Eastman Chemical

Eastman Chemical reported improving second-quarter results as higher prices and volumes drove profit growth and margin expansion.

Why it matters: Eastman shares were down 2% at the time of writing on July 31 as the market reacted to management's third quarter guidance below FactSet consensus estimates. We think management is taking a fairly conservative approach to guidance, only providing the next quarter instead of the full year and assuming energy and commodity chemicals prices moderate from the second-quarter highs driven by the Middle East conflict-related supply shock. Guidance also implies continued weak end market demand. We don't forecast a demand recovery over the next couple of years. However, we expect commodity chemicals prices will remain higher for longer, driving above midcycle profit margins for the commodity chemicals business.

The bottom line: We maintain our $100 fair value estimate for narrow-moat Eastman Chemical. We forecast moderate profit recovery in 2026 versus 2025, but still expect companywide profits to be below midcycle levels. We see an eventual demand recovery driving long-term profit growth. At current prices, we view Eastman shares as undervalued, with the stock trading in 4-star territory and more than 30% below our fair value estimate. For income-focused investors, Eastman also offers a 4.8% dividend yield at the time of writing, and we currently view the dividend as safe. Eastman's specialty chemicals businesses were able to raise prices to offset the impact of energy and commodity chemicals cost inflation, while also growing volumes. This supports our view that Eastman can raise prices for its differentiated products without demand destruction.

We maintain our $100 fair value estimate for Eastman Chemical following the company's second-quarter earnings. We use a weighted average cost of capital of around 8%.

We forecast a profit recovery in 2026. Eastman's 2025 results were affected by a tariff-related slowdown. In 2026, Eastman should benefit from its two specialty businesses—advanced materials, additives, and functional products—seeing more stable results. We forecast strong profit growth in the chemicals intermediates business as the US-Iran conflict created an energy and commodity chemicals supply shock that will lead to a shortage of commodity chemicals and far higher near-term feedstock costs for chemical producers outside of the US. As Eastman products 80% of its products in the US, the company should be a beneficiary, partially offset by chemicals inflation likely weighing on volumes over time. Combined with Eastman's cost reduction initiatives, we see profits rising in 2026, then falling in 2027 as the commodity chemicals business sees lower profits and the specialty businesses see slower growth from lower volume growth.

Over the long term, even if tariffs remain in place, we think global trade flows will shift, and Eastman's sales will recover. Eastman will continue to develop new products in its advanced materials and additives and functional products segments that will allow it to grow profits above GDP. We forecast that operating margins will recover to 20% and 19% in the AFP and AM segments, respectively, by the end of our five-year explicit forecast, well above the 18% and 12% levels achieved in 2025.

To develop new products, we expect Eastman to reinvest roughly 4% of sales from these segments in research and development, consistent with the investment rate over the past several years.

In Eastman's chemical intermediates business, we forecast midcycle margins at around 7%, though we expect this segment will continue to see high cyclicality. Operating profits werenegative profits in 2025, but we expect margins will come in above midcycle levels in 2026 due to the Middle East conflict-related supply shock that is boosting commodity chemicals prices. Eastman’s intermediate products are made from both coal and natural gas, while many of its competitors use higher-cost oil-based naphtha, which sets the global marginal cost and typically informs prices.

Finally, our base case assumes Eastman pays $200 million in legacy Solutia-related environmental liabilities, consistent with management's accrual over the next 30 years.

In a scenario where Eastman sees a prolonged volume decline due to an economic slowdown, we would forecast revenue to decline while operating margins average in the low double digits, well below the company's historical average. Under these assumptions, our fair value estimate would fall to $50 per share.

We award Eastman a narrow moat rating based on the intangible assets stemming from the patent-protected specialty chemical portfolio.

We generally view chemical companies through the commodity processors moat framework. Chemical producers can earn a moat if they convert commodity chemicals into patented, differentiated products, generating pricing power, or if they have a cost advantage in producing commodities. We think the former applies to Eastman.

Eastman's patent-protected specialty chemicals generate 50% of sales in its additives and function products segment and the majority of sales in the advanced materials segment. Its products 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, its customers choose its products for their superior characteristics versus competitors. For example, the company's automotive glass interlayers are among the best in the industry, making Eastman a preferred supplier for automakers that install a heads-up display, which projects key metrics such as speed limit onto the front windshield, in their vehicles. Eastman’s glass interlayers are also among the best at controlling cabin temperatures. They should benefit from greater demand as increased electric vehicle sales will require energy-efficient windows to extend battery range.

This dynamic of Eastman producing the best products in a given segment results in pricing power for the company as evidenced by the company’s ability to raise prices during cost inflation and hold prices when its commodity chemical inputs see falling prices.

In recent years, Eastman’s specialty chemicals have contributed a greater portion of sales as the company has divested more-commoditized businesses in the additives and function products and chemical intermediates segment.

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 US 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, which supports the intangible assets moat source and helps the firm generate positive economic profits, but in isolation, it is not low enough for us to award the firm a cost advantage.

All in all, 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.

Eastman is well positioned to meet evolving chemical demands in auto with window interlayers and specialty plastics through its best-in-class patented products.

Eastman's investments in plants that use sustainable-based feedstocks, including recycled chemicals and wood pulp, should benefit from growing demand for specialty plastics made from these feedstocks.

As Eastman continues to develop new patented products, it should expand its specialty chemical business, which generates higher margins and commands some degree of pricing power.

While the company's coal gasification is a low-cost method compared with many international competitors, other Eastman products are made with higher-cost petrochemicals.

Tariffs will disproportionately hurt Eastman. Nearly 7% of Eastman's revenue in 2024 came from chemicals made in the US and exported to China, while Eastman also sells products in China to manufacturers that export to the US.

The majority of Eastman's volumes are not specialty chemicals, which leaves the company more exposed to the volatility of the cyclical commodity chemical industry.