Editor's note: This column was submitted by Stockpickr member Winston Kotzan.
delves in a mix of businesses, but is the combination a lucrative play for speculative investors or just too volatile a mix?
Virginia-based NewMarket operates two subsidiaries, Afton Chemical and Ethyl Corp. Its Ethyl business primarily produces and sells tetraethyl lead (TEL), a gasoline additive that reduces engine "knock." Tetraethyl lead is known to be a deadly chemical that is hazardous to the environment and has been gradually outlawed in the U.S. through legislation beginning in the 1970s.
Most of Ethyl's sales are in countries other than the U.S. where the use of tetraethyl lead is still legal. Management and industry analysts widely accept that this business is in decline and that revenue from this source is expected to shrink.
For that reason, the bread and butter of NewMarket's business is Afton Chemical. Afton produces various lubricants and gasoline additives. The lubricants it develops are for engines and other complex machinery with moving parts. Additives improve energy performance and help keep dirt particles from engines.
NewMarket's business of additives and lubrication seems well-positioned to benefit from the global economy as more people around the world will be driving cars. Just over half of its business originates from outside North America.
The gasoline-additives business is in constant flux as chemicals are replaced with less environmentally hazardous substitutes. With the revival of ethanol, gasoline producers are now looking to ethanol as a safer means to boost octane. It seems that Afton Chemical is jumping on this ethanol trend with the introduction of a new product named BioTEC.
To stay ahead in this market, the company makes a notable investment in research and development. In 2006 it invested $70 million for R&D, and development and improvement of products appears to be key to NewMarket's long-term strategy.
Since it is difficult to accurately predict long-term growth trends for this industry, ratio analysis seems most appropriate for valuing this company. It trades at a forward
price-to-earnings ratio (P/E) of roughly 11.
When comparing NewMarket with its competitors, I used the enterprise value/EBITDA multiple. This metric is similar to P/E, but it can be used more effectively when comparing companies of varying debt structures. According to Yahoo! Finance, NewMarket currently trades around a 6.7 trailing EBITDA multiple.
This is lower than the 8.6 multiple of its competitor
( LZ) but higher than that of
. Looking at the information on the BASF Web site, I calculated its EBITA multiple as just above 5.
Looking at the return on equity, NewMarket seems to be good at generating value for shareholders. In recent years, the ROE has improved, and for 2006 it was 19.1%.
I tried to relate ROE to the cost of capital (financial jargon for the opportunity cost of an investment). The company recently issued senior notes at 7.125%. Adding a risk premium of about 4%-5% would give us a cost of capital in the low teens. Because the ROE is above the cost of capital, it implies that NewMarket has the potential to generate profitability for shareholders.
Finally, NewMarket has a strong balance sheet with a manageable debt load and consistently positive free cash flow. The strong financial condition and high ROE might make NewMarket an attractive takeover target for
private equity or another specialty chemicals company.
NewMarket's financial strengths may have been what attracted Renaissance Technologies, a renowned quant hedge fund to the stock. Looking at the firm's latest 13-F holdings, Renaissance owns 3.5% of NewMarket's outstanding shares. It also has a 4.2% stake in its competitor Lubrizol.
Please note that as of Sept. 6, BASF is delisted from the
, and its American depositary receipts, or ADRs, now trade on the pink sheets market under a new ticker. The pink-sheets market typically carries riskier securities, but since value of these shares is related to their counterpart shares on the heavily traded Xetra market in Germany, I expect arbitrage to mitigate the trading risks associated with the pink sheets.
According to the 10-Qs, most of NewMarket's improved financial performance of late 2006 and early 2007 is attributable to the introduction of new products with higher operating margins and price increases on existing products. Whether this is a trend that can be sustained for very long is uncertain.
Another threat is that since this is a small company -- NewMarket's market cap is about $768 million -- its customers have significant influence over sales volume. In 2006, more than 10% of revenue came from two customers:
Royal Dutch Shell
NewMarket is also a small player compared to its competitors. Its products directly compete with some of the larger oil conglomerates and chemical companies such as BASF.
The Bottom Line
NewMarket appears to be a great holding for speculation. The possibilities of a takeover and benefits from global growth make it appealing. However, consider the risk and volatility of the stock. With few guarantees on future performance or safety, a few bad cards can send this company in either direction.
As a safer alternative for investing in the additives and lubrication industry, I suggest BASF. Aside from a more diversified business, BASF is also more likely to benefit from the appreciating euro.
At the time of publication, Kotzan was long BP, although positions may change at any time.
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