Stock Analysis: Materials Andrew Givens March 6, 2007 Student Investment Management

Stock Analysis: Materials

Andrew Givens

March 6, 2007Student Investment Management

Executive Summary• Sell entire position of Deltic Timber

– 7,000 shares• Buy equivalent amount of Dow

Chemicals (DOW)– 8,177 shares

• Maintain current underweighting in materials sector

Agenda• Sector Recap• Deltic Timber Company Overview• Deltic Timber Valuation• Dow Chemical Company Overview• Dow Valuation• Recommendation

Sector Recap• Smallest sector in S&P 500

– 3.05% weight– SIM currently underweight (1.5%)

• Highest gainer YTD– Up 5.33%

• Sector trading at historic levels based on– Price to book value– Price to sales

Sector RecapDeltic Timber Corp.

(DEL)Dow Chemicals

(DOW) Recommendations

Sector Recap• Remain underweight in Materials

– Expensive based on valuation analysis– Do not want to “chase” the money after an

excellent first two months of the year– Cyclical industry

• Economy appears to be slowing– Manufacturing utilization rates and MPI both down from

local highs– Expect sector to follow suit

Sector RecapDeltic Timber Corp.

(DEL)Dow Chemicals


Deltic Timber Corporation (DEL)

Sector RecapDeltic Timber Corp

(DEL)Dow Chemicals


• Timber company with 438,000 acres of timber– Arkansas– Northern Louisiana

• Four operating segments– Woodlands– Mills– Real Estate– Del-Tin Fiber (50% equity stake)

• Key economic drivers– New home starts– Growth of GDP



(DEL)Dow Chemicals


• New home starts– Biggest raw

material input is lumber

– Increases & decreases in new home starts will drive lumber prices

Deltic Timber Corporation (DEL)• Projections for new home starts

– Average quarterly home starts (millions)

• Decreased home starts lower lumber prices– Deltic should experience lower sales & a margin

squeeze


(DEL)Dow Chemicals


Historic Projected*

2002 2003 2004 2005 2006 2007 20081.7 1.85 1.96 2.07 1.80 1.62 1.70

*Freddie Mac 2007 Economic Outlook



(DEL)Dow Chemicals


• DCF Valuation– Assumptions

• Discount Rate of 8.86% (Deltic’s WACC)• Terminal Growth Rate of 5%• Capital Expenditures = Depreciation in perpetuity

– Implied equity value per share of $38.23• Currently trading at $49.00 (Monday close)



(DEL)Dow Chemicals


• DCF Sensitivity Analysis

Sensitivity Analysis of WACC and Terminal Growth Rate on Implied Value Per Share

WACC38.23 5.86% 6.86% 7.86% 8.86% 9.86% 10.86% 11.86%4.25% $103.65 $62.30 $43.96 $33.65 $27.07 $22.53 $19.214.50% $120.49 $67.70 $46.44 $35.00 $27.89 $23.06 $19.574.75% $144.90 $74.39 $49.31 $36.52 $28.79 $23.63 $19.955.00% $183.44 $82.87 $52.70 $38.23 $29.78 $24.25 $20.375.25% $253.43 $93.98 $56.72 $40.18 $30.87 $24.93 $20.815.50% $419.83 $109.17 $61.60 $42.42 $32.10 $25.67 $21.295.75% $1,322.50 $131.18 $67.64 $45.02 $33.47 $26.48 $21.81

Term

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Deltic Timber Corporation (DEL)• Multiples valuation

– Relative to Materials Sector


(DEL)Dow Chemicals


High Low Mean CurrentPrice to forward earnings 5.32 1.89 2.93 3.84

Price to EBITDA 2.83 1.22 2.02 2.21

Price to Sales 3.54 2.24 2.88 3.06

Price to Book 1.25 0.77 1.00 0.97

Price to Adjusted Cash Flow 3.27 1.52 2.24 2.82


– Relative to S&P 500


(DEL)Dow Chemicals



Price to EBITDA 2.71 1.35 1.85 2.04

Price to Sales 3.02 1.79 2.38 2.77

Price to Book 1.28 0.73 0.97 1.05



– Absolute


(DEL)Dow Chemicals


High Low Mean CurrentTarget

MultipleTarget # per

shareTarget Price

Price to forward earnings 71.8 25.6 38.8 58.20 38.8 1.02 $39.58

Price to EBITDA 19.5 10.9 14.2 14.50 14.2 2.80 $39.76

Price to Sales 4.46 2.78 3.56 4.00 3.56 11.10 $39.52

Price to Book 3.7 2.3 2.9 3.00 2.9 13.88 $40.25

Price to Adjusted Cash Flow 30.8 17.0 21.3 27.70 21.3 1.79 $38.02

Deltic Timber Corporation (DEL)• Both DCF and multiples analysis give prices in

$38-$40 range• Price target of $38.83

– Weighted average• DCF (50%)• Multiples price targets (12.5% each)

– Implied downside of 21%• Recommendation is to sell entire position


(DEL)Dow Chemicals


Dow Chemical Co. (DOW)


(DEL)Dow Chemicals


• Operates in Chemicals Industry within Materials Sector• Engages in manufacture and sale of:

– Chemicals– Plastic Materials– Agricultural Products

• $40.6 billion market cap• $49.2 billion revenues• Currently trading at $41.76 (Monday close)



(DEL)Dow Chemicals


• Operates in Chemicals Industry within Materials Sector• Engages in manufacture and sale of:

– Chemicals– Plastic Materials– Agricultural Products

• $40.6 billion market cap• $49.2 billion revenues• Currently trading at $41.76 (Monday close)



(DEL)Dow Chemicals


31-Dec-06 31-Dec-05 31-Dec-04

49,124,000 46,307,000 40,161,000 41,526,000 38,276,000 34,244,000

7,598,000 8,031,000 5,917,000

4,307,000 5,244,000 3,398,000

3,724,000 4,515,000 2,797,000 Net Income

Operating Income or Loss

Gross Profit

PERI OD ENDING

Total RevenueCost of Revenue

• Income Statement



(DEL)Dow Chemicals


• Balance Sheet31-Dec-06 31-Dec-05 31-Dec-04

Cash 2,757,000 3,806,000 3,108,000 Receivables 8,241,000 8,247,000 7,741,000 Inventory 6,058,000 5,319,000 4,957,000

17,209,000 17,404,000 15,890,000 13,722,000 13,537,000 13,828,000 14,193,000 14,550,000 15,632,000

45,581,000 45,934,000 45,885,000

Payables 9,310,000 9,384,000 9,645,000 ST debt 1,291,000 1,279,000 861,000

10,601,000 10,663,000 10,506,000 8,036,000 12,524,000 11,629,000 7,515,000 4,692,000 8,730,000

999,000 1,395,000 1,301,000 1,365,000 336,000 1,449,000

28,516,000 30,610,000 33,615,000 16,987,000 14,719,000 11,527,000

(970,000) (559,000) (995,000)830,000 661,000 274,000

-2235000 -1950000 (989,000)17,065,000 15,324,000 12,270,000

Other LT Assets

Other Stockholder EquityStockholders' Equity

Retained EarningsTreasury StockCapital Surplus

Total Liabilities

Long Term DebtOther LiabilitiesDeferred Long Term Liability ChargesMinority Interest

Liabilities

Total Current Liabilities

Total Assets

Total Current AssetsPP&E

PERI OD ENDING

AssetsCurrent Assets



(DEL)Dow Chemicals


• DCF Valuation Assumptions– Discount Rate of 10% (higher than actual WACC of

8.44%)– Perpetuity Growth Rate of 3.25%

• Meant to mimic GDP growth

– Slow revenue growth• Typical for such a large company

• Implied value per share of $50.76



(DEL)Dow Chemicals


• DCF Sensitivity Analysis

Sensitivity Analysis of Discount Rate and Terminal Growth Rate on Value Per ShareDiscount Rate

$50.76 7.00% 8.00% 9.00% 10% 11.00% 12.00% 13.00%2.50% $79.69 $65.38 $55.46 $48.18 $42.60 $38.19 $34.622.75% $82.69 $67.19 $56.64 $48.98 $43.17 $38.61 $34.933.00% $86.07 $69.19 $57.91 $49.84 $43.77 $39.04 $35.253.25% $89.90 $71.39 $59.29 $50.76 $44.41 $39.50 $35.59

3.50% $94.27 $73.84 $60.80 $51.75 $45.10 $39.99 $35.953.75% $99.32 $76.57 $62.45 $52.82 $45.83 $40.51 $36.334.00% $105.21 $79.65 $64.27 $53.98 $46.61 $41.06 $36.73Te

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ate



(DEL)Dow Chemicals


• Multiples Analysis– Relative to Materials Sector


Price to EBITDA 1.82 0.58 0.85 0.82

Price to Sales 0.96 0.59 0.87 0.64

Price to Book 1.55 0.73 1.34 0.79




(DEL)Dow Chemicals


• Multiples Analysis– Relative to S&P 500

High Low Mean Current

Price to forward earnings 1.28 0.56 0.69 0.70

Price to EBITDA 1.89 0.53 0.91 0.76

Price to Sales 0.85 0.5 0.67 0.57

Price to Book 1.51 0.71 1.23 0.85




(DEL)Dow Chemicals


• Multiples Analysis– Absolute

High Low Mean CurrentTarget

MultipleTarget #

per shareTarget Price

Price to forward earnings 21.8 8.2 10.8 10.4 10.80 4.55 $49.14

Price to EBITDA 15.1 3.9 6.9 5.30 6.90 7.25 $50.03

Price to Sales 1.34 0.7 1.01 0.83 1.01 51.20 $51.71

Price to Book 4.8 2.0 3.6 2.4 3.60 14.70 $52.92

Price to Adjusted Cash Flow 15.4 5.4 9.5 6.7 9.50 5.34 $50.73



(DEL)Dow Chemicals


• Both DCF and multiples analysis give prices in the $49-$52 range

• Price target of $50.83• Upside of 21.7%

Recommendations


(DEL)Dow Chemicals


• Unload entire Deltic position– 7,000 shares

• Replace with Dow Chemicals– 8,177 shares

• Maintain underweighting in an overvalued sector

Thank You

Andrew GivensFisher College of [email protected]

Documents

Stock Analysis: Materials Andrew Givens March 6, 2007 Student Investment Management