenue from Huntsman's polyurethanes business was down 1% year over year, investors shouldn't read much into it, because the lower sales were a result of an unexpected disruption in the supply of raw material at the company's facility in Rotterdam. Excluding its impact, second-quarter global volumes for methylene diphenyl diisocyanate, or MDI, rose 3% year over year. MDI is Huntsman's key product, and is primarily used in the insulation industry.
Considering that Research and Markets' latest report projects the global MDI market to grow at a compounded rate of 6% through 2016, Huntsman looks to be doing the right thing by expanding its polyurethanes business. After acquiring 20% stake in Japan-based foam-insulation company Nippo Aqua in March, Huntsman will soon take over Texas-based insulation-component maker Oxid.
But the real deal that could change Huntsman's fortunes is the joint venture it entered into with China-based Sinopec Jinling last year. The two companies are jointly building a propylene oxide facility in China, targeting completion by the end of 2014. Propylene is a key input for polyurethanes.
The Sinopec deal should help Huntsman deepen its foothold in the critical Asia-Pacific market, especially at a time when rival Dow Chemical (NYSE: DOW ) is also eying a share of the pie. Dow is setting up one of the world's largest petrochemical facilities in Saudi Arabia in collaboration with Saudi Aramco. The plant will primarily deal in polyurethanes, and will aim to sell half of the production to customers in the Asia-Pacific region. Projected to be fully operational by 2016, the facility will target annual revenue of $10 billion. To give you an idea of how big that would be, Huntsman's total revenue from its polyurethanes business in 2012 was $4.9 billion.
Undoubtedly, Huntsman faces a daunting task of tackling the cutthroat competition. The good news is that Huntsman currently boasts 18% of the global MDI capacity, which is way ahead of Dow's 12% capacity share. The Sinopec deal should help Huntsman remain on the forefront.
The Foolish bottom line
The second quarter also proved that Huntsman's long-drawn efforts to restructure two of its ailing units – textile effects and advance materials – are starting to pay off. Operating earnings for both businesses improved year over year, with textile effects even reporting an 11% jump in revenue. Together, the two units contribute about 19% to Huntsman's revenue.
With growth plans in place, Huntsman looks well poised to overcome near-term challenges and head higher in the future. Investors will also be happy to know that Huntsman recently increased its dividend by 25% to $0.125 per share after sticking to a payout of $0.10 per share for several years. That yields a sweet 2.7 % dividend yield at current prices.
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