Avient: Strong Q3 Guidance And Clariant Masterbatch Synergies Make Shares A Buy (NYSE:AVNT)


It can be difficult to find a good deal in the current environment because almost any company that is actually worth investing in is trading at multiples that are simply too high for any conservative investor to actually consider. We have seen investors of all types who have fled to the most defensive stocks available which have pushed the dividend yield of these stocks down as the share price skyrockets.

While many companies are struggling, some of the well-known companies are trading at multiples well-above their historical norms. One example of a company that has benefitted from the pandemic is Clorox (CLX).

Clorox - FastGraphs

Clorox was trading at a 10-year P/E ratio high of 26.35x near the end of November 2018 and blew that out-of-the-water with a P/E ratio of 32.01x at the end of July 2020. The current P/E ratio is 28.11x, which is still a very rich valuation given its more normal 10-year average P/E ratio of 20.5x (2009-2019).

ChartData by YCharts

When looking at the P/E ratio of a dividend-paying stock like CLX, I like to also consider how the dividend has been impacted. High-quality companies like CLX can trade with an almost “bond-like” valuation because the safety of the dividend and the business model insulates or even allows the company to thrive from events like COVID.

Avient Offers An Alternative

You won’t catch me investing money into CLX at this point in time because the stock is wildly overvalued. Rather than letting the money sit, I have been looking for potential alternatives that offer a defensive business model and a modest dividend growth history. This is where Avient (AVNT) comes into play because it offers major short-term upside and even more long-term upside based on its most recent acquisition of Clariant’s (OTCPK:CLZNF) Masterbatch.

Clariant Masterbatch Synergies

In AVNT’s most recent update the company noted that the Clariant Masterbatch synergies are greater than originally expected and should result in an additional $15 million above the original estimate of $60 million.

Avient - Acquisition Synergies Source: Avient Investor Presentation

One of the key drivers behind acquiring Clariant’s Masterbatch is that there will be a significant improvement in the EBITDA margin.

Avient - EBITDA Margin Expansion

Source: 2019 Annual Report

Personally, I believe that the market has completely failed to see the potential provided by the Clariant Masterbatch acquisition. The acquisition is immediately accretive to EPS and sets up AVNT for FY-2020 adjusted EPS of $2.60/share. This is a $.95/share increase over the estimated $1.65/share adjusted EPS without the acquisition.

Even more important than these short-term EPS improvements, AVNT will see major EBITDA expansion in its non-distribution segment which will help push operating margins higher (the distribution segment is estimated to generate only 13% of adjusted EBITDA).

Avient - Specialty EBITDA Source: 2019 Annual Report

The improvement in EBITDA margins is sorely needed as AVNT’s operating margins (using the trailing twelve months) have stagnated over the last five years. As operating margins dropped, so did AVNT’s share price.

ChartData by YCharts

The return of higher margins is extremely important for improving the share price as AVNT shifts from being stagnant to a highly profitable company with a number of opportunities for growth going forward.

Sustainability

A 2019 U.S. Consumer Sustainability Survey interviewed 1,000 consumers about their buying habits. More than 2/3rds of those surveyed “consider sustainability when making a purchase and are willing to pay more for sustainable products.”

Interestingly enough, a more recent survey from the U.S. Cotton Trust Protocol found that many companies that produce/sell apparel and textile brands believe that COVID-19 has accelerated the pace at which consumers are demanding environmentally sustainable products and practices. 59% of companies believe consumers will still prioritize price when making purchases.

Avient’s sustainable solutions have grown at an organic compounded annual growth rate of 9%. AVNT is on track to reach an estimated 2020 revenue that is double the sustainable revenue first logged in 2016. AVNT expects that sustainable solutions will see 8-12% CAGR going forward.

AVNT - Sustainable Solutions.jpgSource: Avient Investor Presentation

Any concerns about AVNT’s ability to continue growing this sustainable segment should be alleviated by the fact that 37% of specialty sales were derived from products introduced in the last five years (2019 Annual Report)

AVNT offers sustainable solutions as products but the company also focuses on reducing waste in the development of its products. In the 2019 annual report, AVNT noted that it was able to achieve some pretty impressive reductions when compared with the results from 2018.

Avient - Waste MinimizationSource: 2019 Annual Report

Sustainable products convert into sustainable sales during difficult times, which is why AVNT is worth considering for defensive dividend investors.

Share Price And Dividends

AVNT’s share price has underperformed over the last two years as the company’s operating margins grew stagnant. The Clariant Masterbatch acquisition offers the catalyst that investors have been searching for.

ChartData by YCharts

In addition to the potential for capital appreciation (AVNT is trading at a dirt-cheap multiple in comparison to its peers), there is also a major upside for dividend growth to kick into high gear as noted by management’s investor presentation slides in the previous section.

ChartData by YCharts

Since 2011, the dividend payout per share has quadrupled and has a CAGR of nearly 20%. The current payout ratio is right at 50% but will drop to an estimated 31% based on the adjusted EPS from the Clariant Masterbatch acquisition. Given AVNT’s history of being generous towards shareholders, this could very easily mean 15-20% annual increases in the dividend. Even if earnings stagnated, it would take nearly three years of 20% increases in order to get back to a 50% payout ratio.

I expect that these increases will be more modest and come in closer to 10-12% for the next few years as the company takes the opportunity to pay down debt and repurchase shares that were used to help fund the acquisition. AVNT has typically carried a Net Debt/EBITDA of 2.5-3.0X and is slightly over that with the Clariant Masterbatch acquisition. Management plans to use the increase in free cash flow to bring this multiple down to 2.6X, which would mean that AVNT would be well below that of its peer group.

Avient - Net Debt to EBITDA Source: Avient Investor Presentation

Conclusion And Price Target

Goldman Sachs (NYSE:GS) recently increased its price target from $32/share to $39/share citing the strong Q3-2020 results and the additional synergies from the Clariant Masterbatch acquisition. If we assume the $2.60/share of adjusted EPS is correct, AVNT would be trading at a P/E ratio of 15X. At the current share price of $28.75/share, the stock is trading at an estimated P/E ratio of 10.85x.

I believe the $39/share price target is a very real possibility in the near term and at this point, if AVNT can execute (and everything suggests that it will as the company has navigated the situation with COVID extremely well) then the real multiple should be anywhere from 18.0x to 21.0x. Using the adjusted EPS of $2.60/share I arrive at a share price of $46.80 to $54.60 over the next year. The top-end P/E ratio of 21x comes from the end of 2016 when the company had much stronger operating margins.

ChartData by YCharts

At $28.75/share, I believe the potential upside for investors over the next year is between 60-90% (not including dividends).

I have had a position in AVNT for years and so have my clients. While this has resulted in strong dividend growth, it has also resulted in a position that has substantial unrealized capital losses. With the Clariant Masterbatch acquisition, I change my stance from a Hold to a Strong Buy as AVNT’s long-term strategy of pushing revenues towards specialty applications is finally paying off.

AVNT is not meant to be a direct comparison to CLX by any means; however, I believe that the stock has significant potential to be treated similarly by the market as it continues to strengthen its position in specialty applications that are not nearly as impacted as companies that have products and sales that are much more cyclical.

My clients’ are currently long Clorox and Avient.

Disclosure: I am/we are long CLX, AVNT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article reflects my own personal views and I am not giving any specific or general advice. All advice that is given is done so without prejudice and it is highly recommended that you do your own research. This article was written on my own and does not reflect the views or opinions of my employer.

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