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ikkyu2 (99.52)

Out of OLN

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August 18, 2009 – Comments (6) | RELATED TICKERS: OLN

I've posted a lot about OLN in this space.  If you were paying attention, 2 years ago you caught a run from 14 to 29, collecting a nice 5% dividend while the stock ran up.  You got out at 27 along with me and got back in, if you had the wit, somewhere between 9 and 11.

OLN is a nice stock to analyze for a couple of reasons.  First of all, the $0.80 dividend has not changed in decades.  Second of all, they are a monoline cyclical commodity stock, chlor-alkali, levered to energy and an input for textiles and housing, and the stock more or less behaves that way.  (They have an ammunition division that generally contributes 11-20% of revenues and a disproportionately large amount of margin.)

They don't carry much debt and they recently acquired their next-largest competitor to cement their #3 position in chlor-alkali; their 2 larger competitors, Dow and PPG, are large conglomerates and lack the easy transparency of OLN's balance sheet.  And, finally, PPG gives a very thorough report, including pricing details, about a week ahead of OLN, so if you pay attention, you always know exactly what OLN's going to report, within a penny or two, which is nice if you like to trade the latest quarter's multiples before they're published.

OLN's Cl-Al division is going to report earnings of about $0.12 during 3Q.  I don't know what their ammunition division is going to contribute; last 2 quarters it was 5 or 6 cents per quarter, but these have been the historically strongest 2 quarters for ammunition in the last 20 years and there is no reason to expect that trend to continue.  (Most of the anti-Obama gun nuts who have decided they need to lock and load have, presumably, already done so.)  So I see OLN putting in a $0.17 third quarter, which will not cover their dividend, and they have already guided that they expect 4Q to be "very weak." 

All well and good - they have cash on hand to cover the next two quarter's dividends.  But they've just issued $150 million in debt.

Call me old fashioned - I love a good dividend stock - but I don't like it when a company borrows to finance a dividend.  They could be getting ready to do another acquisition, but if you look at their last one they didn't do so hot; they acquired Pioneer's operations for $436 million, a significant discount to that company's 2006 enterprise value, but they only got a year's worth of production out of them - barely had time to iron out the integration issues and restore margins to where they belong - before they had to start idling capacity.  Right now they're running 70% capacity and they're going to have to idle more in the next 2 quarters, which means they paid $436 million 3 years ago to acquire plants that they won't be running for a year or two.

I like OLN.  I like it well enough that if management really felt like they needed to raise some capital, I'd be happier to see them suspend the dividend to do it.  Raising capital at today's rates to pay their current generous dividend doesn't make sense to me; dividends should come out of free cash flow, just as the debt servicing money will come out of future free cash flow that would otherwise be available to common.

Also, if you paid attention to me and picked up OLN at $10, you've enjoyed a nearly 50% run.

I suggest punching out here for a quarter or two, at least until we see what OLN intends to use this money for. 

6 Comments – Post Your Own

#1) On August 18, 2009 at 5:19 PM, Imperial1964 (97.90) wrote:

I bought OLN at $12 because when they were under $10 I had better values to buy.

I do think the strong ammo demand will continue for at least another quarter.  Ammo isn't quite as scarce as it was before, but some types are still unavailable.

OLN always pays a dividend, even if they have to borrow it.  That's what they have done for decades, if not longer.  I don't like taking on debt, but on the other-hand, their 6% dividend is probably the safest out there.

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#2) On August 18, 2009 at 7:19 PM, ikkyu2 (99.52) wrote:

They gave away 15% of the company, Imp'64.  That means 15% of the company was taken away FROM common and given TO bondholders.

That's not shareholder friendly in my book.  There's more to this game than keeping the dividend alive.

 

 

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#3) On August 18, 2009 at 11:38 PM, Imperial1964 (97.90) wrote:

Technically, part of the company was sold to bondholders.  You may be right it is more than just paying dividends.

Precisely, that $150M is 13% of the company by market cap and that covers little more than 2 years of dividends.  Perhaps they are anticipating a couple of years of losses (they are cyclical after all) and the credit market tightening again.  I wouldn't rule that out, either.

Back in '93, around the last major recession, they lost $94M.  In '85 they lost $165M.

I wish I had time to do some real investigation, but I won't have time for several more weeks.  So for now I'll just have to trust management on this one.  OLN's lower and even middle-management is questionable, but I have great respect for their upper management.

Thanks for noting the information.  And I am also skeptical that borrowing $150M is good for shareholders, but I'm not rushing to sell my shares yet.

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#4) On August 19, 2009 at 12:58 AM, ikkyu2 (99.52) wrote:

Actually agree with everything you say; I did choose to take profits here, but if it goes back down to 11 I will probably re-invest.  OLN's upper management is far smarter at the chlor-alkali game than I, no doubt about that; the only advantage I have over them is they have to play the hand they're dealt, whilst I can punch out.  If they end up making a brilliant acquisition of some distressed play that lets them make inroads into a competitor's market or something like that, then I'll be looking pretty dumb.

It'll be interesting to see what the market's doing come Oct 20th or so, when they post that 13 cent number.  There is a lot of knee jerk stuff that goes on.

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#5) On August 19, 2009 at 1:53 PM, OceanaInc (< 20) wrote:

Olin does have liabilities which it may be trying to resolve -in part because there is legislation poised to require a major investment on them.

The company operates two mercury-based chlor-alkali factories. These factories use a 19th century technology that is very energy intensive to create chlorine and caustic, not to mention the mercury pollution that comes from them. Meanwhile, their competitors (including Dow and Oxychem) are completely mercury-free and use newer, membrane-cell technology. This newer technology is up to 37% more energy efficient. PPG has upgraded its factory in Louisiana to this newer, more efficient technology.

The Mercury Pollution Reduction Act (HR 2190 and S 1428) would require the phase-out of mercury-based chlorine production within two years of passage and is very likely to be passed.  If it is, they'd need to shift to mercury free technology by 2012. Oceana estimated it could cost about $117 million to upgrade the Tennessee plant, while it could cost about $90 million to upgrade the Georgia factory.

Have you considered that Olin may be using the $150m to upgrade one or both of their mercury-based factories?  If so, how would it affect your recommendation?

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#6) On August 21, 2009 at 2:43 AM, ikkyu2 (99.52) wrote:

You can't "upgrade" a mercury plant to membrane cell.  You pretty much have to tear it down and build a new membrane-cell plant, plus a few tens of millions in local environmental remediation.

OLN runs energy-intensive mercury in a couple of its plants because it has dedicated hydroelectric power for them.  The turbines are built, the water spins them, they get power coming across the lines virtually free, so they don't have to concern themselves with energy efficiency - these plants are usually more cost-efficient (not energy efficient) when natural gas prices are moderate to high.  This gives them a competitive cost-of-sales advantage and makes OLN the de-facto lowest cost producer and therefore price setter; replacing these plants with membrane cell technology would make that advantage disappear.

They'd be dumb to do anything with these plants before these Congressional bills pass.  And if that's really what this is - the Senate and the House kicking sand in OLN's face, to the tune of forcing them to make a $150 million capital investment that ends up making them less competitive going forward - well, then, I would be a seller of OLN under those conditions. 

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