For investors willing to take on a bit of risk, DuPont (DD) and the Dow Chemical Company (DOW) represent two of the most attractive investments. They are strong brands that, in my view, come at a cheap price with greater upside than downside.
With DuPont having stellar corn yields and Dow improving its cost structure, both firms are well equipped to maximize the benefits of a recovery. Over the last twelve months, Dow has fallen by 15.6% and DuPont has fallen by 4.8% while the S&P 500 rose by 2.9%. This presents an opportunity for value investors to derive returns from the loss being closed.
From a multiples perspective, Dow is the cheaper of the two. It trades at a respective 11x and 9.3x past and forward earnings while offering an impressive dividend yield of 3.7%. DuPont, meanwhile, trades at a respective 12.6x and 10.7x past and forward earnings while offering a dividend yield of 3.5%. However, Dow is more leveraged with net debt representing 55.2% of market value versus 29.1% of market value for DuPont. In addition, Dow also has margins around 1080 basis points lower than DuPont's 25.5%.
At the third quarter earnings call, DuPont's CEO, Ellen Kullman, noted solid performance:
DuPont turned in a strong third quarter with underlying earnings of $0.69 per share. Double-digit sales increases in all segments and regions and our relentless focus on execution contributed to these outstanding results.
Our Agriculture and Nutrition & Health segments, which represent nearly 1/3 of DuPont annual sales, benefited from strong secular demands related to food and production agriculture. Latin American volume was up 17%, with a strong start to their planting season and demand for our high-performing products and services. Auto builds were up 5% in the quarter, but we saw an interesting dynamic with respect to the 2 businesses that primarily serve that market.
Performance Coatings grew volume 4% on part due to higher OEM build rate, while at the same time, Performance Polymers had a volume decline with automotive supply chain destocking to ensure lean inventories at year end. Industrial markets were mixed with certain businesses very strong and others experiencing a pause as customers wait for a clearer view of the economy to emerge. Against this backdrop, we executed very well, capitalizing on certain growth markets, our strength and innovation and aggressive productivity. These were major contributors to the quarter.
DuPont's Pioneer did particularly well in North America in 2011. The yield advantage in corn grew from 0.8 bu/ac in 2010 to 2.6 bu/ac in 2011, while the soy yield advantage fell slightly from 1.6 bu/ac in 2010 to 1.4 bu/ac in 2011. The firm even outdid ag giant Monsanto domestically. Moreover, higher demand is expected in 2012 for the seed business. Nitrogen sales are indicating greater corn production and a larger market. Risks include input inflation and lower productivity.
Consensus estimates for DuPont's EPS are that it will grow by 21.8% to $4.03 in 2011 and then by 7.9% and 14% more in the following two years. Assuming a multiple of 14x and a conservative 2012 EPS estimate of $4.31, the rough intrinsic value of the stock is $60.34. This implies 29.7% upside. Even if the multiple declined to 12x and 2012 EPS is 5.7% below the consensus at $4.10, the rough intrinsic value of the stock would be $49.20. Hence, the stock is much more skewed towards reward than risk.
Dow similarly has favorable risk asymmetry. Despite macro headwinds, the firm will benefit from improving margins in petrochemicals over at least the next 4 years. I am also bullish on construction and electronics (but not so much on photovoltaics). In addition, inventory decreases in petrochemicals are not indicative of lower demand, as many have made out. Barring lower oil prices, the firm is well positioned to achieving a significantly superior cost structure.
Consensus estimates for Dow's EPS are that it will grow by 35.5% to $2.67 in 2011 and then by 8.2% and 20.8% more in the following two years. Assuming a multiple of 14x and a conservative 2012 EPS estimate of $2.83, the rough intrinsic value of the stock is $39.62. This implies 48% upside. Even if the multiple holds steady at 11x and 2012 EPS is 13.5% lower than the consensus at $2.50, the rough intrinsic value of the stock is $27.50. Accordingly, Dow is one of my top picks in the sector - its high beta will only help to drive risk-adjusted returns as lost shareholder value is recovered.