When legendary investor Mario Gabelli and highly rated hedge fund manager David Einhorn both take large positions in a small-cap stock, it's usually time to take notice. Specialty chemicals producer Chemtura (NYSE: CHMT) isn't the most glamorous company, but that has not stopped investment firms from buying the stock. According to a recent 13D filing, Gabelli's investment firms own nearly 12.2% of shares outstanding in Chemtura -- worth about $205 million as I write. Meanwhile, the most recent 13F filing from Einhorn's Greenlight Capital shows the investment firm holding 3,950,000 shares, currently worth about $90 million. What's behind the interest in this stock?
A turnaround story
In a nutshell, management has transformed Chemtura from a disparate collection of specialty chemicals businesses into a focused industrial chemicals company. In doing so, the company has significantly reduced its debt burden while making substantive capital investments to drive future growth. I'll discuss its growth prospects in due course, but first, a look at management's actions to transform the company:
- Antioxidant & UV stabilizers business sold for $200 million in April 2013
- Consumer products business sold for $300 million in December 2013
- About $391 million in stock bought under a share repurchase authorization
- Restructuring plan announced in November 2014 to reduce annual manufacturing costs by $50 million, or 10%, and annual selling, general, and administrative costs by $12 million
- Chemtura AgroSolutions business sold for $1 billion in 2014
- Proceeds of AgroSolutions sale partly intended to pay off debt, including $101 million of 7.875% senior notes due in 2018
- Following the Chemtura AgroSolutions sale, the company initiated a new $500 million share repurchase authorization, of which $302.3 million was used up in a tender offer completed in December 2014
While Chemtura has been restructured through divestitures, management has also been busy investing in the underlying business. A period of capital investment took place to prepare the remaining two segments; industrial performance products, or IPP, and industrial engineered product, or IEP, for future growth.
Source: Chemtura Presentations, 2014 numbers are trailing four quarters to Q3.
The underlying trends in the remaining businesses are best seen by looking at segment earnings before interest, taxes, depreciation, and amortization or EBITDA. The following chart shows EBITDA and EBITDA margins. As you can see, IPP margins appear relatively stable, but IEP margins seem to be more cyclical in nature.
Source: Chemtura Presentations, 2014 figures are trailing four quarters to Q3.
It's not a particularly impressive performance from a historical perspective, but each segment has growth catalysts going forward.
Industrial performance products
This business sells petroleum additives (about 70% of IPP segment sales) and urethanes (the remaining 30%). According to company presentations, management expects GDP-type growth out of urethanes (often used to make flexible and rigid foams) and its traditional petroleum additives.
However, the excitement centers on its synthetic lubricants, which management believes can grow at 5.5% annually. Essentially, synthetic lubricants increase the time needed between vehicle oil changes, but they cost more than other car oils. The key payoff is higher auto performance.
Chemtura has invested in capacity expansion in Nantong, China, (where production of synthetic fluid is expected to begin in 2015) and in Ankerweg, The Netherlands (production of high viscosity performance polyalphaolefins, or HVPAO, under way in 2014).
Industrial engineered products
Despite the EBITDA and EBITDA margin declines shown above, the IEP segment also has potential growth catalysts. This business sells bromine/bromine intermediates (used in applications such as flame retardants and to control mercury emissions from coal-fired power stations) and organometallics (often used in coatings for LED lighting, semiconductors, and other optoelectronics) Unfortunately, both products have suffered from industry excess capacity in recent years -- hence the margin compression in IEP.
However, Chemtura hopes end demand will eventually catch up with supply and the company can expand IEP sales and margins again. One catalyst in 2015 could come from the Mercury and Air Toxics Standards, a set of rules and standards established by the Environmental Protection Agency. The rules require existing power plants to meet more stringent mercury admission standards by April 2015, or be shut down. Chemtura is set to benefit via a bromine product that controls mercury emissions from coal power plants.
Is Chemtura a good value?
Putting all this together, analysts expect Chemtura's earnings per share to double in the next few years.
Source: Nasdaq.com.
With the current share price of about $23.00, the stock is trading on a P/E of 21 times forward estimates for 2015, dropping to a P/E of 14.3 times in 2017. Clearly, Gabelli and Einhorn are buying the long-term story, and maybe retail investors should follow suit.
