Calculated Supply Chain And Market Expansion Drive Robust Growth And Margin Improvement

Key Takeaways

• Operational cost reductions and workforce productivity improvements aim to positively impact net margins.
  
• Strategic customer diversification and new investments in production capacity signal potential revenue growth and improved market share.
  
• Challenges including inventory destocking, operational issues, a significant fraud event, increasing tax rates, and competitive pressures in various markets may impact revenue and net margins.

Catalysts

Produces and sells specialty and intermediate chemicals to other manufacturers for use in various end products worldwide.

• The company's ongoing $50 million cost reduction goal for 2024 through disciplined efforts in supply chain management and workforce productivity actions is likely to decrease operational costs, positively impacting net margins.
  
• Expected volume growth in global markets, supported by strong second-quarter performance in surfactants and specialty polyols, suggests an increase in revenue.
  
• Stepan's strategic focus on diversifying its surfactant customer base by acquiring over 800 new customers in the first half of the year could lead to revenue growth from increased sales and potentially higher market shares.
  
• The anticipated recovery of the agricultural chemicals business in the second half of 2024 and the completion of operational expense reductions at the Millsdale site are likely to improve earnings and contribute positively to net income.
  
• Finalization of the new alkylation investment in Pasadena, Texas, expected to start in the fourth quarter of 2024, promises future growth in production capacity and sales, enhancing revenue and earnings.

Assumptions

• Analysts are assuming Stepan's revenue will grow by 6.8% annually over the next 3 years.
• Analysts assume that profit margins will increase from 1.6% today to 8.0% in 3 years time.
• Analysts expect earnings to reach $214.1 million (and earnings per share of $9.24) by about September 2027, up from $34.8 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 12.3x on those 2027 earnings, down from 50.6x today. This future PE is lower than the current PE for the US Chemicals industry at 26.0x.
• Analysts expect the number of shares outstanding to grow by 0.64% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.2%, as per the Simply Wall St company report.

Risks

• Continual inventory destocking and lower volumes in the agricultural market, particularly in North America and Europe, indicating potential revenue challenges in these regions.
  
• Operational issues at the Millsdale site leading to lower falcon hydride volumes and higher operational expenses, negatively impacting net margins.
  
• A significant fraud event in one of the company's Asia subsidiaries suggesting vulnerabilities in internal controls, leading to direct financial losses and potentially affecting investor confidence.
  
• Increasing effective tax rate due to the anticipated disallowance of the Domestic Production Activities Deduction (DPAD) and foreign tax credits, impacting net income negatively.
  
• Competitive pressures and less favorable product mix in the Latin American market, which could pressure revenue and margin in the surfactants segment despite volume growth.

Valuation

• The analysts have a consensus price target of $97.0 for Stepan based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $2.7 billion, earnings will come to $214.1 million, and it would be trading on a PE ratio of 12.3x, assuming you use a discount rate of 7.2%.
• Given the current share price of $78.21, the analyst's price target of $97.0 is 19.4% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.