Eastman Chemical Company (EMN)

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Eastman Chemical Company is engaged in the manufacture and sale of chemicals, plastics, and fibers. Based in Kingsport, Tennessee, the company has 16 manufacturing sites in 10 countries, supplying its products throughout the world. It provides key differentiated coatings, adhesives and specialty plastics products is the world's largest producer of polyethylene terephthalate (PET) polymers for packaging and is a major supplier of cellulose acetate fibers. The Coatings, Adhesives, Specialty Polymers and Inks business utilizes raw materials including propane, ethane, butane, high sulfur coal, natural gas, wood pulp and acetone, Eastman produces several products in this category. Products include cellulosic polymers, adhesion promoters, Texanol ester alcohol, solvents, hydrocarbon resins, rosin resins, resin dispersions and polymer raw materials. These products are used for a variety of purposes ranging from packaging to automotive paints to disposable diapers. Eastman makes acetate tow, acetate year and acetyl chemical products. These fibers are used in apparel and home furnishings as well as in cigarette filters and industrial applications. Paraxylene, ethylene glycol, purified terephthalic acid (PTA), propane, and ethane are used by Eastman to manufacture PET polymers and polyethylene products including low density polyethylene (LDPE) and linear low density polyethylene (LLDPE). These polymers are utilized for a variety of packaging purposes, including food, cosmetics, and pharmaceuticals. They are also used for industrial applications. Utilizing some of the same raw materials as the Polymers division paraxylene, ethylene glycol, and PTA Eastman's Specialty Plastics division manufactures copolyesters, polyesters, cellulose esters, cellulosic plastics, and concentrates/additives. These products are utilized in the building and construction industry and for other purposes such as optical and photographic film.

BULL POINTS

The PET business may undergo a restructuring and may become a much smaller business unit at Eastman. In an effort to improve its performance in the polymer business, the company closed its PET polymer operations in Cosoleacaque, Mexico, and Zarate, Argentina. Eastman sold its polymer business in both the areas to ALFA, S.A.B. de C.V. (ALFA), a Mexican industrial company for an undisclosed amount. Further, the company entered into an agreement with Indorama, an Indonesian conglomerate, to sell its PET facility and related businesses in the United Kingdom, as well as its PET and PTA facilities and related businesses in the Netherlands. The total cash proceeds of the transaction are expected to be 226 million Euro or approximately U.S. $330 million. Eastman's unprofitable PET operations in Spain, Argentina, Mexico, and the U.K accounted for 45% of the company's PET capacity. The company saw operating losses in the segment due to lack of integration coupled with a highly competitive, oversupplied market. Unlike Eastman's PET assets in the U.S. and Rotterdam, these facilities are not well integrated. In 2008, the company plans to convert 50,000 metric tons of PET capacity to a new copolyester, Titron, which has received a good response since its launch in 2007. It plans to close all its European PET manufacturing facilities by the end of first quarter of 2008. In South Carolina, Eastman plans to abandon operations at a facility with a 300,000 metric ton capacity of PET polymers and expand PET capacity based on IntegRex technology by 50% in 2008. It plans to shut down the DMT intermediates facility in South Carolina and increase PTA intermediate capacity. By 2008, Eastman plans to cut down its annual costs by $30 million at the South Carolina site. Eastman also plans to increase revenue from cellulose esters used in LCD screens to $100 million in 2009 from $50 million in 2007.

The Fibers segment has improved dramatically, and continues to perform well. Higher demand for acetate filter tow and market share gains in acetate yarn following Celanese's restructuring led to a sharp increase in Eastman's operating profit. The company expects Fibers to continue to benefit from positive secular trends such as the lengthening of cigarette filters. The company also plans Acetate tow capacity expansion at Eastman's Workington, U.K. facility in 2008. Apart from this, Eastman is hiking prices of major products, a policy which is likely to offset higher operating costs and help earnings.

Eastman expects these strategic initiatives to drive earnings in the next five years. It expects earnings per share to double to $10 by 2012. Earnings in 2009 are expected to increase by 10% to 15% year over year. Growth initiatives in the specialty plastics segment are to contribute to $3 per share by 2012. Eastman focuses on the industrial gasification segment. The company expects the Texas and Louisiana project in the division to contribute $2 per share by 2012. It expects the facility to commence operations by 2011.

The balance sheet is in good shape, and Eastman enjoys good financial flexibility. Backed by strong net earnings and a reduction of $89 million in working capital, the company generated cash from operations of $732 million in 2007. Management has plans for capital investment, and substantial changes to the company's dividend payout of $1.76 (2.9% yield) are not likely. In 2007, the company repurchased shares of $382 million at an average price of $64 per share and contributed $100 million to the U.S. defined benefit pension plan.

BEAR POINTS

Free cash flow is likely to be low due to capital expenditures utilizing most of FCF in the coming years. Eastman will generate less distributable cash because capital expenditures will likely exceed depreciation. Restructuring at the South Carolina facility also involved high accelerated depreciation cost. The company expects accelerated depreciation cost of $6 million in 2008. Eastman plans capital spending of $400 500 million, primarily for the new Integrex PET facility and capacity expansions in specialty plastics. Net debt increased by $66 million and totaled $719 million in 2007.

We expect PET volumes and pricing to weaken in North America, based on an estimated 18.8% increase in North American PET capacity. We expect the bulk of capacity additions to arrive when Eastman's new IntegRex plant is scheduled to come online in South Carolina. The facility is expected to have an annual capacity of 770 million lbs/yr (13.6% of N.A. market), which will likely weaken pricing and lower margins. In 2007 and beyond, Eastman intends to bring down some conventional PET capacity, working towards the goal of 100% IntegRex-based PET technology. The rationalization of 250 MTPA of PET capacity in South Carolina, net of a 100 MTPA de-bottlenecking, will remove 2.9% of N.A. capacity and offset partially our forecast of 18.8% supply growth. PET demand growth will likely slow going forward from a mid- to high-single-digit global growth rate (7 9%) to a mid-single digit growth rate (6 7%).

Feedstock and energy cost increases continue to be an issue, particularly for propane and ethane. This tends to increase paraxylene (PX) prices. PX is one of the largest single-product purchases for Eastman and is the backbone of the Performance Polymer segment. This segment has the greatest earnings sensitivity to raw material pricing. Raw materials are 70% of sales, and 80% are purchased under long-term contracts.

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