This is the longest post ever but I'm here because Rogerson's the CEO. He is not a Penny stock CEO. He is a Steve Jobs like turnaround specialist.
Read this post if you want to know what types of happenings are possible with this play!!!! Huge, Huge, did I mention this is Huge!!!
Chemtura's revenues are twice as much as Hercules 3.55 Bn versus 1.6 Bn and the Balance Sheet is much much much cleaner than Hercules ever thought of being......This play is going to be a monster without question. He could sell 5 of the 8 Divisions (which he will not!!)and we'd still be worth 10 times these levels.
This is the story of Hercules (in this exact same industry not more than about 3 1/2 years ago). Rogerson is CEO of Chemtura since December 2008 after the mess was created. He is here to right the ship and has a proven track record!!!!
(I know it's long...)
Hercules (Wilmington, DE) has undergone more than its fair share of turmoil over the past seven years. The combination of a costly cash deal to acquire water treatment chemical firm BetzDearborn in 1998 and legacy issues including asbestos, environmental and tax liabilities, and pension costs put the company into difficult financial straits. It was forced to sell several prized assets, including most of Betz, and Hercules itself was put on the block in 2000 although it failed to receive any attractive offers. The CEO position has changed hands six times since 1998, most recently to Craig A. Rogerson, who was appointed to the post in December 2003.
But Rogerson's arrival heralded a turnaround in Hercules' fortunes. The company has completed a restructuring that has reduced annualized costs by 20%, and it has paid down its debt substantially. It recently received a settlement with its insurers for asbestos liabilities, and obtained refunds on tax deposits related to previous deals. At the same time as the company's finances have been getting healthier, business conditions in most of the specialties markets it participates in have also been improving, allowing the company to increase prices and boost cash flow.
"We are successfully reducing our legacy issues so we can focus on profitable growth," Rogerson says. "The settlement with our insurers means that we should be cash positive on asbestos liabilities again this year," he says. "Noncash pension charges should peak this year or next and decline going forward. We were leveraged at over six times Ebitda after the Betz deal, and we have lowered that to about three times," he adds. "Ebitda has been relatively flat for the past three years, due to increased year-over-year non-cash pension expenses, but our cash flow has improved dramatically," Rogerson says. "That gives us the funds we need to invest in growth and continue to strengthen our financial profile."
Earnings from ongoing operations, which excludes charges and other nonrecurring items, increased by 6% in the second quarter, to $30.0 million, on sales up 6%, to $538.6 million. Most significantly, the company moved from negative cash flow to positive. "Pricing actions yielded approximately $16 million of sales improvement compared to the second quarter of last year, which helped offset the significant increases in raw material, energy, and freight costs," Rogerson says. "Raw material costs increased approximately $18 million from the second quarter of last year; but were up only $700,000 compared to the first quarter," he says.
The results were slightly below Wall Street estimates, but analysts remain upbeat on the company's financial outlook. "Despite a modest miss on second-quarter earnings due to rising raw materials costs, this cash flow-driven investment story remains intact," says David Begleiter, analyst at Deutsche Bank (New York). "With an estimated 20% compound free cash flow growth in 2005-06, improving pricing trends, accelerating volumes in the second half, and a modest valuation, Hercules remains one of the more attractive stocks in the chemical sector," Begleiter says.
Hercules' downsizing has left it with four business lines, all of which have leading positions (chart, p. 15). It commands about 22% of the paper chemicals market-well ahead of number-two player Nalco (chart, p. 16). Hercules' Aqualon unit is the number-one player in the cellulosics market, with a 28% market share-second ranked Dow Chemical has about 19%. Its FiberVisions unit is the leading player in polyolefin fibers, while its Pinova unit is the only producer of pale wood rosins and derivatives.
The company's financial goals are for double-digit cash flow and earnings per share growth, and a 0.5 percentage point annual increase in return on invested capital, Rogerson says. "We compensate executives on cash flow, with a full 50% of our variable compensation based on that measure," he says. The main priority for cash is debt repayment, with a goal of returning to an investment-grade credit rating, he adds. The company says it will focus on investments that encourage top-line expansion via innovation, market growth and extensions, investment in emerging markets, and on small bolt-on acquisitions. It says 5%-8% sales growth should be sustainable over the long term.
Paper chemicals, Hercules's largest division, reported a 5% volume increase and an 8% sales increase in the second quarter. Profits were flat, however, as a result of higher raw material, freight, and energy costs, severance charges, and the effects of a paper industry strike in Finland, which reduced profits by about $2.9 million, Hercules says. There was a 4% positive impact from rate of exchange in the quarter, and a 1% increase in price, offset by a 2% unfavorable product mix, the company says.
PRICE PUSH. That level of price increase is well below the rate reported by many specialty firms in the quarter, however. "Compared to many of our peers, we are doing well on pricing, Rogerson says. "But we have not been as effective as the broad specialty chemical industry, and a lot of those companies are our suppliers," he says. Hercules is back integrated into some paper chemicals, but also buys chemicals from other specialty firms for many of its proprietary formulated products. The pricing picture is improving however, and the company announced another increase in the first quarter. The company recently switched its incentive program for the paper chemicals business to one based on margin rather than volume.
"The paper chemicals market is good in North America; Western Europe is flat but it's hard to tell the exact picture because of the Finnish paper industry strike," Rogerson says. The Asia/Pacific market is also good, especially in China, but its been difficult to get pricing there as the market is fragmented," he says. The company expects overall results to improve as a result of a restructuring to a regional organization, and a new business model that tailors the amount of service to particular customer requirements, versus its previous full-service model. The company recently appointed Paul C. Raymond to head the operation; he formerly ran Honeywell's electronic chemicals business, where he implemented a similar business model.
Hercules claims it has the widest portfolio in paper chemicals, supplying all product sectors with the exception of binders, a market it considers commodity like. "Our paper chemicals business is technology-based with many proprietary formulations," Rogerson says. The company has 20 plants, and several tolling agreements, including a cross-tolling deal with GE, which acquired the nonpaper industry business of Betz in 2002. Hercules also has a separate business unit, industrial specialties, that handles sales of its paper chemicals to other markets, such as wood products or textiles. It does not disclose separate results for that unit, however.
The company's highest-margin business is Aqualon, which supplies cellulosics for rheology modification in coatings and other aqueous systems. "Aqualon has been growing the top and bottom line at double-digit rates, although profit growth has been slower this year due to raw material cost escalation," Rogerson says. It reported a 2% volume increase and a 6% sales increase in the second quarter, but profits decreased by 8%, mainly as a result from higher raw material, freight, energy and selling, and general and administrative costs, the company says. There was a 2% positive impact from rate of exchange, 1% from increased price and 1% from product mix, the company says. There was also a volume shortfall in Europe, mainly a weather effect which affected demand for paints and coatings, but that is expected to recover soon.
The long-term outlook for Aqualon is good, particularly because of a shift of its products into new markets in personal care, pharmaceuticals, and food, Hercules says. Examples include use in "2-in-1" shampoo and conditioner products, pharmaceutical pill coatings, and in dairy products. However, pricing has been a problem in some product lines, including methyl cellulose, because of overcapacity; and carboxymethyl cellulose (CMC), because of dumping. However, the company recently received a positive ruling in a case brought against CMC competitors in Finland, Mexico, the Netherlands, and Sweden (CW, June 22, p. 4), which will now face antidumping duties.
Hercules is interested in boosting its position in methyl cellulose, "the one basic polymer where we're not number one, but we'd like to be," Rogerson says. John Roberts, analyst at Buckingham Research (New York) suggests that Hercules is interested in Bayer's WoIfT Walsrode unit, the number-three methyl cellulose maker. "We have looked at opportunities, including the Clariant business that Shin-Etsu acquired, but a deal like that mentioned with Bayer is not likely," Rogerson says. "We look for synergy opportunities, and you would typically be buying a plant within a large chemical complex and potentially paying a fixed service fee. But there are a number of smaller producers where you may be able to work out a strategic deal in a sale process that doesn't go out to bid-that was the case when in late 2003 we acquired a 10,000 m.t./year CMC plant in China for about $10 million."
The presence of a bidding process was one reason Hercules passed on one major paper chemicals property, that of Raisio, which was recently acquired by Ciba. "We are generally a lot more cautious about acquisitions," Rogerson says. "We learned a number of lessons from the Betz transaction. We are not the eager buyer we once were." Hercules remains interested in smaller, bolt-on acquisitions, he says. It could also face antitrust problems in major paper chemicals, as was the case recently for its FiberVisions unit. FiberVisions dropped a deal last year to acquire Meraklon, a major European rival, because of antitrust concerns.
FiberVisions posted disappointing results in the second quarter; profits remained flat, as sales fell 2% on a 19% slump in volumes, offset by a 14% higher price, a 2% favorable rate of exchange, and a 1% favorable product mix. "The extent of the volume decline was a surprise; we expected only half that, as we had curtailed production where we couldn't get sufficient pricing movement," Rogerson says. The company mothballed fiber lines at Athens, GA and Varde, Denmark in November 2004. The Athens line was restarted in July, but the Varde line remains down until market conditions improve, Hercules says. The volume declines reflect lower demand for diaper coverstock, which is shifting to cheaper spunbond polypropylene, and slower than expected growth in disposable wipes.
"We expected more private-label wipes business to have converted from polyester or rayon, but the run-up in PP prices means the price differential is currently not as broad. We need a more normal spread to return for that substitution to occur. We expect volumes to pick up as new products are introduced, but profit margins depend a lot on PP prices," Rogerson says.
FiberVisions, the last of Hercules' materials business, is one that could be a possible divestment candidate "at the right price and time," Rogerson says. "FiberVisions is not particularly capital intensive, but it's our only cyclical business, because of the PP cost cycle. We could partner, maybe find firms making other PP fiber or filament products. For an outright sale, the price would have to be relatively high for a deal to create value for Hercules," he says.
The company's smallest business unit is Pinova, a wood rosin and terpenes business that was left over when the company sold its resins business to Eastman Chemical in 2001. "Basically no one wanted to buy it four years ago. It has never been cash negative, although it lost money last year," he says. Rogerson promoted Kathryn Fialkowski last year to head the business and charged her with turning it around. "Right now, it is making money," Rogerson says. Analysts note that the business's sole plant is close to the Sea Island, GA resort area, and the site could have significant value if closed and remediated.
Meanwhile, the dramatic improvement in Hercules' cash flow has allowed it to reduce debt, and get closer to its goal of an investment-grade credit ratings. Debt has been cut from $2.75 billion before the Betz sale, to $1.1 billion today. "We are not yet investment grade, but some of our debt trades like investment grade," Rogerson says. "We want to return to investment grade-it demonstrates financial discipline, and it gives us more flexibility to do things. But I don't want to leverage up heavily to do a deal."
Pension costs continue to be a big drag on the company's finances. The company has just 2,800 employees, but almost 25,000 retirees. Hercules will have $47 million in non-cash expenses pension expense this year, but that is expected to decline going forward, Rogerson says. The asbestos picture has improved, however. The company received a significant settlement from its insurers, meaning that it will be cash flow positive on asbestos this year. "Over time, asbestos cash outlays are expected to average about $15 million/year, versus as much as $30 million/year in previous years, he says. The company supports federal legislation for an asbestos fund. The cash costs to Hercules would likely be modestly higher than $15 million/year "but it would be good for us because of the certainty legislation would bring," he adds. "It's certainly the lesser of two evils"
The company says it is also spending more to support its growth plans. Aqualon received the largest chunk last year, including a major expansion of hydroxyethyl cellulose capacity worldwide. "The focus this year is on enhancing our plant capabilities to produce newly developed products, particularly those that target new markets, Rogerson says. "We have market leadership across several areas, including coatings, oil drilling, and food, and supporting new applications is driving growth." The company also made an investment to support a boost of paper chemicals production as part of an expanded deal with GE.
While Hercules remains cautious on M&A, smaller bolt-on deals will be considered "if they can create value," Rogerson says. It is particularly interested in deals that will take it into developing regions, and deals that would expand its exposure to the food and personal care industries. "The one business I really regret we had to sell was our food gums business-what became CPKelco when combined with the former Monsanto food gums business. We'd be interested in deals in the ingredients area," he says."
The company could be interested in a larger deal, but only if it was a part equity transaction that didn't require a large degree of leverage, Rogerson says. "We are open to value creating merger deals. If we were a $4-billion company we'd have more mass over which to spread R&D and other corporate costs," he says. "We've gotten quite a bit smaller in the past few years because of divestments, and there are advantages to being bigger, but only if we take those advantages and drive value creation for our shareholders."
Analysts say they are pleased with Rogerson's efforts. "The past 18 months appears to represent a return to normal, ongoing operating mode," Roberts says. "Challenges remain, and while the entire senior team is relatively young-most in their 40's-we believe the company faces nothing they haven't managed through before," Roberts says. "Aside from debt, the other legacy issues this management team inherited include high pension liabilities, asbestos and environmental liabilities, and pending legal issues. But the issues are well known by investors, appear improving in aggregate, and do not appear to be distracting management from operations."
A return to normal operations means Hercules has also rejoined ACC. "We dropped out because had real financial challenges in 2001-it was always was our intention to rejoin," Rogerson says. "Hercules is in a different position now and we are trying to improve the outside perception of the company. It used to be 'poor Hercules, I wonder if they will make it,'" he says. "There is still a lot of work to do, but we are dealing with our legacy issues, and driving a successful growth strategy; funding innovation and productivity initiatives, focusing on emerging markets and targeting strategic bolt-on acquisitions. I want people to know that Hercules is back on track and we are excited about our future."
