DuPont is a global producer of basic and specialty chemicals serving a broad range of industries through seven segments. The U.S. and Canada comprised about 39% of sales in 2010, followed by EMEA at 26%, Asia / Pacific at 23% and Latin America at 12%. In 2010, the company derived the largest portion of pre-tax operating profit from its agricultural and nutrition segment, followed closely by the performance chemicals and performance materials segments.
In 2011, the company reorganized its operating segments making full-year comparisons more difficult, but the major segments remain in place. Performance chemicals has increased its share of profits and the legacy pharmaceuticals segment continues to decline due to patent expirations.
The best performing segments over the past several years have been agriculture and performance materials, although while the former has produced steady profits, the latter’s results have been volatile. Like a number of other chemical companies, DuPont often makes major changes to its reporting segments which make longer-term comparisons difficult; however, it clear that results in the remaining segments are quite volatile and correlate with economic conditions – a state of affairs to be expected from a chemical company.
DuPont has managed to grow revenue and ebitda at 5.3% and 6.2%, respectively since 2006 although net income has not grown to the same degree. A small portion of the average annual growth is due to acquisitions. The principle areas of investment for the company, R&D and capital expenditures have grown at a slightly lower rate.
Since DuPont and the chemical industry in general are cyclical, it is helpful to look at recent averages in profitability. On this score, DuPont’s average net income since 2006 is about $2.7 billion or 21% lower than at present.
Several adjustments could be made to this figure to better represent a run-rate average. Adding one additional high profitability year to account for a longer business cycle than six years adds about $40 million of net income while underlying asset growth over the period adds about $250 million. The eventual decline in the run-off pharmaceutical business has a major impact on historical profitability since that business generated $1 billion of pretax operating profit for several years in the historical period. A reduction in average profitability of $400 million has been assumed. The recent Dansico acquisition should add about $175 million of average profit over a cycle – and potentially more based on realized synergies. Adding these factors together leaves an average profitability of about $2.8 billion.
Based on actual results for the first three quarters of 2011 and projected fourth quarter results, DuPont is trading at about 11.6x earnings after adjusting for cash. One-year forward earnings based on First Call estimates leave the company trading at 10.6x earnings. Using the long-term average earnings detailed above, the preferred method in my view, the multiple is 15.9x.
The chemicals business generally produces quite low returns on capital over the business cycle, at best just above the cost of capital. As such, the value of growth, should it occur, would be small – perhaps a single multiple of earnings. With that in mind and especially considering recent economic weakness, DuPont would only be worth taking a close look at around a 12-13x multiple. This is not to say that the company’s stock is dramatically overvalued, but given current levels the chance of it outperforming the market are low and it is clear from historical stock performance that the chance of a large decline in value given a recession is high.