DuPont: Investing In This Chemical Stock Smells Like Money

Sep.11.13 | About: E. I. (DD)

E. I. du Pont de Nemours (DD) is the leader in the global agriculture industry with a 39.35% market share. To maintain its market dominance it acquired a major stake in an African seed-producing company, Pannar Seed. DuPont is well positioned to gain in the African market since Pannar Seed is one of the largest companies in Africa. The attractive valuation of DuPont also supports its future growth.

Reaping growth with seeds

DuPont generates 36.88% of its total revenue from its agriculture segment, its highest revenue-generating segment. On July 31, 2013, its agriculture business unit, DuPont Pioneer, announced the acquisition of an 80% stake in Pannar Seed. DuPont considers Africa a significant growth market, as substantiated by DuPont Pioneer's president Paul Schickler.

He said African grain production is less than two tons per hectare, "about one-third of what is achieved in other developing regions and only one-fifth of yields in developed countries. With 35-million hectares available for maize production, Africa represents a significant opportunity for improved productivity."

Mr. Schickler added that this acquisition is "one of the biggest transactions in DuPont's history and the biggest" it has made in Africa.

DuPont hopes to grow with this 'big' deal, so it announced plans to invest $6.18 million in South Africa by 2017, to establish a research and development, or R&D, facility. This facility will improve DuPont Pioneer's seed breeding practices, since the companies will combine germplasm facilities. Germplasm refers to the collection of seeds for research purposes. With this R&D facility, the company hopes to produce better genetic seeds in the future, thereby enhancing its agriculture business.

DuPont's agriculture segment revenue grew by 13.82% year over year to $10.29 billion last year. Even if we consider this growth rate to be constant, this deal will generate around $11.70 billion revenue in 2013.

Share Repurchase

DuPont is the global leader in the agriculture segment. The other global leaders are Dow Chemical (DOW) with market share of 20.06% and CF Industries (CF) with share of 18.6%.

CF Industries announced a $3 billion share repurchase program in 2012, which will last through 2016. Under this repurchase program it purchased 5.8 million shares from January 2013 to August 5, 2013. We assume that the company will continue to purchase the shares at the same pace throughout 2013. So, if in eight months the company purchased 5.8 million, then in 12 months the company is expected to purchase 8.7 million shares this year.

Year

Net Income

Outstanding Shares

EPS

2012

$1.8 billion

64.7 million

$28.54

2013

$1.8 billion

56 million

$33

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Consequently, the number of shares in 2013 is expected to decrease to 56 million. If the net income of $1.8 billion in 2012 is considered to be constant for this year, then the earnings per share, or EPS, will grow by 15.62% to $33 per share. We feel there is more upside potential for the EPS growth as the net income will increase in the future quarters, thereby inclining CF Industries' share price.

Molding growth with plastics

Though Dow Chemical is the world's second-largest company in the agriculture segment, its agriculture segment's contribution to the company's EBITDA is quite low compared with its 'performance plastic' segment. In the second quarter of fiscal year 2013, the agriculture segment accounted for just 6.9%, that is $290 million, of EBITDA as against 23.8% of EBITDA contribution by performance plastic. The agriculture segment's EBITDA also reduced by 5.53%, year over year, in the second quarter. Looking at the meager contribution of its agriculture segment and decline in year-over-year change, Dow Chemical is focusing more on its performance plastic segment.

To grow its performance plastic segment, the company is focusing on expansion on the U.S. gulf coast, which has considerable natural gas reserves. Natural gas is used for producing ethane, which in turn is used as a raw material for ethylene, a hydrocarbon. The most commonly used plastic, polythene uses ethylene in its manufacturing process. Dow Chemical is one of the largest producers of ethylene in the world.

The natural gas supply is increasing on the U.S. gulf coast due to increasing fracking activities. This increasing supply led to a decline in the price of natural gas in the U.S. In a bid to capitalize on this, Dow Chemical announced on August 27, 2013, plans to expand its facilities in the U.S. gulf coast by expanding its four leading franchises in Texas, and Louisiana, that have close proximity to fracking operations. The expansion plans exceed $4 billion and are aimed at increasing the production of ethylene from the low-cost natural gas. Expansion projects at these facilities are expected to start "soon."

Ethylene is manufactured under its performance plastic business segment that experienced revenue growth of 5.71% quarter over quarter to $3.7 billion in the second quarter of 2013. Assuming this growth rate to be constant, we expect this segment to generate revenue of $3.91 billion and $4.13 billion in the third and fourth quarters respectively. In the second quarter, this revenue accounted for 25.3% of the company's total revenue. As the growth in ethylene will benefit the major revenue contributing segment of Dow Chemical, it will significantly increase the company's earnings, thereby significantly inclining its stock.

Valuation

DuPont's stock trades at a higher PE ratio than the industry and its peers. This valuation ratio makes CF Industries' stock the most attractively priced. CF Industries' PE is better than its peers and industry, partially due to its share repurchase program.

Valuation Parameter

Industry

DuPont

CF Industries

Dow Chemical

P/E

19

22.48

6.79

18.63

Dividend yield (%)

2.45

3.15

0.82

3.32

P/B

10.03

4.04

2.31

2.38

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Source: Finviz.com

The stocks of all three companies look attractive with various parameters. The dividend yield and P/B ratio of DuPont makes its stock attractive. CF Industries' P/E ratio and P/B ratio are better than its peers and industry. Dow Chemical's P/B ratio and dividend yield are better than those of the industry.

Conclusion

The attractive valuation and strong fundamentals of all the three companies hint at their revenue generation capabilities. DuPont is counting on its hefty deal in Africa, which is backed by its attractive valuation. We consider this deal a turnaround factor for the company. Investors looking for long-term growth can comfortably rely on this stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Shweta Dubey, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article