A Hidden Gem in the Chemicals Space

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Perhaps no industry in the world of personal finance fits the term 'under the radar' better than the chemical/cleaning products segment. The whole idea behind a majority of the products created by this industry is to operate outside of the public's field of view. People usually do not want to know how surfactants in industrial detergent work to clean surfaces; they merely want to know that the process achieves the desired results.

It is no surprise companies like Stepan go largely unnoticed by the masses. However, the quiet nature of these types of businesses is also a major reason why the companies can be great bargains for investors in the long term.

A quiet but diverse business
Stepan operates primarily as a manufacturer and distributor of basic and intermediate chemicals to various countries around the world. The company's two main business segments include surfactants, which are key ingredients in consumer- and industrial-cleaning compounds, and polymers, which are used as coatings, adhesives, and insulators in the commercial construction and roofing and aerospace businesses. The company also produces a number of specialty chemicals, which are used mainly in the food/nutrition/pharmaceutical industries.

The broad uses of many of the chemicals that Stepan produces are what make the company's business so appealing. The diverse nature of the company's chemicals gives Stepan exposure to a number of powerful industries, including the food/nutrition/pharmaceutical space, agricultural, and oil industries as well as the aerospace and defense fields.

In a previous earnings call, management explained that further diversifying the company's business mix is a top priority. Judging from Stepan's latest earnings call, the company is in the process of further strengthening its distribution to agricultural and oil industries, despite recent challenges, including the rising cost of raw materials and increased competition, which has temporarily stifled global demand.

Of the company's progress so far, president and CEO F. Quinn Stepan Jr. explained, "Surfactant sold for used and enhanced oil recovery are expected to improve compared to the slow year-to-date results. Demand for agricultural surfactants should remain strong."

Commitment to shareholder value
Despite challenges on numerous fronts, the company's commitment to creating value for shareholders should never be questioned. In the latest earnings report, management announced that it was increasing the company's quarterly cash dividend by 6%. The company now pays an annual dividend of $0.68 per share, which equates to a yield of 1.1%.

What is most impressive about the company's latest dividend increase however, is that it marks the 46th consecutive year in which Stepan has raised its quarterly dividend on common stock. In terms of consistency with regard to dividend raises, it doesn't get much better than that!

Additionally, management has maintained a strong balance sheet in recent years. Despite recent acquisitions, including the purchase of a North American polyester-resins business from Bayer MaterialScience in the second quarter, total debt stands at just $276.8 million, or 20.8% of the company's current market capitalization.

Solid growth at a cheap price
As was mentioned before, management at Stepan has spent a good deal of 2013 battling a combination of rising material costs and increasing competition, which has adversely affected revenue and earnings-per-share growth in the current year. However, growth is expected to pick up significantly in 2014.

Stepan is projected to grow revenue 6.8% next year, which is almost double the rate at which the company is expected to finish growing revenue in 2013. On the EPS front, things are looking even better as growth is projected come in at a robust 23.8%.

When compared to similarly sized companies in the specialty chemical space like Balchem  and Innosphos , Stepan's projected growth appears admirable. The following is a breakdown of all three companies' projected growth rates for 2014.





Revenue Growth 2014




EPS Growth 2014




The data above indicates that Stepan is growing at rates that are similar to Balchem and Innosphos. However, the company  distances itself from its peers in terms of valuation. Despite the solid growth estimates, shares of Stepan still trade at cheap valuation multiples. The company's trailing-12 month P/E is only 17.6 and its forward P/E is a cheaper 13.3.

These multiples are significantly cheaper than Balchem's trailing and forward P/E multiples of 40.86 and 32.69 and also slightly cheaper than Innosphos' respective multiples of 21.94 and 13.65. The low P/E ratios for Stepan indicate that the company's growth isn't being priced in yet by investors. 

A hidden gem
While there are certainly faster growing companies in the chemical sector, few are as cheap as Stepan and even fewer have as solid a track record with regard to preserving shareholder value. The company's commitment to dividend growth is about as good as it gets.

With a very challenging 2013 almost behind it, Stepan seems poised to make a comeback in 2014. As such, at current levels investors should consider the small-cap company for long-term growth.

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The article A Hidden Gem in the Chemicals Space originally appeared on Fool.com.

Philip Saglimbeni has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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