Before selecting a stock, there are a number of things that you need to consider in order to ensure that you are buying the stock of a high-quality company whose shares are poised to grow in value over time. Some of these concerns include what the company does, its competitive advantages, valuation, dividend payouts and sustainability, and earnings consistency.
Another important thing that you need to consider is the financial condition of the company in question. You want to know if the company is able to continue paying its bills, and how much debt it carries. The balance sheet is one of the most effective tools that you can use to evaluate a company's financial condition.
In this article, I will discuss the balance sheets of DuPont (DD), Dow Chemical (DOW), and Monsanto (MON) in order to get some clues as to how well these companies are doing. While DuPont and Dow are very similar in regard to what they do, I also included Monsanto due to the fact that DuPont is moving further and further toward agriculture and nutrition. Monsanto is a very dominant player in the agriculture field and competes against DuPont in several areas.
I will go through the balance sheets of these three companies, reviewing the most important items, and seeing if there are any major differences between them, making one a better investment than the others. Information that I used on DuPont can be found here, information on Dow can be found at this link, and information that I used on Monsanto can be found here. Note that this article is not a comprehensive review as to whether either of these three stocks should be bought or sold, but rather, just an important piece of the puzzle when doing the proper due diligence.
This article might be a bit too basic for some and too long-winded for others, but I hope that some of you can derive benefit from it.
DuPont produces a wide array of products, materials, and services for several different markets. Its business is divided into seven different segments. Its agriculture segment produces Pioneer Hi-Bred seeds and crop protection chemicals. The electronics and communication segment produces items like metalization pastes and backsheet materials for use in solar cells and modules. The industrial biosciences segment produces industrial enzymes for use in detergents, food manufacturing, and ethanol production. The nutrition and health segment produces cultures, emulsifiers, natural sweeteners, and other items that are used in food production. Their performance chemicals segment provides titanium dioxide, which is used in automotive pigments, as well as fluoropolymers like Teflon. The performance materials segment produces plastics that are used in automotive applications, packaging, electronics, aerospace, and consumer goods. And, last, but not least, its safety and protection segment produces Kevlar body armor and Nomex fiber that is used in flame-resistant clothing. Thirty-five percent of its sales are from the U.S. and Canada, while 40% comes from the emerging markets. Sales in the emerging markets have grown by 8% in 2012 versus 2011.
The business of Dow Chemical is divided into six different segments. The electronics and functional materials segment manufactures materials that are used in liquid crystal displays, semiconductors, pharmaceuticals, and even food items. Their coatings and infrastructure solutions segment produces insulation, adhesives, and coatings that don't emit as many volatile organic compounds that are bad for the environment. The agricultural sciences division manufactures herbicides, insecticides, and seeds. The performance materials segment produces materials that are used in electronics, pharmaceuticals, cleaning, natural gas processing, lubricants, and transportation. Their performance plastics segment provides commodity plastics for use in packaging, medical, and electronics applications, just to name a few. Their feedstocks and energy segment produces some of the base materials and chemicals that go into producing their other products. Some of these items include chlorine, caustic soda, and ethylene. 84% of what is produced by this segment is used by the other segments. 65% of their business is outside of North America.
Monsanto, unlike the other two companies, is a pure agricultural play. They produce seeds for corn, cotton, soybeans, and vegetables. They also produce plant biotechnology traits that improve crop yields, along with crop protection chemicals. While I don't have the geographical data when it comes to their sales, they are a global company with a substantial presence outside of North America.
Cash and Cash Equivalents
The first line in the Assets column of the balance sheet is for the amount of cash and cash equivalents that the company has in its possession. Generally speaking, the more cash the better, as a company with a lot of cash can invest more in acquisitions, repurchase stock, and pay out dividends. Some people also value stocks according to their cash positions. Some of the larger and more mature companies tend not to carry a lot of cash on their balance sheets, as they might be more inclined to buy back stock with it, or pay out dividends.
As of Dec. 31, 2012, DuPont had $4.4B in cash. This isn't bad for a company with a market capitalization of $44.6B. The stock trades at 10 times its cash position, which may make it a compelling value for some investors. They used some of their cash flow to pay out $1.59B in dividends and buy back $400M worth of stock in 2012. Their dividend is well-supported by its free cash flow of $3.06B.
Dow Chemical had $4.32B in cash, and carries a market capitalization of $38.3B. So, it trades at less than 9 times its cash position, making it attractive from that angle. They did not buy back any stock in 2012, but they did pay out approximately $1.65B in dividends, with its free cash flow of $1.86B.
Monsanto has $4.95B in cash, with a $54.4B market cap, trading at just 11 times its cash position. Over the last 12 months, Monsanto paid out $642M in dividends, and bought back $432M worth of stock with its $2.4B in free cash flow.
The table below illustrates this information pretty clearly. From looking at this table, it looks like the dividend payouts and buybacks are well-supported by the free cash flows. However, I would be concerned a bit about DOW at this point, as the dividends are chewing up almost 90% of the free cash flow, not leaving much room for anything else. Monsanto looks to be in the best overall position in this regard.
|Symbol||Market Cap.||Cash Position||Dividend Payouts||Buyback Amount||Free Cash Flow (TTM)|
Table 1: Cash Positions and What DD, DOW, and MON Do With Their Cash
Receivables constitute money that is owed to a company for products or services that have already been provided. Of course, the risk with having a lot of receivables is that some of your customers might end up not paying. For this reason, you usually like to see net receivables making up a relatively small percentage of the company's sales.
DuPont has a total of $5.45B in receivables on 2012 sales of $35.3B. This accounts for 15.4% of sales. While this figure is higher than what you would normally want, it is lower than the figure from 2011, which amounted to 17.5% of sales.
Dow Chemical had a total of $9.67B in net receivables, with 2012 sales of $56.8B. This accounts for 17.0% of sales, where receivables amounted to 16.0% of sales in 2011. Apparently, in the chemical industry, this relatively high receivables percentage is the norm as fellow chemical company, PPG Industries (PPG) had a receivables percentage of 22% of sales.
Monsanto had $2.87B in net receivables on $14.0B of sales. Receivables here amount to 20.5% of sales.
It sounds like these high receivables percentages are the industry norm.
With manufacturing companies like the ones we're reviewing today, I like to keep an eye on inventory levels. I usually like to see inventory levels stable or slightly rising from one year to the next. If I see inventory levels rising, then I want to see revenues rising as well, to indicate higher demand for the company's products. I don't like to see rapidly fluctuating inventory levels that are indicative of boom and bust cycles. In some instances, if inventory ramps up without increases in volumes or revenues, then it may indicate that some of the company's products are going obsolete.
DuPont had $7.42B worth of inventory at the end of 2012. This is slightly higher than the $7.20B that they carried at the end of 2011. This 3% increase in inventory was accompanied by a 3% increase in sales.
Dow Chemical had $8.48B in inventory at the end of 2012, versus $7.58B at the end of 2011. Sales over 2012 were down by 5%, but volumes rose by 1%.
Monsanto had $3.57B in inventory, versus $3.14B a year ago. This jump in inventory was accompanied by a 20% rise in sales. So, no worries there.
The only company that I might be worried about here is Dow Chemical, as their inventory ramped up quite a bit without an accompanying increase in sales.
Another factor that I like to look at is the current ratio. This helps to provide an idea as to whether or not the company can meet its short-term financial obligations in the event of a disruption of their operations. To calculate this ratio, you need the amount of current assets and the amount of current liabilities. Current assets are the assets of a company that are either cash or assets that can be converted into cash within the fiscal year. In addition to cash and short-term investments, some of these assets include inventory, accounts receivable, and prepaid expenses. Current liabilities are expenses that the company will have to pay within the fiscal year. These might include short-term debt and long-term debt that is maturing within the year, as well as accounts payable (money owed to suppliers and others in the normal course of business). Once you have these two figures, simply divide the amount of current assets by the amount of current liabilities to get your current ratio.
If a company's operations are disrupted due to a labor strike or a natural disaster, then the current assets will need to be used to pay for the current liabilities until the company's operations can get going again. For this reason, you generally like to see a current ratio of at least 1.0, although some like to see it as high as 1.5.
The current ratio of DuPont is 1.57. Dow Chemical has a current ratio of 2.06, and Monsanto carries a current ratio of 1.96. The current ratios of all three companies here are fantastic.
Table 2: Current Ratios of DuPont, Dow Chemical, and Monsanto
With companies that have significant amounts of inventory, I like to consider another ratio that is known as the quick ratio. While inventory is generally regarded as a current asset that can be converted into cash within a year, what if it can't be converted for some reason or another? The quick ratio takes this uncertainty into account. When calculating the quick ratio, just subtract the inventory from the current assets, and then divide the rest by the current liabilities. Ideally, you like to see this ratio at 1.0 or above. For DuPont, the quick ratio comes out at 1.02. For Dow Chemical, it comes out at 1.32. Monsanto has a quick ratio of 1.38. All of these ratios are outstanding for these three companies.
Table 3: Quick Ratios of DuPont, Dow Chemical, and Monsanto
Property, Plant, and Equipment
Manufacturing, like any other industry, requires a certain amount of capital expenditure. Land has to be bought, factories have to be built, machinery has to be purchased, and so on. However, less may be more when it comes to outlays for property, plant, and equipment, as companies that constantly have to upgrade and change their facilities to keep up with competition may be at a bit of a disadvantage.
However, this does not appear to be the case with either of the three companies being discussed today. DuPont has $12.7B in this area, which is down from $13.4B the year before. Dow Chemical has $17.5B in property, plant, and equipment, which is basically the same as the $17.3B it had the year before. Monsanto has $4.35B in property, plant, and equipment, compared to $4.23B a year ago.
I don't see anything to be worried about here for either of these companies.
With both of these companies, the biggest intangible asset is goodwill. Goodwill is simply the price paid for an acquisition that's in excess of the acquired company's book value. The problem with a lot of goodwill on the balance sheet is that if the acquisition doesn't produce the value that was originally expected, then some of that goodwill might come off of the balance sheet, which could, in turn lead to the stock going downhill. Then again, acquisitions have to be judged on a case by case basis, as good companies are rarely purchased at or below book value.
DuPont has $4.62B of goodwill on its balance sheet, $2B more than what it had a couple of years ago. The goodwill increased mostly as the result of their purchase of enzyme producer, Danisco in 2011. Dow Chemical has $12.7B of goodwill on its balance sheet, which is constant when compared to the year before. Monsanto has $3.44B of goodwill on its most recent balance sheet, also constant versus the year before.
These three companies also have intangible assets like trademarks, patents, customer lists, purchased and licensed technology, and the like. These other intangible assets total $5.12B for DuPont, $4.71B for Dow, and $1.21B for Monsanto. These assets are important as trademarks, patents, and brand strength can present a strong barrier to entry against would-be competitors.
Due to the problems with goodwill that I just spoke about, you generally don't like to see intangibles account for more than 20% of total assets. However, they account for 20.7% of Monsanto's assets and 25% of Dow's assets. However, you must also consider that much of these assets are good, in that trademarks, brand strength, and patents aren't going away like lost goodwill from a bad acquisition. So, I wouldn't be too worried about this.
|Symbol||Percentage of Assets That Are Intangible|
Table 4: Percentage of Total Assets That Are Intangible
Return on Assets
The return on assets is simply a measure of the efficiency in which management is using the company's assets. It tells you how much earnings management is generating for every dollar of assets at its disposal. For the most part, the higher, the better, although lower returns due to large asset totals can serve as effective barriers to entry for would-be competitors. The formula for calculating return on assets looks like this:
Return on Assets = (Net Income) / (Total Assets).
For DuPont, the return on assets would be $3.18B in core earnings, divided by $49.7B in total assets. This gives a return on assets for the trailing twelve months of about 6.4%, which isn't bad, but nothing to write home about either. For Dow Chemical, the return on assets is $2.29B in core earnings, divided by $69.6B in total assets, producing a return on assets of 3.3%, which is uninspiring. Monsanto's return on equity is calculated by dividing its core earnings of $2.21B by its total assets of $22.5B, producing a return on assets of 9.8%, which is pretty good. So, Monsanto is superior in this regard.
|Symbol||Return on Assets|
Table 5: Returns on Assets of DuPont, Dow Chemical, and Monsanto
Short-Term Debt Versus Long-Term Debt
In general, you don't want to invest in a company that has a large amount of short-term debt when compared to the company's long-term debt. If the company in question has an exorbitant amount of debt due in the coming year, then there may be questions as to whether the company is prepared to handle it.
DuPont carries $1.28B in short-term debt, while Dow Chemical carries $1.07B. Monsanto has short-term debt of just $26M. Given the earnings power and cash positions of these three companies, I wouldn't be too worried about the short-term debt.
Long-term debt is debt that is due more than a year from now. However, an excessive amount of it can be crippling in some cases. For this reason, the less of it, the better. Companies that have sustainable competitive advantages in their fields usually don't need much debt in order to finance their operations. Their earnings are usually enough to take care of that. A company should generally be able to pay off its long-term debt with 3-4 years' worth of earnings.
Right now, DuPont carries $10.5B of long-term debt, while Dow Chemical carries a whopping $19.9B of long-term debt. Monsanto is the leanest of the three in this regard with $2.05B in long-term debt.
In determining how many years' worth of earnings it will take to pay off the long-term debt, I use the average of each company's core earnings over the last 3 years. The average earnings of DuPont over this period is $3.2B. The 3-year average for Dow Chemical is $2.51B, while the 3-year average for Monsanto is $1.65B. When you divide the long-term debt by the average earnings of each company, here is what we find.
Years of Earnings to Pay off LT Debt = LT Debt / Average Earnings
For DuPont, here is how it looks: $10.5B / $3.2B = 3.28 years
For Dow Chemical, it looks like this: $19.9B / $2.51B = 7.93 years
And, for Monsanto: $2.05B / $1.65B = 1.24 years
When it comes to long-term debt, I'm not worried too much about DuPont, and especially not worried about Monsanto. However, it will take Dow Chemical almost 8 years worth of their earnings in order to pay off their long-term debt. While the majority of it doesn't come due until 2018 or later, it is still a very important concern, as Dow will have to come up with some way to pay it. If interest rates at that point are higher than they are now (and they probably will be), then refinancing the debt won't be an attractive option.
When it comes to long-term debt relative to earnings power, Monsanto is superior here, while DuPont doesn't have much to worry about. Shareholders of Dow Chemical, though, should be really concerned.
In the equity portion of the balance sheet, you will find the treasury stock. This figure represents the shares that the company in question has repurchased over the years, but has yet to cancel, giving the company the opportunity to re-issue them later on if the need arises. Even though treasury stock appears as a negative on the balance sheet, you generally want to see a lot of treasury stock, as strong, fundamentally-sound companies will often use their huge cash flows to buy back their stock. For this reason, I will usually exclude treasury stock from my calculations of return on equity and the debt-to-equity ratio in the case of historically-strong companies, as the negative effect of the treasury stock on the equity will make the company in question appear to be mediocre, or even severely distressed, when doing the debt-to-equity calculation, when in reality, it might be a very strong company.
DuPont has $6.73B in treasury stock. Monsanto has $3.07B in treasury stock, while Dow Chemical doesn't have any.
The debt-to-equity ratio is simply the total liabilities divided by the amount of shareholder equity. The lower this number, the better. Companies with sustainable competitive advantages can finance most of their operations with their earnings power rather than by debt, giving many of them a lower debt-to-equity ratio. I usually like to see companies with this ratio below 1.0, although some raise the bar (or lower the bar if you're playing limbo) with a maximum of 0.8. Let's see how DuPont, Dow Chemical, and Monsanto stack up here.
Debt To Equity Ratio = Total Liabilities / Shareholder Equity
For DuPont it looks like this: $39.6B / $10.1B = 3.92
For Dow Chemical: $47.7B / $21.9B = 2.18
And, for Monsanto it comes out as: $10B / $12.5B = 0.80
Now, here is where DuPont shareholders need to be concerned. That debt-to-equity ratio is REALLY high. Of the nearly $40B in liabilities for DuPont, over $15B is related to employee benefit costs, compensation, and pensions, all of which are very real expenses that sometimes get left out of the earnings analysis. There are also some litigation expenses in there from lawsuits that are related to their selective herbicide, known as Imprelis, which has been found to be responsible for killing trees. This is a relatively new item, and the amount of damages for which DuPont may be held responsible is growing.
Dow Chemical also has a sub-par debt-to-equity ratio, while Monsanto, once again, looks just fine.
A variation of this ratio that I like to use takes into account the presence of treasury stock on the balance sheets of very strong companies. When there is almost $7B of treasury stock on the balance sheet, the regular debt-to-equity ratio makes it look like DuPont may be more distressed than it really is. Here, I add the treasury stock back in to the equity, as treasury stock can be re-issued at a later date if the need arises (although you hope that never happens). I call this ratio the adjusted debt-to-equity ratio. It's calculated like this.
Adjusted Debt To Equity Ratio = Total Liabilities / (Shareholder Equity + Treasury Stock)
For DuPont, it looks like this: $39.6B / $16.8B = 2.36
For Monsanto, the adjusted ratio looks like this: $10B / $15.6B = 0.64
For Dow Chemical, this value is the same as the regular ratio due to there being no significant treasury stock on the balance sheet.
DuPont does look better when you factor in its treasury stock, but with an adjusted debt-to-equity of 2.36, it still looks like it's very distressed.
For the sake of comparison, I also calculated these ratios as of the end of calendar 2011. DuPont had a debt-to-equity ratio of 4.59, while Dow Chemical carried a ratio of 2.10. Monsanto had a debt-to-equity ratio of just 0.52. So, the debt-to-equity ratios of both Dow Chemical and Monsanto have crept up, while DuPont has improved, but still has a lot of work to do.
In this department, Monsanto is best by far, as it is the only company of the three to have a debt-to-equity ratio below my threshold of 1.0. The table below illustrates what I just discussed here.
|Symbol||2012 Debt/Equity Ratio||2011 Debt/Equity Ratio|
Table 6: Debt To Equity Ratios Of DuPont, Dow Chemical, and Monsanto
Return On Equity
Like the return on assets, the return on equity helps to give you an idea as to how efficient management is with the assets that it has at its disposal. It is calculated by using this formula. Note that this is the adjusted form, which negates the negative impact of treasury stock on the equity.
Return On Equity = Net Income / (Shareholder Equity + Treasury Stock)
Generally speaking, the higher this figure, the better. However, it can be misleading, as management can juice this figure by taking on lots of debt, reducing the equity. This is why the return on equity should be used in conjunction with other metrics when determining whether a stock makes a good investment. Also, it should be mentioned that some companies are so profitable that they don't need to retain their earnings, so they buy back stock, reducing the equity, making the return on equity higher than it really should be. Some of these companies even have negative equity on account of buybacks. Once again, this is why I strip the negative effect of treasury stock from my calculations.
So, the return on equity for DuPont is as follows:
$3.18B / $16.8B = 18.9%
For Dow Chemical, it comes out as: $2.29B / $21.9B = 10.5%
For Monsanto, it amounts to: $2.21B / $15.6B = 14.2%
If you do the calculation like most and count the treasury stock as a negative to equity, then DuPont would have an even higher return on equity of 31.4%, while Monsanto would have a return on equity of 17.7%.
On the surface, these returns on equity look pretty good, but in the case of Dow Chemical and DuPont, the numbers are inflated by their relatively small equity positions in relation to their debts.
Retained earnings are earnings that management chooses to reinvest into the company as opposed to paying it out to shareholders through dividends or buybacks. It is simply calculated as:
Retained Earnings = Net Income - Dividend Payments - Stock Buybacks
On the balance sheet, retained earnings is an accumulated number, as it adds up the retained earnings from every year. Growth in this area means that the net worth of the company is growing. You generally want to see a strong growth rate in this area, especially if you're dealing with a growth stock that doesn't pay much in dividends or buybacks. More mature companies, however, tend to have lower growth rates in this area, as they are more likely to pay out higher dividends.
DuPont has $14.3B of retained earnings on its most recent balance sheet. At the end of 2009, DuPont had $10.7B in retained earnings. So, retained earnings over that three-year period increased by a cumulative 33.6%, which is rather impressive.
Dow Chemical has $18.5B in retained earnings, versus $16.7B from three years ago. Retained earnings here increased by 10.8%.
Monsanto has retained earnings of $5.88B on its most recent balance sheet, while three years ago, it had just $2.66B. So, Monsanto takes the cake here with cumulative 3-year retained earnings growth of 121%!
After reviewing the balance sheets of DuPont, Dow Chemical, and Monsanto, we see that these three companies have several things in common. Some of these include attractive multiples relative to their cash positions, dividends that are supported by free cash flows, decent current and quick ratios, and intangible assets like trademarks, licensed technology, and patents that give each company a sustainable competitive advantage in certain areas.
However, DuPont really concerns me with its high debt-to-equity ratio that approaches 4. Its returns on assets and equity are decent, as well as its cash position and retained earnings growth, but if DuPont is to improve its balance sheet, then it has to find a way to improve its equity relative to its liabilities.
Dow Chemical has a whopping amount of long-term debt that will take almost 8 years worth of earnings to pay off, and its return on assets is relatively low. Its debt-to-equity ratio is also higher than it should be. They need to get more efficient and generate more earnings power somehow if this company is going to be able to handle its financial obligations in the years to come.
Monsanto is the clear winner here as far as who has the best balance sheet. Monsanto has the best return on assets, and the lowest amounts of both short and long-term debt. They also pay a dividend that appears to have room to increase.
Thanks for reading and I look forward to your comments!
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.