Risky Upside For DuPont, Huntsman Warrants Fear

Includes: DD, DOW, HUN
by: Takeover Analyst

Despite signs of unemployment decline, economists are largely pessimistic about the near-term economy with some forecasting a double dip. As industrial production remains uncertain, now may not be the best time to invest in chemical manufacturers. I find that DuPont (NYSE:DD) and Huntsman (NYSE:HUN) are, while somewhat more undervalued than what analysts have acknowledged, clear "holds" for now.

With Rockwood Holdings (NYSE:ROC) trading at the absolute low-end of peers at 10.4x past earnings, both DuPont and Huntsman have room for multiples expansion. The former trades at a respective 12.8x and 11.1x past and forward earnings while the latter trades at a respective 13.6x and 5.3x past and forward earnings. For comparison, Dow Chemicals (NYSE:DOW) trades in line with DuPont. As both companies have high betas, investors willing to take on the substantial risk are likely to benefit from meaningful out performance if the economy recovers.

Even though I do not foresee a double dip, the chances are skewed toward continued domestic stagnancy. At the third-quarter earnings call, Huntsman's CEO, Peter Huntsman, noted some of the challenges to TiO2 and how it is offsetting the decline in volumes.

Our Pigments division earned $161 million of adjusted EBITDA for the third quarter. Demand for TiO2 remains high, although it's moderated slightly. Industry producer inventory levels are less than 45 days, suggesting the supply chain is tight. Our inventory levels are significantly below the industry estimates as we continue to sell everything we can make.

Our third quarter 2011 sales volumes decreased 8% compared to the prior year, primarily because we had lower finished goods inventory available for sale. We continue to see positive traction with our announced prices. Third quarter average selling prices increased 38% on a local-currency basis compared to the prior year. In addition to benefiting from improved industry economics, we've been reshaping our revenue mix to higher value-added products.

Huntsman faces a $69M sequential headwind to EBITDA from the impact of continued poor volumes in Q4. Markets have seen softer demand during this quarter, which has put pressure on margins. TiO2 has further been restocked. With that said, I am optimistic that greater construction and pricing increases will offset the impact of raw materials going forward.

Consensus estimates for Huntsman's EPS are that it will grow by 102.4% to $1.85 in 2011 and then by 13.7% and 26.7% more in the following two years. Assuming a multiple of 8x and a conservative 2012 EPS of $1.85, the rough intrinsic value of the stock is $14.80, implying 45.1%. Since it could be some time before the discount is closed, I would recommend holding out for now and investing in more certain companies.

Like Huntsman, DuPont also faces downward earnings revision. 17 of the last changes to EPS have all gone for a net change of 2.8%. Even though analyst forecasts typically go down around 11% by the end (more so of late), this is a meaningful reduction in expectations. At the same time, the company has had strong corn yields. During the third quarter, DuPont experienced double-digit growth in all key segments. Agriculture, Nutrition and Health, which make up around one-third of the business, benefited from significant underlying demand. Going forward, Pioneer remains a catalyst for the company as yield advantages further improve.

Consensus estimates for DuPont's EPS are that it will grow by 18.4% to $3.92 in 2011 and then by 8.7% and 12.9% more in the following two years. Assuming a multiple of 13.5x and a conservative 2012 EPS of $4.21, the rough intrinsic value of the stock is $56.84, implying 20.6% upside. If the multiple sinks to that of Rockwood and assuming 2012 EPS is 4.2% below consensus, the stock would fall by 10%. This is not the most favorable risk/reward right now.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.