Eastman Chemical Company (EMN) April 7, 2018 Basic Materials Diversified Chemicals Stock Rating HOLD

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1 The Henry Fund Henry B. Tippie School of Management Stephen Welling Eastman Chemical Company (EMN) April 7, 2018 Basic Materials Diversified Chemicals Stock Rating HOLD We recommend a HOLD for Eastman Chemical. A growing global economy will increase demand for Eastman s products. Eastman has expanded its niche and specialty offering allowing them a favorable operating margin. If they continue to divest of commoditized product offerings and invest in specialty products they will sustain steady growth through our forecast horizon. Our target price shows potential upside of 7%, based primarily on our DDM. Drivers of Thesis The demand for the end-user products that Eastman provides chemicals and materials for is steadily growing at a slow but stable rate. Due to this we forecast that revenues will increase at a CAGR of 4.78% over our forecast horizon. Eastman has generated impressive cash-flows that have historically been returned to investors via dividends and share repurchases. We forecast that dividends per share will increase at a CAGR of 7.95% while Eastman will continue to be aggressive in share repurchasing. Eastman is investing and expanding its specialty chemical lines while divesting itself of increasingly commoditized product lines. Risks to Thesis Investment Thesis Target Price $ Henry Fund DCF $ Henry Fund DDM $ Relative Multiple $ Price Data Current Price $ wk Range $ Consensus 1yr Target $ Key Statistics Market Cap (B) Shares Outstanding (M) Institutional Ownership 88.4% Five Year Beta 1.19 Dividend Yield 2.2% Est. 5yr Growth 2% Price/Earnings (TTM) Price/Earnings (FY1) Price/Sales (TTM) 1.57 Price/Book (mrq) 2.73 Profitability Operating Margin 16.1% Profit Margin 14.5% Return on Assets (TTM) 8.7% Return on Equity (TTM) 27.8% Many chemical products are becoming increasingly commoditized squeezing company margins. Eastman Chemical is levered to the global economy, as many of its business segments create products whose demand ebb and flow with the overall economy. A slowdown in global economic growth will harm end-markets and in-turn harm Eastman s revenue growth. Earnings Estimates Year E 2019E 2020E EPS $5.71 $5.80 $9.56 $7.76 $8.11 $8.50 growth 19.9% 1.6% 39.3% -23.2% 4.3% 4.7% EMN Industry P/E Profit Margin P/FCF Source: Factset % 25% 15% 5% -5% 12 Month Performance Company Description EMN S&P 500 A M J J A S O N D J F M Source: Yahoo Finance Eastman Chemical Company produces diversified chemicals used in many everyday products. Their products are purchased by those in a variety of industries including transportations, construction, consumables, and consumer/medical durables. The company has 48 manufacturing sites in 14 countries that supply its products throughout the world. Important disclosures appear on the last page of this report.

2 EXECUTIVE SUMMARY We recommend a HOLD for Eastman Chemical. A growing global economy will increase demand for Eastman s products. Eastman has expanded its niche and specialty offering allowing them a favorable operating margin. If they continue to divest of commoditized product offerings and invest in specialty products they will sustain steady growth through our forecast horizon. energy, fuels, and water. The percentage of sales to each respective industry is depicted in the graphic below. Eastman must successfully navigate negative industry trends of increased commoditization and consolidation to remain competitive in the market. Macroeconomic trends provide both favorable and unfavorable conditions for Eastman going forward. A growing global GDP will increase demand for consumer products that require Eastman s products in order to produce. However, increasing raw materials prices will squeeze margins lowering firm profitability. Our model forecasts modest revenue growth of 4.78% CAGR while increasing dividends and share repurchases in line with Eastman s historical performance and management guidance. These primary assumptions reveal potential upside in excess of 7%. COMPANY DESCRIPTION Eastman Chemical (EMN) is a global advanced materials and specialty additives company that produces a wide range of products found in items people use every day. Eastman was originally created in 1920 to produce chemicals for Eastman Kodak Company s photographic business but was spun-off to become a public company in December of The company has 48 manufacturing sites in 14 countries that supply its products throughout the world. Eastman s headquarters and largest manufacturing facility is located in Kingsport, Tennessee. The products sold by Eastman are used in over nine end markets including: transportation, consumables, building & construction, industrial chemicals & processing, filter media, consumer/medical durables, food, feed & agriculture, personal care/health and wellness, and Source: Eastman Chemical k Eastman Chemical participates and reports in four broad business segments. These segments include additives & functional products, advanced materials, chemical intermediates, and fibers. Each business segment offers a multitude of products that serve many end markets. The diversification of product offerings makes forecasting revenue challenging. Our model forecasts revenue based on the five-year CAGR in each business segment. Eastman exists in a mature industry and its revenue growth has been stagnant over the last five years with a CAGR of 0.42%. However, between 2016 to 2017, overall revenue growth picked up to 5.67%. The graphic below depicts revenue growth by product category as well as the percent of total revenue that each product category represented in Page 2

3 Product Category Percent of Total Revenue Growth % (16 to 17) Additives & Functional Coatings & Ink 8% 8% Additives Adhesive Resins 6% -4% Tire Additives 6% 12% Care Chemicals 5% 27% Specialty Fluids 5% 33% Animal Nutrition & 4% 12% Crop Protection Segment Total 35% 12% Advanced Materials Specialty Plastics 14% 4% Advanced Interlays 9% -1% Performance Films 4% 2% Segment Total 27% 2% Chemical Intermediates Intermediates 19% 8% Plasticizers 6% 4% Functional Amines 5% 24% Segment Total 29% 9% Fibers Acetate Tow 7% -17% Acetyl Chemical 1% 0% Products Acetate Yarn 1% 0% Segment Total 9% -13% Source: Eastman Chemical k Source: Eastman Chemical k As seen below, historic revenue growth has been erratic in this segment. Because of the wide variety of products and end-markets they serve, we chose to model growth as a percentage of historical growth. We forecast revenue growth in this segment at 4.4% in 2018, and 4.2% thereafter. Additives & Functional Products In 2017, this segment posted sales of $3,342 million which represents 35% of Eastman s total revenue. Additives & functional products is Eastman s most profitable product category with an operating margin of 19.3% in As seen below, the additives and functional products segment provides chemicals to end users in the transportation, building & construction, animal nutrition, crop production, energy, personal & homecare, as well as other markets. Source: Eastman Chemical k, and Model Data This segment is further broken down into six product categories: coatings and ink additives, adhesive resins, tire additives, care chemicals, specialty fluids, and animal nutrition & crop protection. Page 3 Coatings & Ink Additives The coatings and ink additives category offers polymers that are used in building & construction (architectural coatings), transportation (original equipment

4 manufacturer), refinish coatings, durable goods (wood, industrial coatings and applications), and consumables (graphic arts, inks, and packaging). Sales from the coatings & ink additives product category represented 23% of the additives & functional products segment sales and 8% of total revenue in Eastman s revenue from this product category has fallen at a CAGR of -0.99% over the last five years. Adhesive Resins The adhesive resins product category offers five products which are all are protected by registered trademarks. Eastman s adhesive resins are used in consumables (resins used in hygiene and packaging adhesives) and building & construction (resins for construction adhesives and interior floorings). Eastman s revenue from this product category has fallen at a CAGR of -2.44% over the last five years. This drop is reflective of industry trends which fell at a CAGR of -3.1% over the same horizon. 1 However, adhesive resins are projected to grow at a CAGR of 5.12% 2 over our forecast horizon due to increased demand in construction, automotive and healthcare. We expect Eastman to continue to perform in-line with the industry and it stands to benefit from strengthening end markets. Tire Additives The tire additives product category offers three products, all of which are protected by registered trademarks. This product category is sold to tire manufacturers as well as those who produce other rubber products such as hoses, belts, seals, and footwear. The revenue from the tire additives product category has fallen at a CAGR of -0.14% over the last five years. But over the last three years has begun to tick up again, rising at a CAGR of 1.39%. The global tire market experienced very slow growth from due to low crude oil prices and the effects of the Eurozone Crisis. 3 Over the past five years, revenue from tire additives has grown at a CAGR of 2.2%. Over the past three years, automobile production has grown at CAGR of 2.33%. 4 This suggests that Eastman is trending in the same direction as the market, but growing at a slower rate. The global auto industry is expected to grow at a CAGR of 1.5% over our forecast horizon. Slow growth in the global auto manufacturing industry will have adverse impact on Eastman s revenue growth in this category. Care Chemicals The care chemicals product category offers a variety of alkylamine derivatives. The products in the care chemical product category are comprised of amine derivative-based building blocks for the production of flocculants (used for industrial and municipal water treatment) and intermediates for surfactants (used in soaps and detergents). Both end markets of water treatments as well as soaps and detergents are expected to grow over our forecast horizon. The global water treatment industry is expected to grow at a CAGR of 7.4% over our forecast horizon. 5 This is due to scarcity of fresh water coupled with increasing regulation on liquid discharge from industrial facilities. 6 Additionally, the global soap and detergent market is projected to grow at a CAGR of 8.83% through Growth in this market is attributed to rising disposable income and rapid urbanization in developing countries. 8 In 2017 sales of care chemicals comprised 17% of segment revenue and 5% of total revenue. Care chemicals have only recently become a reported product category, and as such a 5-year CAGR is not available. However, the category revenue impressively grew 27% from 2016 to We expect that increasing end market demand will propel continued growth in this segment throughout our forecast horizon. Specialty Fluids The specialty fluids product category offers four products, three of which are protected by registered trademarks. The products in this category are used in industrial chemical processing (heat transfer fluids for chemical processes), renewable energy, and commercial aviation. The renewable energy market is expected to grow at a CAGR of 4.9% through Growth in this market is driven by declining supply of non-renewable energy sources and an increasing concern of environmental issues. 10 The global commercial aviation market is expected to grow at a CAGR of 4.1% though our forecast horizon. 11 Increasing disposable income will bolster air travel in emerging markets in the Asia Pacific region which is expected to drive growth in the market. 12 In 2017 sales of specialty fluids comprised 13% of segment revenue and 5% of total revenue. Specialty fluids have only recently become a reported product category, and as such a 5-year CAGR is not available. However, the category experienced the largest revenue growth among product categories in 2017 at 33%. Page 4

5 Animal Nutrition & Crop Protection The animal nutrition & crop protection product category offers a variety of formic acid solutions as well as alklamine derivatives. These products are used in animal nutrition as well as agriculture and crop protection. Demand for food is expected to increase between 59% and 98% by 2050 driven by population growth. 13 Increasing demand for food will correlate with increasing agricultural production. In 2017 sales of care chemicals comprised 12% of segment revenue and 4% of total revenue. Animal nutrition & crop protection have only recently become a reported product category, and as such a 5-year CAGR is not available. However, the category revenue grew 12% from 2016 to We expect steady growth in this product category as food demand increases. Advanced Materials In 2017, the advanced materials business segment posted sales of $2,578 million representing 27% of Eastman s total revenue and an operating margin of 18.7%. The advanced materials business segment is comprised of three product categories: specialty plastics, advanced interlayers, and performance films. The graphic below depicts the six primary end use markets that the advanced materials category serves. These six end markets include transportation, consumables, building & construction, consumer/medical durables, personal care/health & wellness, and electronics. We forecast revenue in this segment will grow 4% in 2018, 3% in 2019, and 2% thereafter, which is depicted below. Source: Eastman Chemical k, and Model Data Specialty Plastics The specialty plastics product category offers eight products, all of which are protected by either a registered or un-registered trademark. In 2017 sales of specialty plastics comprised 51% of segment revenue and 14% of total revenue. Products in this category are used in consumables consumer packaging, cosmetics packaging, in-store fixtures and displays; durable goods consumer housewares and appliances; health & wellness medical devices; and electronics electronics displays. Revenue from specialty plastics sales has grown at a CAGR of 1.2% over five years. A strong global economy will increase consumer spending, which will increase revenue from specialty plastics as this product category is levered to global economic growth and customer spending. Advanced Interlayers Source: Eastman Chemical k The advanced interlayers product category offers two products which are both protected by registered trademark. Products in this category are used in the transportation industry automotive safety glass, automotive acoustic glass, and head-up displays; and building & construction laminated glass for architectural interlayers. In 2017 sales of advanced interlayers comprised 33% of segment revenue and 9% of total revenue. The advanced interlayers product category revenue has grown at a CAGR of 1.37% over the last five years. As mentioned previously, automobile production has grown at a CAGR of 2.2% over the past five years. 14 The global auto industry is expected to grow at a CAGR of 1.5% Page 5

6 over our forecast horizon. The global construction industry has grown at a CAGR of 2.26% over the last five years 15 and is expected to increase growth to a CAGR of 3.7% over our forecast horizon. 16 We expect that the increase in advanced interlayers revenue growth due to the global construction industry growth will be offset by the slowing growth in global automobile production. Performance Films The performance films product category offers four products which are all protected by registered trademark. Products in this category are used in the transportation industry automotive after-market window film and paint protection film; and building & construction residential and commercial window films. In 2017 sales of performance films comprised 16% of segment revenue and 4% of total revenue. Revenue from performance films has grown at a CAGR of 6.32% over the last five years. The global window films market is expected to grow at a CAGR of 5.21% over our forecast period. 17 Future growth in the industry will be driven by an increase in demand from commercial construction that will outweigh the shrinking demand from the automotive industry. We believe that Eastman will grow the performance films product category with the market as they shift their sales focus toward the commercial construction industry. Source: Eastman Chemical k Chemical Intermediates In 2017, the chemical intermediates business segment posted sales of $2,769 million representing 29% of Eastman s total revenue and an operating margin of 9.3%. The chemical intermediates segment has the lowest operating margin of the four business segments due its many commoditized product offerings. The chemical intermediates business segment is comprised of three product categories: intermediates, plasticizers, and functional amines. The graphic below depicts the nine primary end use markets that the chemical intermediates category serves. These nine end markets include industrial chemicals & processing; building & construction; food, feed, & agriculture; personal care & wellness; consumables; energy, fuels & water; consumer/medical durables; transportation; and electronics. We expect revenue in this segment will grow 2% year over year throughout our forecast horizon as depicted below. Source: Eastman Chemical k, and Model Data Intermediates The intermediates product category offers six largely commoditized products, none of which are protected by trademarks. This product category is sold to the following end-use industries: industrial chemicals and processing, building and construction (to those who manufacture paint and coating applications, construction chemicals, building materials), pharmaceuticals and agriculture, health and wellness, and packaging. In 2017 sales of intermediates comprised 64% of segment revenue and 19% of total revenue. Over the last five years intermediates revenue has been decreasing at a CAGR of - 4.2%. Over the same time horizon, the chemical intermediates industry in the U.S. has decreased at a CAGR of -3.2%. 18 While Eastman is a multinational corporation, and we primarily focus on global markets in this report, Page 6

7 consumers in the U.S. and Canada comprise nearly 70% sales in the chemical intermediates segment, which makes the U.S. chemical intermediates industry CAGR useful. Chemical intermediates are expected to grow over our forecast horizon by a CAGR of 1.3% due to slowly increasing in oil prices, higher consumer spending, and U.S. construction growth. 19 Eastman is pursuing a strategy to divest itself of product lines in this business segment unless they support other specialty product offering in other business segments. Low industry growth coupled with divesting of product lines in this product category will lead to continued revenue loss. Plasticizers The plasticizers product category offers five largely products, three are protected by registered trademarks, one is protected by an unregistered trademark, and one is not protected by a trademark. This product category is sold and used in building and construction non-phthalate plasticizers used in interior surfaces; consumables food packaging, packaging adhesives, and glove applications; and health and wellness medical devices. In 2017 sales of intermediates comprised 19% of segment revenue and 6% of total revenue. Since 2013, revenue from plasticizers has decreased at a CAGR of -3.48%. In 2017 Eastman achieved revenue growth of 4% from this product category due in part to increasing prices. 20 The plasticizers industry is expected to grow at a CAGR of 5.7% from 2018 to We expect Eastman to continue to achieve revenue growth in this product category, though not at the rate of the market. Functional Amines The functional amines product category offers alkylamines, which are not protected by trademarks. This product category is sold to consumers in agrochemicals, energy, consumables, water treatment, animal nutrition, and industrial intermediates industries. In 2017 sales of intermediates comprised 17% of segment revenue and 5% of total revenue. Revenue from functional amines has grown at a CAGR of 2.76% from 2015 to This product line was created as a result of Eastman s acquisition of Taminco, which was finalized Dec. 5, Eastman is the largest producer of alkylamine in the world and will continue to enjoy revenue growth in this product category above expected industry growth of 2.5% CAGR through our forecast horizon. 23 Fibers In 2017, the fibers business segment posted sales of $859 million representing 9% of Eastman s total revenue and an operating margin of 16.4%. The fibers business segment is comprised of three product categories: acetate tow, acetyl chemical products, and acetate yarn. As acetyl chemical products and acetate yarn comprise 1% of total revenue each, and have experienced stagnant growth, we will not discuss either product category in further depth. We expect revenue growth in this segment to decrease -11% year over year throughout our forecast horizon, in-line with its historical average. Acetate Tow Source: Eastman Chemical k, and Model Data The acetate tow product category offers Estron, which is protected by a registered trademark. This product category is primarily used to create cigarette filters by endmarket users. In 2017 sales of acetate tow comprised 77% of segment revenue and 7% of total revenue. Revenue from acetate tow has decreased at a CAGR of % from 2013 to This decreasing revenue growth in this product category is primarily driven by global cigarette use and a shrinking number of smokers. 24 Over the next several years the acetate fibers is expected to remain fairly flat, with a CAGR of 0.1%. 25 Due to the challenging market conditions, we expect Eastman to continue to experience decreasing revenue growth in this product category. Page 7

8 RECENT DEVELOPMENTS Q4 and 2017 Year End Results In Q4 of 2017 Eastman experienced 8% revenue growth over Q and generated an EPS of $1.62 which represented an 11-basis point increase over the previous year. Management credited fourth quarter growth to increasing sales in high-margin specialty businesses and improvements in chemical intermediates. 26 Eastman s 2017-year end results were strong. The company generated $1 billion of free cash flow for the year, which enabled it to return $646 million to stockholders via dividends and share repurchases. It also allowed the company to further deleverage by repaying $350 million of its debt. 27 The company offered guidance for 2018, stating a free cash flow target of $1.1 billion (representing a 10% increase over 2017), with modestly stronger earnings in the first half of the year than the second half. The company expects to benefit from revenue synergies through launching new products, improving commercial execution of acquired businesses, and a slight improvement in its tax rate. 28 Coal Gasification Incident In early October of 2017 there was an explosion at Eastman s plant in Kingsport, Tennessee. The company attributed the explosion to a process upset in a part of the plant that performs coal gasification. Fortunately, there were no injuries caused by the explosion. The Tennessee Department of Environment and Conservation performed a six-month investigation and ruled the incident as a malfunction, thus not recommending any penalties or fines for the emissions related to the explosions. 29 The agency attributed the cause of the explosion to blockage of a 30-year-old valve. Repairs to the site were completed at the end of December 2017, and a restart was accomplished in January of The expected net reduction of operating earnings is between $25 and $50 million, with $112 million of net costs in the fourth quarter partially offset by additional expected insurance recovery in Trade War Fear of a trade war has been heightened as the U.S. and China have recently been exchanging tariff threats on the others products. The tariffs proposed by the Chinese in retaliation to the Trump administration s tariffs have the potential to negatively impact U.S. chemical companies. China s tariffs announced on April 4, 2018 are 40 percent chemicals which include PVC and plastics. In 2017, China imported 11% of all U.S. plastic resins, or $3.2 billion worth. 31 The American Chemistry Council, who lobby on behalf of DowDuPont and other large chemical companies, stated that its members currently have planned to invest $185 million in new U.S. factories or expansions but a trade war with China would put those plans in question. However, none of the tariffs announced by the United States or China are set in stone. In the middle of May 2018 U.S. businesses will be consulted on the impacts of the tariffs and have a week to voice their concerns. After this period the Trump administration will have 180 days to decide whether to implement the tariffs. As the Chinese will only implement tariffs in retaliation of U.S. imposed tariffs, the U.S. s decision to go forward with or rescind the discussed tariffs will ultimately dictate the effect on the chemicals industry. If the U.S. does opt to go forward with tariffs, Eastman will be adversely impacted as sales to the Asia Pacific area (including China) accounts for almost 25% of its total revenue. INDUSTRY TRENDS Product Commoditization Eastman exists in an industry that is experiencing rapid commoditization of its products. This has occurred due to production technology for chemicals becoming more readily available, and a swift buildup of capacity, especially in emerging markets. 32 Because of this, chemical producers are not selling customers products tailored to meet a need; rather, products are being sold based on price. In addition, the overall number of chemical producers has also increased. This has taken place despite consolidation occurring in mature western markets. Proliferation of producers has tended to encourage capacity additions that have got ahead of market growth, depressing prices and margins. 33 The graphic below Page 8

9 depicts the commoditization of products in the chemical industry. Source: McKinsey & Company Source: McKinsey & Company The trend toward greater product commoditization has impacted Eastman s revenue growth in certain business segments. Revenue from Eastman s intermediates segment has decreased at a CAGR of -0.4% over the last five years, while revenue from its plastics segment has grown at slow CAGR of 1.97% over the same horizon. These trends support the graphic above and a shift toward greater commoditization harming revenue growth. As this is occurring throughout the industry, Eastman will not be disproportionately impacted as it has continued to add specialty products to offset this trend. Industry Consolidation The chemical industry has experienced a dramatic slowdown of organic revenue growth due to the commoditization of its products in a majority of its sub segments across the world. Because of this, many chemical companies are looking to the mergers and acquisitions markets to achieve inorganic growth. The graphic below shows the how consolidation is touching each subindustry. Over the last three years the industry has seen enormous M&A deals such as Dow/Dupont, Linde/Praxair, ChemChina/Syngenta, and Bayer/Monsanto. M&A deals peaked in 2016 with over 300 deals, averaging $849 million per deal saw a slight dip to 250 deals, however, a significant decrease in average deal size to $270. Eastman will continue to follow the industry trend by pursuing a strategy of inorganic growth through acquisitions as stated in its k filing. They will focus on acquisitions that provide them specialty products as they have in the past. In 2012, Eastman acquired Solutia Inc., a global leader in performance materials and specialty chemicals. In 2014, Eastman acquired BP plc's global aviation turbine engine oil business and Knowlton Technologies, a company that designs, accelerates prototyping, and manufactures of wet-laid nonwovens in filtration, friction, and custom designed composite webs. At the end of 2014, Eastman also acquired Taminco Corporation, a global specialty chemical company and Commonwealth Laminating & Coating, Inc., a specialty films business. These acquisitions follow Eastman s strategy of acquiring specialty chemicals and niche products that allow higher margins as opposed to more commoditized products. We expect Eastman to continue to make acquisitions throughout our forecasted horizon, however we have not included it in our model as the company has not stated any specific targets and it would be difficult to predict with any degree of accuracy. Page 9

10 MARKETS AND COMPETITION Peer Comparisons Peer comparison is somewhat difficult as Eastman competes with many firms across products, but no one firm across all products. As mentioned previously, the diversified chemical industry is mature and has seen very stagnant growth over the last five years. While firms in the industry are not experiencing rapid growth, they do enjoy largely stable revenues with healthy dividend yields. This is due to firms serving niche markets or having specialty products that are needed in specific end markets. The information below compares Eastman with other large & mid-cap chemical companies. Source: Factset Eastman compares favorably with its peers across the fundamentals, beating the median/average metric across the peer group in all categories with the exception of the debt to equity ratio. Eastman has the most favorable P/E ratio at and the third highest dividend yield at 2.18%. We will look more closely at Huntsman and DowDupont as they beat the median/average in 4 and 3 of the categories, respectively. Huntsman Corp. Huntsman Corp. manufactures chemicals for the plastics, automotive, and construction industries. The company operates in four reportable business segments including polyurethanes, performance products, advanced materials, and textile effects. Huntsman and Eastman compete head to head in the sales of alkylamine derivatives which are used for water treatment and personal & home care. While Huntsman has an attractive dividend yield of 2.29%, it has experienced decreasing revenue in four of the last five years. Overall revenue has decreased at a CAGR of -5.82%. Huntsman also experiences greater volatility than Eastman with a beta of The increasing commoditization of Huntsman s products is creating an alarming downward revenue trend makes Huntsman an unattractive investment as compared to Eastman. DowDupont Inc. DowDupont is an extremely diversified company which generates revenue from developing specialty materials, chemicals, and agricultural products. It operates in seven reportable segments: agriculture; performance materials & coatings; industrial intermediates & infrastructure; packaging & specialty plastics; electronics & imaging; nutrition & biosciences; transportation & advanced polymers; and safety & construction. Eastman competes head to head with DowDupont in its coatings and inks additives, care chemicals, specialty fluids, crop protections, and intermediates product categories. DowDupont has the highest dividend yield of the peer group at 2.39%, however it is also trading at the highest P/E multiple of DowDupont also posted the highest sales of the peer group in 2017 of $62.5 billion. However, DowDupont had narrow margins of only 2.3% representing only $1.7 billion in net income. Dow chemical and Dupont finalized a merger at the end of As with any merger, and especially ones of this scale, it will be important to track the new entity to see if the two companies can successfully create synergies and scale advantages going forward. ECONOMIC OUTLOOK The macroeconomic drivers that most strongly impact Eastman are global GDP, commodity prices, and interest rates. Global GDP Eastman Chemical participates in the global economy. Eastman generates 44% of its revenue from sales in North America, 27% to Europe, Middle East, and Africa, 24% to Asia Pacific, and 5% to Latin America as seen below. Page 10

11 2017 Revenue By Geographic Region 5% North America sources include natural gas, coal, and electricity. The graphic below depicts the inputs necessary to create Eastman s end products. 27% 44% Asia Pacific Europe, Middle East, and Africa 24% Latin America Source: Eastman k Because Eastman generates revenue from markets across the world, global GDP is an important economic metric to track. Global GDP had a stronger than expected 2017, and 2018 is expected to grow up to 3.1% in 2018 according to The World Bank s forecast. 34 The increase in growth is expected due to increases in investment, manufacturing, and trade. Near term growth in developing countries is expected to increase to 4.5% in 2018 with just a slight uptick in advanced economies up to 2.2%. Source: Eastman k While it would not be practical to discuss each raw material, input, and energy source, we believe it will be useful to discuss a few items that have the potential to have the biggest impact on Eastman s margins. Wood Pulp Wood pulp is used in Eastman s creation of acetate tow, acetate yarn, excipients, and cellulose esters. Wood pulp prices have steadily increased from 2013 until 2017 as seen below. Global GDP growth in 2018, especially expected U.S. GDP growth, will spur increased product demand in Eastman s business segments used in consumer products. Raw Materials Eastman Chemical relies on several raw materials to produce its products. These raw materials include propane, cellulose, paraxylene, propylene, methanol, fatty alcohol, polyvinyl alcohol, and a wide variety of precursors for specialty organic chemicals. Key purchased energy Wood pulp is also the main input for paper. The price for wood pulp is tied to consumer spending. Increased consumer spending will drive demand and increase the price of wood pulp which is used in paper-based packaging Page 11

12 used to ship and package consumer products. While the price for wood pulp is appreciating, it is doing so slowly and will not have a material impact on Eastman s margins. Eastman will be able to increase prices to maintain any margin squeezing from appreciating wood pulp prices. Coal Coal is used in Eastman s creation of acids, anhydrides, arylides, and esters. The price of coal appreciated in 2017 (as seen below) at a higher rate than expected due to an increase in demand from China. The price of coal is expected to further appreciate in Source: World Bank Crude Oil Source: FRED The further appreciation of coal has the potential to squeeze Eastman s profit margins. Natural Gas Natural Gas is a required input to produce olefins and syngas. Syngas (Synthesis gas) can be produced from many sources, including coal, biomass, or natural gas. Olefins are a petrochemical, that are produced by refining natural gas liquids (like ethane and propane). Olefin and syngas are then used in a number of different Eastman products. As seen below, the price of natural gas in the U.S. has decreased at a CAGR of -8.98% over the last four years. However, natural gas prices in the U.S. are expected to rise at a CAGR of 3.19% over our forecast horizon. As of April 6, 2018, crude oil (WTI) was priced at $62.06 per barrel. We anticipate oil prices to increase in the near term to $63 per barrel and decrease in the long term to $57 per barrel. Lower oil prices have been a result of increased supply due to the addition of new production and a decrease in global demand. Crude oil is an important input in plastics and other Eastman products. Low oil prices have a negative impact that outweighs the benefit of having a lower input cost. When oil prices dip it lowers the demand for chemical products as well as decreases the price for the products. Price reductions are greater than the reduced input costs and margins are negatively affected. 35 Interest Rates The U.S. has experienced several years of near 0% interest rates due to the great recession in With a strengthening economy, the federal reserve is transitioning away from financial crisis policies and increasing the federal funds rate. The federal funds rate, which influences the rate banks are willing to lend money, has risen to 1.51%. 36 This reflect a 75-basis point increase in The graph below illustrates the federal funds rate over the last several years: Page 12

13 Eastman Chemical is levered to the global economy, as many of its business segments create products whose demand ebb and flow with the overall economy. A slowdown in global economic growth will harm endmarkets and in-turn harm Eastman s revenue growth. Source: FRED We predict that the federal funds rate will continue to rise to 1.76% within the next six months and that the Federal Reserve will continue to raise the rate to 2.76% over the subsequent two years. Rising interest rates are an indication of broader economic strength. However, increasing rates slow economic growth by making borrowing more difficult. Eastman has over $1 billion worth of debt securities scheduled to mature over the next two years. If Eastman chooses to refinance, it will be burdened with higher interest expense. CATALYSTS FOR GROWTH Eastman and the diversified chemical industry are mature and have or will shortly achieve steady state growth. Eastman has articulated an earnings growth strategy rooted in acquisitions and share repurchases. Eastman has also stated a focus on internal product development. As they are successful in creating strong new products they will enjoy the benefits of increased revenue growth. INVESTMENT POSITIVES The demand for the end-use products that Eastman provides chemicals and materials for is stable and steadily growing, although at a slow rate. Eastman has generated impressive cash-flows that have historically been returned to investors via dividends and share repurchases. Eastman is investing and expanding its specialty chemical lines while divesting itself of increasingly commoditized product lines. INVESTMENT NEGATIVES Many chemical products are becoming increasingly commoditized squeezing company margins. Revenue: VALUATION Revenue growth was projected based on the historical growth rate of each business segment coupled with end market outlook. While not ideal, we felt that this was an appropriate method given wide range of products serving numerous end markets. We projected revenue growth in Additives & Functional Products to grow at 4.4% in 2018, and 4.2% thereafter. Advanced Materials is modeled to experience growth of 4% in 2018, 3% in 2019, and 2% thereafter. We expect Chemical Intermediates to experience revenue growth of 2% year over year. We expect Eastman s Fiber segment to continue to decrease by -11% year over year in-line with decreasing cigarette demand. As industry prices have largely been decreasing over the last several years, we expect growth will be derived as a result of global GDP growth and M&A activity. COGS: Cost of goods sold, as a percentage of sales is expected to remain constant at 74% throughout our forecast horizon. There has been minimal fluctuation in COGS over the last three years, with nothing more than a 75-basis point swing in any given year. Terminal Growth Rate: Our model expected a terminal growth rate of 2.1%. This value is derived from long term economic expectations as well as an expectation of Eastman Chemical achieving steady state growth in Treasury Stock Our model predicts that Eastman Chemical will repurchase $500 thousand worth of shares a year throughout the forecast horizon. This is in line with the company s 2017 announcement to repurchase $2 billion worth of shares over the next several years. Page 13

14 Cost of Equity: We used the CAPM formula to derive the cost of equity. The inputs used were a 30-year treasury bond as the riskfree rate at 3.07%, 5 year beta of 1.19, multiplied by an equity risk premium of 4.8%. These inputs generated a cost of equity of 8.78%. Pre-Tax Cost of Debt: We used a pre-tax cost of debt of 4.8%, which was the rate at which Eastman recently issued a fixed rate bond. The bond will become payable in September of DCF Output: Based on the above assumptions our DCF model produced a target price of $ Our target price is above the oneyear consensus estimates of $109 and above its 52-week trading range. We feel that our assumptions are sound, however, with revenue being volatile and difficult to forecast, we feel the intrinsic value of Eastman Chemical is better measured by our other models. DDM Output: Our dividend discount model produced a target price of , which represents a 5% upside over its current trading price. We feel that this model more accurately captures the value of Eastman Chemical as its dividend payments have been reliably growing over the past five years. We used a P/E multiple of which was the diversified chemical sector P/E put forward by Professor Aswath Damodaran of NYU Stern School of Business. We modeled CV growth of 2.08%, CV ROE of 16.58%, and Cost of Equity of 8.78%. These inputs, coupled with our future cash flows, equated to a share price of $ Relative P/E Output: Our relative P/E valuation produced a target price of $ We compared Eastman to large and mid-cap chemical companies in which it competes head to head with in at least one product category. The company s used in the analysis were Huntsman Corp., DowDupont, PPG Industries Inc., PolyOne Corp., FMC Corp., Ashland Inc., Westlake Chemical, and Kraton Performance Polymers. The average P/E multiple among the companies selected was 15. KEYS TO MONITOR As the industry faces greater commoditization of its products, it will be important to monitor Eastman s profit margin. If profit margins are decreasing without offsetting sales growth, it will indicate that Eastman has failed to find niche products or serve specific markets and its products have become commoditized. REFERENCES 1. IBISWorld Industry Report 3521 Plastic & Resin Manufacturing. 2. PRNEWSWIRE, Global Adhesive Market Outlook. 3. Global Tire Market Forecast & Opportunities, Statista, Worldwide Automobile Production Since Future Market Insights, Water Treatment Market. 6. Id. 7. Grandview Research, Global Soap Detergent Market. 8. Id. 9. PRNEWSWIRE, Global Renewable Energy Market Expected Growth. 10. Id. 11. Global Newswire, Global Commercial Aircraft Market Growth. 12. Id. 13. HBR.org, Global Demand for Food is Rising. 14. See reference Inside Construction, Global Construction Outlook. 16. PRNEWSWIRE, Global Construction Outlook. 17. PRNEWSWIRE, Global Window Films Market. 18. IBISWorld Industry Report, Organic Chemical Manufacturing in the US. 19. Id. 20. Eastman.com, Company News. 21. Markets & Markets, Plasticizers Market Worth Billion USD by See reference IHS Markit, Chemical Economics Handbook. 24. Id. 25. Id. 26. Q Eastman Chemical Earnings Call. 27. Id. 28. Id. 29. News Channel 11, Eastman Officials Say They ve Made Changes After Oct s Explosions. 30. Eastman Chemical 2017 Investor Presentation. Page 14

15 31. Daily News, Trade War Bad for Chemical Industry, Says Group. 32. McKinsey, Commoditization in Chemicals. 33. Id. 34. World Bank, Global Economy to Edgy up to 3.1% in McKinsey, Oil Price Shocks and the Chemical Industry Preparing for a Volatile Environment 36. FRED, Effective Federal Funds Rate. IMPORTANT DISCLAIMER Henry Fund reports are created by students enrolled in the Applied Securities Management program at the University of Iowa s Tippie College of Business. These reports provide potential employers and other interested parties an example of the analytical skills, investment knowledge, and communication abilities of our students. Henry Fund analysts are not registered investment advisors, brokers or officially licensed financial professionals. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any of the aforementioned securities. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Henry Fund may hold an investment position in the companies mentioned in this report. Page 15

16 Eastman Chemical Revenue Decomposition Fiscal Years Ending Dec E 2019E 2020E 2021E 2022E Additives & Functional Products Coatings and Inks Additives growth rate -7% -36% 8% Adhesive Resins growth rate -17% 0% -4% Tire Additives growth rate -5% -5% 12% Other growth rate 171% 4% 24% Total Additive & Functional Products Revenue 3,351 2,973 3,342 3,490 3,636 3,788 3,946 4,111 growth rate 15% -11% 12% 4.4% 4.2% 4.2% 4.2% 4.2% Advanced Materials Specialty Plastics growth rate -4% 3% 4% Advanced Interlayers growth rate -2% 8% -1% Performance Films growth rate 35% 5% 2% Total Advanced Materials Revenue growth rate 1% 5% 2% 4% 3% 2% 2% 2% Chemical Intermediates Intermediates growth rate -21% -1% 8% Plasticizers growth rate -21% -5% 4% Functional Amines growth rate 1653% -13% 24% Total Chemical Intermediates Revenue growth rate -6% -4% 10% 2% 2% 2% 2% 2% Fibers Acetate Tow growth rate -13% -19% -17% Acetyl Chemical Products & Acetate Yam growth rate -8% -28% 0% Total Fibers Revenue growth rate -12% -21% -13% -11% -11% -11% -11% -11% Total Revenue Growth 1% -7% 6% 2% 2% 2% 2% 2.1%

17 Eastman Chemical Income Statement Fiscal Years Ending Dec E 2019E 2020E 2021E 2022E Sales Cost of sales Gross profit (loss) Selling, general & administrative expenses Research & development expenses Asset impairments & restructuring charges (gains), net Operating earnings (loss) Interest expense Interest income Net interest income (expense) Early debt extinguishment & other related costs Other income (charges), net Earnings (loss) from continuing operations before income taxes Provision (benefit) for income taxes from continuing operations Earnings (loss) from continuing operations Earnings (loss) from discontinued operations, net of tax Net earnings (loss) Less: net earnings attributable to noncontrolling interest Net earnings attributable to Eastman Chemical Co Weighted average shares outstanding - basic Year end shares outstanding Net earnings (loss) per share - basic Dividends per common share

18 Eastman Chemical Balance Sheet Fiscal Years Ending Dec E 2019E 2020E 2021E 2022E Cash & cash equivalents Trade receivables, net Miscellaneous receivables Inventories Other current assets Total current assets Properties & equipment at cost Less: accumulated depreciation Net properties Goodwill Intangible assets, net of accumulated amortization Other noncurrent assets Total assets Trade creditors Accrued payrolls, vacation & variable-incentive compensation Accrued taxes Post-employment obligations Derivative hedging liability Interest payable Environmental contingent liabilities, current portion Other payables & other current liabilities Payables & other current liabilities Borrowings due within one year Total current liabilities Long-term borrowings Deferred income tax liabilities Post-employment obligations Other long-term liabilities Total liabilities Common equity Retained earnings (accumulated deficit) Accumulated other comprehensive income (loss) Total stockholders' equity before treasury stock Less: treasury stock at cost Total Eastman Chemical Co. stockholders' equity Noncontrolling interest Total equity Total liabilities & equity