Olin Stock's Fantastic Run in 2016 Was Way Too Much
A specialist in producing specialty chemicals -- and gun ammunition -- Olin Corporation (NYSE: OLN) is not the sexiest name on the stock market today, but it nonetheless had a terrific time in 2016. Over the course of just 12 months, Olin stock surged 48% -- nearly five times the performance of the S&P 500 at large. But can the stock repeat this feat in 2017?
I don't think it can -- and I'll tell you why not.
Since Olin is the maker of Winchester ammunition, many investors view it as a "guns and ammo" stock. That's not a good thing. Image source: Getty Images.
2016 in a nutshell
In many respects, 2016 was a great year for Olin Corporation. Although final Q4 results are not yet in, sales shot up 162% through the first three quarters of the year, with operating profits surging 89%. Granted, most of these gains came through the company's $5 billion acquisition of Dow Chemical'schlorine business in 2015 -- but however it happened, sales and profits are both moving on up.
In Q1, Olin credited "improved volumes" of the company's chlor alkali (caustic soda and chlorine) and vinyls products with growing the business organically. In Q2, the epoxy business began to turn around, with management calling it the "improvement story" of the quarter, while chlor alkali continued to enjoy "favorable market dynamics." Then, in Q3, Olin reported "sequential improvement across all three segments" of its business.
Overall, Olin sounded optimistic notes in its latest quarterly update, as it drew closer to 2017. Yet even so, the company's future looks uncertain as we start the new year. For one thing, thanks to the same Dow acquisition that boosted sales and operating profits, Olin now carries a heaping helping of debt on its balance sheet. According to S&P Global Market Intelligence data, the company's $3.6 billion in long-term debt is about 28 times the size of its $127 million cash reserves.
And while Olin is free-cash-flow positive, and can be expected to begin deploying that cash to whittle down the debt it took on, the company's valuation -- even when valued on free cash flow -- looks rich, to say the least.
Valuing Olin
Valued on its $259 million in trailing free cash flow, Olin stock sells for a multiple of 17. Factor in the stock's heavy debt load, however, and Olin's enterprise value-to-free cash flow ratio swells to 31 times FCF. With the one-time windfall of revenue and profits from Dow now already on the books, analysts who follow the stock predict Olin will only grow its profits at about 8% annually over the next five years -- a growth rate that makes the stock look expensive at a multiple of 31 -- or even 17.
What's more, even that growth rate may be imperiled if, as investors seem to expect, Donald Trump's election as president results in decreased demand for guns and ammunition. Currently, Olin's Winchester ammunition business, only its second-largest business by revenue, is the company's most profitable business by margins. S&P Global data shows that Winchester earns Olin 16.3% operating profit margins, which is more than twice the profitability of the overall business. Accordingly, a diminished demand for guns and ammunition could seriously crimp Olin's profits, even if the much larger chlor alkali business improves.
Long story short, with Olin's heavy debt load, weak prospects for growth, and even a risk that growth will be derailed, 2017 looks a lot less optimistic for the company than 2016 did.
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Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.