This week, Fool analysts Todd Wenning and Bryan Hinmon are presenting two stock ideas for inclusion in the Fool DRIP Portfolio. Energy stocks are on the docket today with Bryan presenting The Lubrizol Corporation, and Todd making a case for Chevron.
Two weeks ago, Todd and I put forth two DRIP Portfolio candidates in Badger Meter and Caterpillar, and came to the same conclusion -- neither were good buys at current prices. We realize that the lack of action is sort of a letdown, but we'd much rather you hang on to your money than pay too much for a stock!
This week, however, both of us feel that our candidates are good buys right now. Todd will make a strong case for energy behemoth Chevron, but I'd rather give a chance to a smaller, lesser-followed company.
Their high-science formulations touch us every day, and we don't even know it. Fuel for the car? Yep, Lubrizol's additives are in there. Gear oil for that wind turbine you installed on your roof? In there, too. Did you use Pantene this morning to wash your lustrous locks? Cha-ching! Heck, you could be laid-up in a hospital and Lubrizol may have supplied additives to the plastic tubing on your IV drip.
Sure, lubricants sound slippery and unimportant, but we use them every day. Lubrizol might just be the additive your portfolio needs to crank up performance.
Four Reasons to DRIP Into Lubrizol
- Stability + Opportunity. Lubrizol's Additives division chugs along steadily through the economic cycle and provides consistent profits to fund the R&D, science and acquisition of new chemistry to generate sales for its Advanced Materials business. This yin-and-yang combination means Lubrizol has a long growth runway and the cash to fund it.
- Pricing Power. Volatility in crude oil prices and commodity chemical prices can wreak havoc on a chemical company's margins. Lubrizol sells into the gasoline markets and uses base oil as an input, but since 2004 it has passed through 18 separate price increases and restore its margins from historic lows. That sort of pricing power aids long-term success.
- More Cash, More Opportunities. Lubrizol has nearly $1 billion in cash (almost $14 per share). In fact, the company's strong financial position is reflected in its BBB+ credit rating, which is a notch or two above the typical chemical company's rating. With its financial house in order the company's board decided in April to raise its dividend 16% and just two months later authorize a repurchase program for 10% of shares. Meanwhile, management is keeping an eye out for acquisitions and is selectively reinvesting in new capacity in Kentucky and China. With executive compensation tied to return on invested capital I like the odds of these investments working out and cash being spent wisely.
- It's trading at a good-to-fair price. Solid businesses like Lubrizol don't go on sale often. However, with some investors fearing recent earnings and margin trends aren't sustainable shares look tempting. I ran a discounted cash flow model assuming 5% sales growth that trails off to 2.5% in perpetuity and 9% cost of capital. The result was $104 per share. If operating margins drop 200-300 basis points shares are fairly valued today. Also, shares are selling at an Enterprise Value-to-EBITDA multiple of just 5.45x, compared to their 5- and 10-year averages of 7.68x 7.27x. With shares near $90 it seems at least a fair time for a long-term investor to initiate a position.
Risks to consider
Improved science from competition. Historically, Lubrizol has been a leader in the science of lubricant additives and as a result only three additional firms compete in the base additives business. Recently, Afton Chemical, a division of NewMarket
(NYSE: NEU), released a new passenger car motor oil additive. While this product hasn't proved superior to anything Lubrizol offers, it highlights the ever-evolving scientific battles that occur.
Supplier or competitor? The remaining two competitors, Infineum (a joint venture between ExxonMobil
(NYSE: XOM)and Royal Dutch Shell (NYSE: RDS-A)) and Oronite (a subsidiary of Todd's selection Chevron (NYSE: CVX)), are also Lubrizol customers. Lubrizol is therefore a friend and foe of these energy titans all at the same time. While this dynamic is tenuous, its existence speaks to Lubrizol's great product that competitors can't match.
- Flying cars, electric scooters, and teleportation. Electric cars (I'm not certain about flying ones) need no oil changes and have fewer moving parts. Ergo, if we all switch to electric cars tomorrow, Lubrizol is in a heap of trouble. Political support may speed up this transition, but we Earthlings are still a long way away from a gasoline-free society.
Foolish bottom line
Just because you've never heard of Lubrizol doesn't mean it doesn't deserve a spot in your DRIP portfolio. With shareholder-friendly management, steady businesses, great international prospects and a growing dividend, Lubrizol makes Bill Nye the Science Guy fill up his beaker.
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Fool analyst Bryan Hinmon owns shares of Microsoft as a part of the Fool DRIP Portfolio. Chevron is a Motley Fool Income Investor selection. The Fool owns shares of ExxonMobil. The Fool has established a bear put spread position on Caterpillar. Fool has a disclosure policy.