PolyOne, a new full position

This is a specialty chemical company that was first recommended by The Reitmeister Trading Alert (a Zack’s newsletter). Being a trading newsletter he’s since sold out of it, so I’m not giving away anything, but I sometimes find good longterm buys from his short-term picks. What interested me is that they have 19 quarters in a row of double-digit year-over-year growth in adjusted EPS. They’ve also remade the company in the last 10 years as their specialty, higher margin chemicals have grown from 2% to 65% of their revenue. Remember though, chemicals can be a cyclical industry (though specialty chemicals probably less so). They pay a rapidly increasing dividend and they have bought back over 8 million shares since early 2013. They have over $100 million in Free Cash Flow per quarter so can afford to buy back and give dividends and still have plenty left over for growth and acquisitions.

Here are a couple of recent press releases.

Saul

Oct 2014 – 25% raise in dividend
Declared a quarterly cash dividend of ten cents per share, representing a 25% increase and the fourth consecutive year of annual dividend growth.

We have increased our annual dividend 250% since we initiated it in 2011. This reflects the rapid pace at which we have strengthened our financial performance, and underscores the confidence we have in our ability to continue to achieve accelerated earnings expansion into 2015 and beyond.

July 2014 - June quarter results
• Adjusted earnings up 38% to $0.51 - the 19th consecutive quarter of double-digit adjusted EPS growth.
• Led by the Specialty Platform, all segments delivered year-over-year operating income gains
• Free cash flow for the quarter increased to $100 million, expanding capacity for further investment to drive growth

They continued to exit certain unprofitable products associated with the Spartech acquisition completed in March of last year. Accordingly, revenues were $1.01 billion for the second quarter of 2014, compared to $1.04 billion in the second quarter of 2013.

These actions, coupled with other ongoing initiatives to expand margins, resulted in a 38% increase in adjusted earnings per share to $0.51 for the second quarter of 2014, up from $0.37 in the second quarter of 2013.

“I am pleased to report adjusted earnings per share increased 38% to $0.51 for the second quarter representing an all-time high for PolyOne. This marks our 19th consecutive quarter of year-over-year double-digit adjusted EPS growth – an impressive accomplishment reflecting the power and sustainability of our strategy. Mix improvement continues to be at the heart of our transformation as our specialty businesses reached record levels of operating income and profitability for the quarter. Driven by an expanding portfolio of specialty solutions, our underlying mix of earnings has never been stronger with specialty now contributing two-thirds of our segment income.”

Our strong track record of converting earnings to cash continued this quarter as we generated $100 million of free cash flow. We ended the quarter with $261.5 million in cash. This, coupled with our availability under our asset-based revolver, gives us significant capacity to invest in innovation, aggressively pursue acquisition opportunities and deliver cash to shareholders. During the quarter, we repurchased approximately 1.8 million shares at an average price of $38.15, bringing the total share buyback since early 2013 to 8.2 million shares."

We are very pleased with our first half performance. While our second quarter is seasonally our strongest, we expect to deliver strong year-over-year double-digit EPS expansion for the balance of 2014. With a growing pipeline of new and differentiated solutions, we are very confident in our ability to continue to create value for our customers and deliver market-beating performance for our shareholders.

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I forgot to mention, PolyOne (POL) sold off from a high of $43.50 to a low of $32 something with this recent craziness and is now at $33 and change and just over 20 times earnings.

Saul

Hi Saul,

Thanks for the heads-up.

I quickly went over the last earnings report for sales information on the continuing operations, and I don’t know if you’ve seen this.

http://www.polyone.com/en-us/news/Pages/CorporateNews.aspx

It looks like the six months YoY sales growth looks okay. But the three months YoY sales growth is minimal.

Taking a quick pass at the numbers, it looks like they are improving margins nicely. But they are doing this without increasing revenues much. This could be a drag on the stock price.

For example, their “Designed Structures and Solutions” segment had revenues decrease by over 15% (199MM to 164MM) while its gross margin was up almost 5% (25.5MM to 26.3MM). Perhaps there are good reasons for this. Discontinued operations may be “Corporate and eliminations”, which is a separate is line item showing larger negative margins. But it cannot be determined from the report. The other two segments had quarterly YoY revenue declines as well.

Given the lack of sales growth in their continuing operations, I’d be afraid to invest in this company. However, if it ever becomes a Fool pick, I’d follow it better and lean on the full community coverage.

Perhaps you’ve dug into it a bit deeper and figured this out already. But I wanted to try to add just a bit of value to your analysis.

DJ

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But the three months YoY sales growth is minimal.

Hi DJ,

Thanks for looking into POL. However, you missed this line from my write-up:

They continued to exit certain unprofitable products associated with the Spartech acquisition completed in March of last year. Accordingly, revenues were $1.01 billion for the second quarter of 2014, compared to $1.04 billion in the second quarter of 2013.

They are closing out of unprofitable lines that they acquired, but continuing operations are growing fine.

Saul

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DJ, I’d suggest you listen to the last conference call where they were very explicit about it. Also the CEO saying the 19 quarter of double digit year-over-year won’t end on his watch. (A brag, but it shows his intentions, and that he’s not worried about it.) Also profit was up significantly even in Europe, the “sick man” of the world.

Best,

Saul

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One last thought. As a part of remaking the company, they have, and continue to, eliminate commodity products which added to revenues but not to profits. It’s clear that margins and profits are definitely going steadily up.

Saul

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Hi Saul,

This is what I saw in the quarterly earnings announcement, which doesn't indicate sales growth, even among the divisions in which they are 
not divesting:

          Three Months Ended June 30,          Six Months Ended June 30,

                          2014        2013           2014        2013

Sales:
Global Color,
Additives & Inks          **$228.7**      $229.4         $448.3      $434.7

Global Specialty 
Engineered Materials       **157.8**       158.8          315.2       311.7

   
Designed Structures 
& Solutions                **164.0**       198.9          337.6      240.4

Specialty Platform         **550.5**       587.1        1,101.1       986.8

Performance Products 
& Solutions                211.2       210.3          418.8       376.9

PolyOne Distribution       287.0       275.1          571.1       543.1

Corporate 
& eliminations             _**(43.2)**_      (34.9)         (83.2)      (68.1)

Sales                   $1,005.5    $1,037.6       $2,007.8    $1,838.7

So in 3 of the 5 divisions that are presented, the quarterly revenue has gone down. Now, I interpreted **Corporate & Eliminations** as an adjustment 
to revenues to reflect discontinued operations. If this is how they adjust for discontinued operations, the quarterly YoY revenue growth is negative. 
I didn't see anything in the press release that says revenues would have been higher is divested operations were included. Perhaps this is incorrect 
and I'm missing something. 

Here is the press release, which does not mention anything about sales growth:

<i>PolyOne Announces Second Quarter 2014 Results
CLEVELAND, July 21, 2014 /PRNewswire/ --

Adjusted earnings per share increased 38% to $0.51, marking the 19th consecutive quarter of double-digit adjusted EPS growth; GAAP EPS 

totaled $0.33 versus $0.39 in the prior year quarter. Led by the Specialty Platform, all segments delivered year-over-year operating
income gains driven by continued mix improvement and synergies from the 
Spartech acquisition. Free cash flow for the quarter increased to $100
million, expanding capacity for further investment to drive growth. PolyOne Corporation (NYSE: POL) today reported its second quarter
results.  As expected and to drive earnings growth, the company continued to exit certain unprofitable products associated with the
Spartech acquisition completed in March of last year.  Accordingly, revenues were $1.01 billion for the second quarter of 2014, compared to
$1.04 billion in the second quarter of 2013.  

These actions, coupled with other ongoing initiatives to expand margins, resulted in a 38% increase in adjusted earnings per share to $0.51 for
the second quarter of 2014, up from $0.37 in the second quarter of 2013. Recently announced asset realignment actions taken in Brazil led to 
higher restructuring costs this quarter. As a result, GAAP earnings per share totaled $0.33 for the second quarter of 2014 versus $0.39 in the
second quarter of 2013. 

"I am pleased to report adjusted earnings per share increased 38% to $0.51 for the second quarter representing an all-time high for PolyOne,"
said president and chief executive officer Robert M. Patterson. "This marks our 19th consecutive quarter of year-over-year double-digit 
adjusted EPS growth – an impressive accomplishment reflecting the power and sustainability of our strategy." 

Mr. Patterson added, "Mix improvement continues to be at the heart of our transformation as our specialty businesses reached record levels of
operating income and profitability for the quarter. Driven by an expanding portfolio of specialty solutions, our underlying mix of 
earnings has never been stronger with specialty now contributing two-thirds of our segment income."

Q2 2014 Adj EPS
 

Q2 2014 Transformation
"Our strong track record of converting earnings to cash continued this quarter as we generated $100 million of free cash flow," said executive
vice president and chief financial officer Bradley C. Richardson.

Mr. Richardson continued, "We ended the quarter with $261.5 million in cash.  This, coupled with our availability under our asset-based
revolver, gives us significant capacity to invest in innovation, aggressively pursue acquisition opportunities and deliver cash to 
shareholders. During the quarter, we repurchased approximately 1.8 million shares at an average price of $38.15, bringing the total share
buyback since early 2013 to 8.2 million shares."

Commenting on the company's outlook, Mr. Patterson said, "We are very pleased with our first half performance in 2014 and the underlying
momentum and strength of our earnings growth.  While our second quarter is seasonally our strongest, we expect to deliver strong year-over-year
double-digit EPS expansion for the balance of 2014.  With a growing pipeline of new and differentiated solutions, we are very confident in 
our ability to continue to create value for our customers and deliver market-beating performance for our shareholders."

About PolyOne 
PolyOne Corporation, with 2013 revenues of $3.8 billion, is a premier provider of specialized polymer materials, services and solutions. The
company is dedicated to serving customers in diverse industries around the globe, by creating value through collaboration, innovation and an 
unwavering commitment to excellence. Guided by its Core Values, Sustainability Promise and No Surprises Pledge(SM), PolyOne is committed
to its customers, employees, communities and shareholders through ethical, sustainable and fiscally responsible principles. For more 
information, visit [www.polyone.com](http://www.polyone.com).</i>

Naturally, listening to the conference call will help a lot. I'll do this when I have some additional time.

DJ
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Hi DJ,
After I read Saul’s post, I went to read the company’s earning releases and past couple of CC transcripts. I noticed that Q2 revenue dropped as well. Here are the excerpts from CC to address the issue,
From Q1 CC:
“Sabina Chatterjee - Wells Fargo Securities, LLC, Research Division
Just wanted to ask a question on Global Color. It looks like pricing gains were really impressive, but volumes were down about 6%. Was this dynamic more a function of continued pruning on your part or actual weakness in the industrial end markets?
Robert M. Patterson - Chief Operating Officer and Executive Vice President
Really, we didn’t see any weakness in industrial end markets or any region, to speak of. So it is an ongoing improvement in mix that continues to drive operating income expansion despite what you might see as lower volumes.
Sabina Chatterjee - Wells Fargo Securities, LLC, Research Division
Okay, so on that front, have we reached a more optimized portfolio with the pruning actions or would you say there’s still x percent to go before you hit sort of what you would feel is ideal?
Stephen D. Newlin - Chairman, Chief Executive Officer, President and Member of Environmental, Health & Safety Committee
Sabina, I wouldn’t – I really wouldn’t categorize it as a certain specific percentage that we’d want to go. I would categorize it as it’s an iterative process of high grading your business and concentrating your products to add more and more functionality and customer benefit into them. And then potentially and usually selling them at not only a higher price per pound, but at a higher profit margin, because we’re creating some additional value for that customer by reducing processing, et cetera. And we have this ongoing process that you know very well, and that’s always improving the accounts. But a lot of this is done by, for example, a conversion from a dry to a liquid color, which would reduce revenue, would reduce tonnage but would improve profitability. So that’s – we’re just continuing on that march. There’s a, I guess, more intense element of that going on in Spartech right now, which I expect will continue at a more brisk pace there for the next 3 years or so. But it is a chronic, I think, aspect, an important aspect, of our ongoing strategy even in our core business. We just don’t really map it out and say we’re going to take this percentage out this year. A part of it is driven by the technology development pipeline and how robust that continues to be.”
From Q2 CC:
“Frank Joseph Mitsch - Wells Fargo Securities, LLC
Okay, great. Clearly margin expansion was terrific in Q2, a lot of that done via pruning, I’m guessing, and where do we stand on that effort, I mean, is the bulk of that behind us, are we in the midst of it, are we in the, where do you think we stand on that particularly as it pertains to the Spartech portfolio.
Robert M. Patterson
Well, first of all you do see some level of impact from exiting unprofitable business in each of our segments as they all with the exception of POD, I have some Spartech business that they inherited, and that’s largely where these actions were contained to. So you do see that across the board. But most predominantly in the DSS segment, which of course was entirely Spartech. So, I believe that we’re always going to see some ongoing mix improvement and exiting unprofitable businesses, but for the balance of this year and going forward at a much slower pace.”

It seems to me, Spartech legacy businesses are in most of if not all POL business segments, even those three specialty businesses. So when the company exited the unprofitable businesses, revenue took a hit, even with the efforts to enhance the product mix and offer innovative products, but going forward, I think the revenue will go upwards again. There is big tailwind behind the chemical industry, the oil price is down quite bit so the input cost will be lower. Also, I heard Nancy from Cornerstone Macro mentioned on the Wealthtrack show that there will be several big chemical plants built here in the States, so clearly, this is plus as well.

In terms of valuation, I followed Saul’s instruction and plotted the eps vs stock price, when the stock price went to 43 something, the pe was 31. And now is back to just north of 20, if you calculate the ttm eps based on the street estimate for Q3. This is more reasonable.

The one concern I do have right now is company’s business in EU. Since 14% of 2013 revenue was from that region. This will be a wild card.

Zangwei

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