Year End #18: POL - Good growth at a reasonable

POL or PolyOne is a relatively new position for me. I got the idea from Zacks Reitmeister Letter. PolyOne is a chemical company, which has transformed its business from a commodity, high volume, low margin company, to a specialty, high margin company. They now have 21 successive quarters of double-digit year-over-year growth in adjusted earnings (usually much more than 10%). I entered it about 15 weeks ago at $32.75 and fairly quickly took an average or full position in it roughly at that price. It got up to $39.00 a month ago and was at $36.00 at yesterday’s close.

Here’s what their adjusted earnings growth has looked like. You’ll note that their December quarter is always sequentially lower, but up substantially from the year before.

2012: 24 30 24 18 = 96
2013: 31 37 36 26 = 130
2014: 44 51 49 36 = 180

Note that adjusted earnings were up 35% and 38% year over year. Revenue, on the other hand, has been flat as they predicted, as they are exiting acquired lines of unprofitable commodity products from a recent acquisition.

Trailing earnings look like this on a quarterly basis, from Dec 2012 to Dec 2014


At $36 they are exactly at a PE of 20.

In October they raised their dividend by 25%. They have lots of Free Cash Flow, and they repurchase lots of shares

Declared a quarterly cash dividend of ten cents ($0.10) 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 underscores the confidence we have in our ability to continue to achieve accelerated earnings expansion into 2015 and beyond.

Here’s a January public article from Seeking Alpha that I found interesting and useful

Jan 2015 –- PolyOne’s Transformation Is Ongoing And Will Drive Profits Further

• The shares have stumbled in recent months, likely due the risk surrounding the change of CEO. But this is a healthy consolidation after a strong run.
• The transformation to a specialty company is not complete and the firm, through organic growth and acquisitions, will drive specialty to 75% of revenue in 2 years.
• We think sometime in 2015 the firm’s debt will be upgraded to investment grade, which could propel the equity along with the debt.

PolyOne has undergone a massive transformation that has re-positioned the company as a specialty polymer provider from a commodity player less than a decade ago.

The Transformation Is Ongoing - When Stephen Newlin became CEO of PolyOne back in early 2006, the company was largely a commodity producer. The business model relied on volume to drive sales and they were heavily tied to cyclical end markets which created boom and bust cycles.

The shift in the business model has been nothing short of dramatic going from a low-margin commodity plastics company to a high-margin specialty engineered products business with a much more diverse end-customer.

In 2005, the specialty business accounted for just 2% of operating income but now is nearly 64%. Earnings have grown at a massive 22% compound rate since 2005. Most other metrics show similar strong results including return on invested capital which has risen from 5% to over 10% in 2013.

The on-time delivery rate was just 81% back in 2006, which was actually in line with the industry average. But Newlin got it up to 94%.

We think the market has recognized this transformation and boosted the share price accordingly. From late 2011 through the end of June last year, the shares have risen by a whopping 348%! Since June, however, the shares have given back nearly 15%. We would argue that the consolidation that the shares have undertaken since June has been healthy and is likely to set up the stock for a resumption of gains in 2015.

In early 2014, PolyOne announced a CEO succession as Mr. Newlin was preparing to retire. Robert Patterson took the helm of the firm in May of last year serving as both President and CEO. Mr. Newlin is remaining on as the Chairman of the Board. Mr. Patterson was previously the COO and executive vice president. We think the new CEO will continue where Mr. Newlin left off.

Levers of Further Growth Will Continue To Drive Shares
The company laid out their bridge to 2015 EPS of $2.50, up from $0.82 in 2011 for a 32% CAGR over the period. The company is now much more diversified and no end market now accounts for more than 18% (transportation). Most of the growth is likely to come from innovation as the company continues to invest in R&D ($53 million in 2013 versus just $20 million in 2006). The firm has invested heavily in their pipeline as well in marketing, technology and sales teams.

Today, the innovation pipeline has $1.7 billion of market potential new products, the largest it has ever been. We think some of these products could be significant game changers that can quickly expand their presence in higher margin applications within markets such as healthcare, consumer and packaging. The firm has a vitality index which measures the percent of sales from products introduced in the last five years. The index has risen to 43%, well above their goof 35% or better. These new products carry much higher margins and returns on capital.

We think this is the first of many levers that the company is using to grow EPS at double digit rates. They are also still realizing synergies from their Spartech acquisition, conducted two years ago, which is also likely to aid the bottom line. Just recently, they disclosed that they shuttered a former Spartech facility and are still rationalizing and integrating back office function. In addition to the synergies from that past acquisition, management has given hints that they will continue to conduct some additional acquisitions to further augment their product portfolio and boost underlying growth.

Other avenues to get to that $2.50 include a strong share buyback program that has been reducing outstanding shares by approximately 2% per year but has been accelerated as of late. In the trailing twelve months, diluted shares outstanding has been reduced by over 5%. The company has 10.3 million shares available for repurchase under the current authorization with plenty of free cash flow to support a continuation of the current pace of buying.

They also see additional cost savings from their Lean Six Sigma (LSS) program, which achieved strong cost savings across their infrastructure, especially related to G&A expenses. They have over 70 Lean Six Sigma projects underway focusing on safety, quality and value.

Credit Upgrade Likely Coming
Since 2008, the company saw their pension funding go from 60% funded status, to over 100% as of the end of the third quarter. Meanwhile, leverage continues to decline with net debt-to-EBITDA dropping from over 4.0x in the first quarter of 2013, to below 1.9x currently. The company has a small debt issue maturing next year amounting to $48 million. The next issue is not due until 2020 and amounts to $317 million. The coupons on these two issues are in excess of 7% (one is a legacy issue from an acquisition) and are likely to be called and/or refinanced at much lower rates. The lower interest expense and likely lower net debt level and leverage, will boost their credit rating to investment grade. We think this could aid the equity in addition to the debt issues.

Four Megatrends Aligned with Key End Markets
One of the initiatives that management has pushed is aligning the firm in key end-markets to take advantage of megatrends that they see growing those markets at higher rates. They believe the four megatrends are 1) improving global health and wellness, 2) protecting the environment, 3) Globalizing and localizing, and 4) decreasing dependence on fossil fuels.

In the beginning of December, they acquired an Accella unit for $49 million. The unit is a specialty polymer coating producer which Polyone management noted would expand their offerings in consumer products, automotive parts, outdoor recreational equipment and food packaging. Management noted that the acquisition is congruent with their megatrend philosophy.

Despite the incredible run, valuation remains cheap even using modest future assumptions for growth. The shares trade at 16x ntm earnings, just ttm 8.5x EBITDA, and at a PEG of 0.83x. We think the company can grow the top line conservatively at a mid-single digit rate while continuing to expand further into specialty products, boosting operating margins and profitability.

Free cash flow last year grew to $137 million, up from just $74 million the year before. We think the company has reached an inflection point whereby cash flow from operations is growing at exceptional rates while the cash needs to maintain and grow the business are growing much slower, leaving more to hit the free cash flow line. We think free cash flow this year could rise to 4.4% of revenue or $185 million and $230 million in 2015, or 4.8% of revenue. On 2016 estimates, the company has a 5.5% free cash flow yield- quite a value for a company that is growing at such a high rate.
As we noted above, the company has expanded their specialty platform to 65% of operating income in 2014, up from 43% in 2010. Given the new acquisition, we think the firm can achieve 70% in 2015 and forecast them expanding to approximately 75% by 2016. At that level, the firm should be generating EBITDA of at least $550 million.

Under our base case scenario, we think the shares are worth approximately $50, compared to the $36.00 they trade at today. Any short term declines in the price should be viewed as excellent opportunities to enter the name or accumulate more shares.

Conclusion - PolyOne has undergone an exceptional transformation from a commodity producer to a specialty supplier of polymers. We think the industry is likely to experience strong growth over the next few years due to a shift towards specialty engineered products that are more cost effective in their end-markets.

Finally, their last quarter report:

Adjusted earnings increased 38% to 36 cents

Achieved 21st consecutive quarter of strong double-digit adjusted EPS growth

Full Year Results
Adjusted earnings up 37% to a record $1.80

40% EPS CAGR driven by relentless focus on specialty transformation and mix improvement

Adjusted earnings per share increased 38% to $0.36 from $0.26

Revenue was $869 million, down from $924 million. As expected, the revenue decline resulted from ongoing mix improvement, including the exit of unprofitable products associated with the Spartech acquisition and certain operations in Brazil, weaker business conditions in Europe, and unfavorable foreign exchange.

For the full year, revenue was $3.84 billion, up 2% from $3.77 billion. This growth, combined with significant profitability expansion, led to adjusted earnings expanding 37% to an all time record $1.80.

“2014 was yet another great year in our company’s history, underpinned by our unwavering commitment to our four pillar strategy and achieving our aggressive goals. Three of our businesses have already reached their 2015 margin targets with DSS and PP&S having line of sight to getting there this year,” added Mr. Patterson. “Innovation and mix improvement continue to be at the heart of our specialty transformation as 44% of our specialty platform sales were from products introduced in the last five years.”
"Our strong free cash flow for the year enabled us to repurchase 6.3 million shares of common stock and increase our annual dividend 25%. We also completed the acquisition of Accella, thereby accelerating growth in our Specialty platform. With liquidity of $475 million and a net debt to EBITDA of 1.9x, we have ample financial capacity to pursue strategic acquisitions, invest in innovation and continue our share repurchases and dividends. We see tremendous growth opportunities to pursue and capture regardless of economic conditions. I am confident that we will deliver another year of strong double-digit adjusted EPS growth in 2015.

Conclusion: Good results

This company won’t tear up the world, but they have excellent growth at a very reasonable price.



Earning call transcript just came out.…


Thanks Saul. Great write-up. Love learning about new ideas.

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Extracts from the Conference Call

Conference Call Prepared Remarks
Bob Patterson - President & CEO
…Global color, additives and inks, and global specialty engineered materials, led the way, achieving record fourth-quarter Op Inc and margin. In fact, our color business has already reached the midpoint of its 2015 margin target.

For the full year, adjusted EPS was $1.80 per share, a 37% increase from last year. Perhaps even more impressive is that in the last 3 years we have more than doubled our earnings. And since our transformation began, adjusted EPS is growing at an annualized rate of 40%. These strong results were delivered this year despite continuing difficult economic conditions in Europe.

…Back in 2011, our return on sales in Asia was 4%. In just 3 short years that has more than tripled to 12.7% in 2014. In Asia, as we have everywhere else around the world, we’ve improved our mix with a focus on specialty applications.

…5 years ago, we had little to no presence in the shooting sports industry. And today, we have nearly $20 million in sales, with the biggest names in shooting sports and accessories. This is a market in our sweet spot of high-performance, light-weight solutions where failure is not an option.

…As we have transformed, we have shed volume intentionally. We’ve done this to create a more profitable and sustainable specialty enterprise in higher-margin end markets.

Just look at our quarter results; we reported revenue of $869 million versus $924 million last year. As expected, the revenue decline resulted from ongoing mix improvement, including the exit of unprofitable products from the Spartech acquisition, as well as certain operations in Brazil. And we also experienced weaker business conditions in Europe, and unfavorable foreign exchange.

…In the quarter, operating income grew 17%, and adjusted EPS increased 38%, and that’s the bottom line.
As evidence of our strategy in action, I’d like to take a closer look at our European results. Last quarter, we cautioned of heightened concerns about demand conditions in Europe, as well as a weaker euro. We also highlighted that earlier in the year we had taken proactive actions to reduce cost, and improve mix that we believed would help us to offset lower revenues in the region. And we delivered.

Sales in Europe declined 12%, but operating income was up 53%. This is directly tied to our operational excellence and ongoing mix improvement. If we had not been proactive in taking action in Europe, we would now be playing catch-up like some other companies.

…As our investors know, when we acquired Spartech, it was a business that had struggled for years. In 2014, we made bold moves that previous managers had been unwilling to take, and executed a strategy to consolidate operations, all while improving safety, quality, and on-time delivery to our customers. During the year, we completed the closure of plant facilities, but much work remains to improve quality and operational efficiencies at our remaining plants. Our results for the quarter were impacted by our efforts to do just that. And I have every confidence that we will get the former Spartech operations up to PolyOne standards in very short order.

Brad Richardson - EVP & CFO
As Bob said, we delivered another outstanding performance, which continued the strong results we saw in the first 3 quarters of 2014.

This represents our 21st consecutive quarter of strong double-digit adjusted earnings growth. All of our segments in our specialty platform had record return on sales. And 3 of our segments have already reached their 2015 margin targets.

I was also very proud to see our global color, additives and inks, and global specialty engineered materials, overcome the headwinds in Europe to report record fourth-quarter operating income and return on sales. Our specialty businesses now account for 65% of our full-year segment income, and are clearly on track with our 2015 target.
Let’s review each of our segments in greater detail.

Our global color, additives and inks was also impacted by weakness in Europe, Russia and Ukraine. But thanks to actions taken to streamline operations, improve mix, this team remained proactive in upgrading their portfolio, and would not let economic weakness prevent them from another record quarter. Overall for the segment, operating income increased to $27 million, and return on sales was 14.1%. And just as a frame of reference, 5 years ago the return on sales in this segment was 5%…

Our balance sheet and free cash flow remain strong, which is critical to our transformation. Working capital management improved year over year to 9.9% of sales on a trailing 12-month basis, from 10.9% last year. Our continued focus on converting earnings to cash, grow free cash flow of nearly $45 million for the quarter, and contributed to our overall cash balance of $239 million, giving us total liquidity of $475 million.

This balance sheet strength, coupled with rapid earnings growth, allows us to continue returning value to shareholders in the form of cash dividends and share repurchases. Late last year, we announced a 25% increase in our quarterly cash dividend. This was our fourth consecutive increase, and our dividend is now 250% higher than when we initiated it in 2011.

Additionally, during the year we repurchased 6.3 million shares, bringing our total shares repurchased in early 2013 to 11.3 million shares. We repurchased an additional 1.3 million shares over and above the shares issued in connection with Spartech. We still have another 8.7 million shares remaining on our Board-approved repurchase program, and we’ll continue to remain opportunistic in our share buy-back efforts. We also maintained a low net-debt-to-EBITDA ratio of 1.9, and we continue to make strategic investments, including the acquisition of Accella in December for $47 million.

Bob Patterson - President & CEO
Think about this: When we acquired Spartech, we did so for a purchase price of $393 million on $53 million of EBITDA. After our first full year of ownership, the EBITDA contribution from Spartech has more than doubled to $112 million. That’s extraordinary value creation in its simplest terms, and we are very proud to have delivered this for our shareholders. In EPS terms, the Spartech deal added $0.38 per share when compared to our pre-acquisition results….

We received numerous awards in 2014 including customer satisfaction, quality, and Company performance. I’d like to share a small sampling of those with you now. We earned 5 major Supplier of the Year awards. And there is no greater honor than to be recognized by customers such as Becton, Dickinson as the very best. And for us, that’s our goal. We were recognized for the fourth consecutive year by CFO Magazine as having best-in-industry working capital. And the Society of Plastics Engineering in Europe recognized PolyOne as having a best lightweighting innovation solutions. These are just a few of the awards in 2014….

We have a robust pipeline of products and solutions under development, spanning both the product technology side and value-added services. …And finally, lightweighting: Metal replacement technologies are a rapidly growing part of our solutions portfolio, meeting strict performance requirements, and removing barriers to replacing metal with polymers. We can reduce weight, streamline production, and generate cost efficiencies for our customers.

Our pipeline is just one of the many reasons I am highly confident we will deliver another year of strong double-digit adjusted EPS growth in 2015…


Are you completely comfortable with that $1B debt load? I know they’ve acquired some companies and all, but that seems like a lot, it’s almost 1/3 of their market cap.

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