Eastman's Specialty Chemicals Should Benefit From Long-Term Demand Growth Despite Near-Term Slowdown

Strategist

Seth Goldstein

Through acquisition and internal development, Eastman owns a solid portfolio of specialty chemicals. Eastman's specialty chemicals include plastics and components used in safety glass, window tinting, and specialty plastics, all of which offer a solid growth profile. To increase its specialty portfolio, the firm invests roughly 4% of sales from its additives and functional products and advanced materials segments into research and development, which is in line with its specialty chemical peers. Eastman is well positioned to meet growing demand for auto window interlayers, including heads-up displays, and specialty plastics.

Eastman also holds a solid position in acetate tow, which is primarily used to make cigarette filters. The acetate tow industry has experienced falling prices due to overcapacity in China over the past several years. However, a handful of players dominates the industry, a factor that led to disciplined capacity shutdowns by all of the major companies during the industry downturn. To offset some of the decline, Eastman has been investing in capacity for other uses for its fibers, including fabrics and apparel.

Eastman uses multiple feedstocks, including natural gas, coal, wood pulp, and recycled chemicals and plastics. The company plans to widen its recycled plastic feedstock capacity over time, which will replace traditional carbon-based feedstocks. Eastman's long-term goal is to eventually make all its cellulosic plastics and polyesters from plastic waste. We think this strategy will provide Eastman with solid growth as demand for products from this feedstock grows over time. Further, the company can charge a premium for its sustainable feedstock-based products, which allows it to recover the higher cost of production.

Eastman's coatings, adhesives, specialty polymers, fluids, and inks businesses generate solid operating margins. Along with the fibers segment, these businesses provide a relatively stable earnings base to offset swings in other areas. As with other chemical companies, Eastman's business model is subject to a high degree of operating leverage, as changes in volumes can have an outsize impact on profits.

Business Strategy & Outlook

We award Eastman a narrow moat rating based on the intangible assets stemming from its patent-protected specialty chemicals portfolio. Eastman's patent-protected specialty chemicals compose roughly 50% of its specialty portfolio and have an average patented commercial life of 10 years. While Eastman sells a diverse portfolio of chemicals that have a wide range of end uses. Additionally, the company's automotive glass interlayers, which are among the best in the industry, should benefit from greater demand as increased electric vehicle sales will require energy-efficient windows to extend battery range. The interlayer products should also benefit from the heads-up display feature being installed in a greater proportion of vehicles.

Although some of Eastman's products are low-cost, we don't think the cost advantage moat source is strong enough on its own to support a moat for the company. Eastman's ethylene and propylene production uses low-cost U.S. natural gas, which gives the firm’s olefin stream a low-cost base. While Eastman's coal-based production of methanol, acetic acid, and other chemicals gives the company a low-cost base for some of its products, the coal-based feedstock makes other products more expensive. On a consolidated basis, we think Eastman's cost position is on the lower half of the cost curve, but not low enough for us to award the firm a cost advantage. We award Eastman a narrow economic moat as its patented-protected specialty chemicals combined with its solid cost position give us confidence that the firm will outearn its cost of capital over the next 10 years.

Narrow

Economic Moat

Eastman Chemical

Eastman Chemical Co. engages in the provision of specialty chemicals. It operates through the following segments: Additives and Functional Products, Advanced Materials, Chemical Intermediates and Fibers. The Additives and Functional Products segment includes chemicals for products in the transportation, consumables, building and construction, animal nutrition, crop protection, energy, personal and home care, and other markets. The Advanced Materials segment produces and markets its polymers, films, and plastics with differentiated performance properties for value-added end uses in transportation, consumables, building and construction, durable goods, and health and wellness markets. The Chemical Intermediates segment consists of large scale and vertical integration from the cellulose and acetyl, olefins, and alkylamines streams to support operating segments with advantaged cost positions. The Fiber segment offers cellulose acetate tow for use in filtration media, primarily cigarette filters. The company was founded by George Eastman in 1920 and is headquartered in Kingsport, TN.

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Eastman Chemical Co. engages in the provision of specialty chemicals. It operates through the following segments: Advanced Material (AM), Additives and Functional Products (AFP), Chemical Intermediates (CI), and Fibers. The AM segment produces and markets its polymers, films, and plastics with differentiated performance properties for value-added end uses in transportation, consumables, building and construction, durable goods, and health and wellness markets. The AFP segment includes chemicals for products in the transportation, consumables, building and construction, animal nutrition, crop protection, energy, personal and home care, and other markets. The CI segment consists of large scale and vertical integration from the cellulose and acetyl, olefins, and alkylamines streams to support operating segments with advantaged cost positions. The Fibers segment offers cellulose acetate tow for use in filtration media, primarily cigarette filters. The company was founded by George Eastman in 1920 and is headquartered in Kingsport, TN.

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