New Ashland Is Poised For Growth In the Event of a $3 Billion Refining Sale

14 June 2004 00:01  [Source: ICB Americas]

Ashland will be flush with about $1 billion in net cash. Joseph Chang reports.

Fresh off getting US antitrust clearance to sell its 38 percent stake in refining company Marathon Ashland Petroleum LLC (MAP) to Marathon Oil Corp. for $3 billion, Ashland Inc. is on track to be flush with cash. Wall Street chemical analysts are bullish on the new Ashland, which will be poised to make numerous bolt-on acquisitions in specialty chemicals.

While Ashland has received antitrust clearance, it is still waiting for a ruling on the tax-free status of the deal by the US Internal Revenue Service (IRS). If the IRS rules favorably, which Ashland anticipates, the deal is expected to be completed by the end of the year. However, if the IRS does not grant tax-free status to the deal, Ashland says it will not go through with the transaction.

Last week, Prudential Financial analyst Andrew Rosenfeld upgraded his rating on Ashland from “neutral weight” to “overweight,” based on its upcoming transformation to a more focused chemical sector and road construction company. The analyst also raised his profit estimates on Ashland—from $3.70 to $4.90 for fiscal 2004 (ending September 30), and from $1.85 to $2.50 for fiscal 2005.

“The new Ashland should be valued at higher earnings and cash flow multiples given its superior remaining businesses and lower volatility with the removal of its refining segment,” says Mr. Rosenfeld. “The multiple expansions are coupled with an improved earnings and cash flow outlook given our expectations for a lower cost structure, improved organic growth and a successful acquisition strategy.”

Restructuring Ahead of Schedule

Ashland launched a company-wide restructuring program last October, aimed at achieving $75 million in annual cost savings by the end of September 2004. The plan entails eliminating 500 jobs, representing 2 percent of its work force. The job cuts come on top of 200 positions eliminated in 2002, which resulted in cost savings of $25 million.

“While far from complete, it appears the restructuring and cost savings programs are ahead of schedule,” notes Mr. Rosenfeld. “We believe the cost reductions have primarily been the result of streamlining manufacturing, back office, global sourcing, and focusing on using its distribution expertise within its other businesses.”

Ashland boasted annual sales of $7.5 billion in fiscal 2003 (ended September 30), spread out between Ashland Distribution ($2.8 billion), Ashland Paving And Construction (APAC) ($2.4 billion), Valvoline ($1.24 billion) and Ashland Specialty Chemical ($1.17 billion). However, the company’s 38 percent stake in MAP generated the bulk of its operating profits, accounting for $263 million of total operating income before unallocated corporate expenses of $371 million. Specialty chemicals kicked in $31 million in operating profits while distribution contributed $32 million.

Business Trends Are Strong

In late May, Ashland reported its business trends for April, showing strong sales growth in its chemicals businesses from the year-ago period. In April, sales in specialty chemicals gained 15 percent to $118 million. Distribution sales increased 13 percent to $279 million.

“The sources of the large improvement [in specialty chemicals] are lower SG&A [selling, general and administrative] expenses, higher volumes and improved pricing,” says JPMorgan analyst Jeffrey Zekauskas, who also has an “overweight” rating on Ashland. The analyst adjusted his June quarter sales estimate for specialty chemicals up from $323 million to $336 million, but cut his operating profit forecast from $19 million to $17 million because of higher than expected raw material costs.

Mr. Zekauskas sees strong growth in distribution in the June quarter, raising his estimates on sales from $806 million to $819 million, and operating income from $15 million to $19 million.

Overall, the analyst boosted his fiscal 2004 earnings per share estimate on Ashland from $3.65 to $3.70, and his fiscal 2005 number from $2.65 to $2.70.

Cash Windfall on the Horizon

Shares of Ashland had been on a tear along with the rest of the refining group, rising from a 52-week low of $30.02 in June 2003, to over $50 in March. But since announcing the sale of its refining business in March, the stock has treaded water. However, Ashland’s stock jumped $1.59 to $50.59 on the Prudential upgrade.

Ashland has a market capitalization of about $3.6 billion. With no net debt and a positive cash position if the MAP deal closes, the company is trading at a significant discount to sales of $7.5 billion. Even by stripping out the APAC division, Ashland trades at just 70 percent of sales.

At the end of March, Ashland had $1.56 billion in debt and $180 million in cash, resulting in net debt of $1.38 billion. The company also had an asbestos litigation reserve of $615 million.

Following the sale of MAP and two other businesses to Marathon Oil—the maleic anhydride business and 61 Valvoline Instant Oil Change centers in Michigan and Ohio—Ashland could have around $1 billion in net cash on its books.

Under the terms of the deal, Ashland will receive cash and MAP accounts receivable totaling $2.7 billion, as well as 38 percent of the cash MAP generates from operations between March 19, and the close the transaction. Ashland shareholders will also get $315 million in Marathon Oil stock (based on a 20-day averaging period prior to closing). The transaction is expected to close by the end of the year.

If the transaction closes at the end of 2004, Ashland will receive 38 percent of four-quarters worth of cash flow generated by MAP, according to an Ashland official. In the first two fiscal quarters of fiscal 2004, (October 1, 2003, through March 31, 2004), MAP’s cash distributions to Ashland rose to $146 million versus $93 million in the comparable year-ago period.

Taking a conservative view, if MAP can generate $200 million in cash flow during the estimated time frame it takes for the deal to close, Ashland could get net cash or liquid proceeds of $2.9 billion. The proceeds from MAP could be higher as refining margins continue to remain strong.

Ashland plans to pay down essentially all debt, including around $300 million in leases and off-balance sheet debt-like instruments, notes Prudential’s Mr. Rosenfeld.

Acquisitions to Come

Ashland could use the proceeds from the MAP sale to make a sizeable number of acquisitions, but the company will focus on value. Gary Cappeline, president and chief operating officer, chemicals sector, noted in an April industry meeting that M&A earnings before interest, taxes, depreciation and amortization multiples should not be higher than 5x to 8x. He said Ashland prefers midlevel transactions between $50 million and $150 million. “We don’t believe it’s in our own best interests to make $1 billion transactions.”

“We expect the specialty chemicals area to be the primary focus for the use of capital obtained from the MAP transaction,” says Prudential’s Mr. Rosenfeld. “The company appears to have learned from its past acquisition mistakes and has implemented one of the more rigorous review processes to ensure assets are purchased at or below fair values, in our view.” Ashland notes that acquisitions will also take place in core businesses such as APAC and Valvoline.

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