Will Ashland Channel Ben Graham?

April 14, 2009


Well, there's the constancy of the company's dividend payments for one thing. Over the past eight years – the length of the current commodity bull market – dividends have added an average 4.4% to Ashland's compound annual return.

Ashland is liquid, too, with a current ratio of 2.5, well above Graham's benchmark. In fact, the company isn't highly leveraged. Ashland could readily pay down its obligations out of pocket: Its $45 million long-term debt is paltry in comparison to the $1.8 billion in net current assets on its books.

Best of all, Ashland's stock is now cheap. With shares at the $14 level, Ashland's price-to-earnings multiple is only 4.9x. A 15x multiple is Graham's bargain threshold. On a price-to-book basis, the stock's also a deal. A 0.3x multiple is screamingly cheap.

Yet, with all that, there's something about Ashland that Graham wouldn't like. The company's earnings have downtrended recently. But then, whose didn't?

Ashland is due to release its first-quarter earnings on April 27. Analysts polled by Thomson are betting that 27 cents a share gets posted. That's the freshest estimate. The guess has actually been a moving target, wobbling from 32 cents to 25 cents over the past quarter as the market's lurched and surged.

Ashland's nemesis last year was margin compression brought on by a then-inflationary spiral in input costs. That pressure's been relieved recently, though pricing power has been maintained on the revenue side.

The question before investors and traders now is whether this margin improvement is accurately discounted in analysts' earnings projections.

The vacillation in the first-quarter earnings estimate speaks to analysts' own trepidation about being surprised. Their fears are justified. The past three quarters' consensus forecasts were well off their marks. Twice, the green-eyeshade set was too pessimistic, and once it was giddily overconfident.

As evidence of the difficulty in modeling profits in the current market, the forecasts' deflection has been widening. Fourth-quarter 2008 earnings came in at 25 cents, 67% higher than expectations. In the prior quarter, analysts' forecast 30 cents in earnings. Ashland instead delivered a penny-per-share loss, a -103% earnings surprise. There was a 20% positive surprise in 2008's second quarter.

The corollary to an earnings surprise is a share price reaction. The immediate upshot to last quarter's higher-than-expected EPS was a 12% pop in the stock price to $8.25. The sparkle quickly fizzled, though. A month after the announcement, Ashland's stock price had been dragged down to $6.26. And a month after that? Ashland shares have made a round trip back to black. The stock's now trading 95% higher than its pre-release price.

Most of that price action is intrinsic to Ashland and not driven by the broader market. The company's r2 (r-squared) correlation to the Dow Jones US Basic Materials Sector Index is only 35%, even though chemical outfits like Ashland make up 52% of the benchmark's weight.

So, is another 95% uptick in the cards for Ashland? Maybe. A gain of that proportion would put Ashland's share price at $28, about where it was in October 2008 when the Valvoline started hitting the fan.



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