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OLIN Corp. ($OLN) - Short Idea

The Olin Corp. ($OLN) is a leading manufacturer and distributor of chemical products and ammunition. Olin has 3 operating segments: Chlor Alkali Products and Vinyls, Epoxy and Winchester. Chlor Alkali is the largest segment, representing 58% of sales, with Epoxy and Winchester representing 20 and 22% respectively. Chlor Alkali produces different chemicals, Epoxy manufactures and distributes epoxy materials/products, and Winchester produces ammunition (used in a variety of applications, including military, recreational, law enforcement and construction). We believe that Olin presents a compelling short due to future compounding losses of revenues caused by legislation, increased volatility due to the shifting dynamics of the Winchester business, and an increase in crude oil prices (relative to natural gas). It currently trades at a premium to historic EV/EBITDA (currently 7.2x, greater than post COVID average of 5.6x), P/E (currently ~16x) and has shown consistent decreases in EBITDA margins (6% from 17 to 23 just YoY).



Business



Chlor Alkali Products



Chlorine, caustic soda, chlorinated organic compounds (e.g. methyl chloride), along with other products (including hydrochloric acid and bleach) are the primary materials included in the segment. The raw materials needed for these products are electricity, salt, ethylene, and methanol. Electricity is the largest by far and is mostly generated from natural gas and hydroelectric sources – Olin does have long-term contracts and owns power assets, but a large portion of natural gas is sourced from the market. Most salt requirements are met by internal supply, while ethylene is sourced from a supply agreement with Dow chemical. Around 32% of demand for Chlor Alkali products is international.



Epoxy



A full range of epoxy materials, such as aromatics, allylics, resins and additives are a part of the segment, with applications in civil engineering, protective coatings, wind energy, electrical laminates, consumer goods and composites. Several key raw materials are sourced from the Chlor Alkali business, ensuring reliable supply. The business primarily operates in North America and Western Europe, with international sales accounting for the majority (57%).



Winchester



Winchester is the oldest business, having existed as a business under Olin for nearly a century. It is a premier developer and manufacturer of small caliber ammunition for sale to domestic and international retailers (commercial customers), law enforcement agencies and domestic and international militaries. It is the smallest business internationally, with over 89% of sales being domestic. While the other two businesses are seasonal (due to construction and engineering peaking in summer), Winchester shows the highest seasonality due to the rise in hunting sales during fall.



Legislation: As for the Chlor Alkali business, recent environmental legislation threatens to disrupt operations. A significant portion (the majority) of the production capacity utilizes diaphragms, which use asbestos. Because of the impacts of chlorine production in the Epoxy segment and the Chlor Alkali segment, legislation threatening the prohibition of asbestos use could substantially reduce production capacity along with introducing significant restructuring costs. For example, ~400,000 tons of Chlor Alkali capacity at the McIntosh, AL plant was closed in Q3 2022. Over $19 mn in restructuring costs have been incurred so far and another $20 mn is expected over the next 3 years. Legislation has already been passed and Olin proposes a 7-year program to phase out the use of diaphragm production, which the American Chemistry Council is not on board with. Olin’s key competitors (OxyChem and Westlake) are also subject to the same legislation – however, Westlake has significantly less productive capacity which will be tied up because of this, while OxyChem is only the second largest diaphragm producer (after Olin). The compounding impact of this legislation (due to significant volumes of chlorine used in the Epoxy segment previously being sourced from Chlor Alkali, providing steady and reliable supply) will significantly reduce further earning potential and will act as a competitive disadvantage in the future. The news of the legislation did not lead to a significant decrease in price due to Olin's history of mentioning insulation from legislation due to their closing of plants utilizing diaphragms. We believe the extent of the insulation was overstated due to 1) the unanticipated reaction of the time horizon requested by Olin to phase out diaphragm use by the ACC and 2) greater exposure than its competitors. Half of the 8 US plants still using diaphragm production are operated by Olin, and according to our estimates, Olin could face restructuring charges of an average ~$13 mn per plant in a year alone, and ~$14 mn over the next few years. Furthermore, an increase in the ratio of crude oil prices to those of natural gas would be inherently harmful to Olin due to a decrease in price competitiveness. OxyChem is already competitively advantageous to Olin due to the more reliable supply of oil, and this coupled with the latter could cause higher operating costs throughout 2024 and 2025.



Winchester Sales: 30-40% of Winchester revenues are from law enforcement/military contracts and are relatively stable. The rest of the sales are recreational – traditionally, recreational sales have shown higher margins. The gross margin of the ammunition business decreased from 23% in 2022 to 17% 2023, primarily due to lower commercial volumes. Due to the volatile nature of firearm legislation and the upcoming election, and the increasing focus of Olin on the commercial side of the business (it recently acquired White Flyer – a trap/skeet/clay targets business), the stock is likely to show higher volatility in the coming months. The general perception surrounding the acquisition is positive due to the fair price paid for the assets, but Olin’s shifting focus to commercial sales provides more exposure to risk. While any speculation about the election is, well, speculation, the past stability of the margins/income of the business is likely to come into question, causing short-term downward price pressure. This is supported due to the well documented price movements before elections from 1996 to 2016 (2020 was an exception to this rule due to the rapidly improving fundamentals and steady increases in Chlor Alkali revenue throughout the year).



Insider Selling/Management: There has been a strong pattern of insider selling shown in 2024. 5 executives have sold more than 22% of their holdings since February of this year. The exit of Scott Sutton (the former CEO who accelerated the significant improvements in company fundamentals) hints at a change in insider dynamics. Sutton’s departure was sudden and unexpected, with Kenneth Lane now acting as the CEO. Lane has had significantly less experience in the chemicals/commodities business, formerly serving as the VP of LydonBasell, a packaging and logistics firm. No information has been provided as to the reasons behind Sutton’s abrupt departure from the firm, which we view as overwhelmingly negative.



I do not hold a position with the issuer such as employment, directorship, or consultancy.


I and/or others I advise hold a material investment in the issuer's securities.


Catalyst

Decrease in earnings due to restructuring costs over the next 2-3 years


Decrease in margins due to increasing commercial sales


Increase in crude oil prices

 

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