While the chemical sector is currently overwhelmed by bearish sentiments, the reward, in some cases, is truly not worth the risk. In this article, I will run you through my DCF model on DuPont (NYSE:DD) and then triangulate the result against a review of the fundamentals compared to Huntsman (NYSE:HUN) and Dow (NYSE:DOW). I find that while Huntsman and Dow are attractive value plays, DuPont is too risky right now despite the bull case.
First, let's begin with an assumption about the top-line. DuPont finished FY2011 with $38.7B in revenue, which represented an 18.3% gain off of the preceding year. I model growth trending from 16% to 8.6% over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold eating 71% of revenue versus 10% for SG&A, 5% for R&D, and 4.7% for capex. Taxes are estimated at 19% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital to get free cash flow. I estimate this figure hovering around 1% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $44.31, implying 7.6% downside.
All of this falls within the context of decent operating performance:
"DuPont delivered strong results in the first quarter in line with our expectations at a time when markets were mixed.
Sales were up 12%, with 5% organic growth and 7% from acquisitions. We had excellent price performance in the quarter, driven in part by new product introductions, which were up more than 50% versus prior year. Not surprisingly, Pioneer had one of the largest year-over-year increases in its area. Productivity projects are tracking well across our businesses. The strength of our portfolio, coupled with very sharp execution, drove double-digit growth in sales and operating income this quarter".
From a multiples perspective, DuPont is still expensive compared to peers. It trades at a respective 12.9x and 10.2x past and forward earnings versus 15.8x and 8.7x for Dow and 9.2x and 5.8x for Huntsman.
Consensus estimates forecast Dow's EPS growing by 2.8% to $2.61 in 2012 and then by 28% and 22.5% in the following two years. Assuming a multiple of 11x and a conservative 2013 EPS of $3.30, the stock would hit $36.30 for 23.3% upside. With a dividend yield of 4% and a beta of 1.8 that well positions the firm to quickly recover lost shareholder value, risk/reward is very compelling.
Consensus estimates forecast Huntsman's EPS growing by 29% to $2.18 in 2012 and then by 0.5% and 11.9% in the following two years. Assuming a multiple of 11x and a conservative 2013 EPS of $2.17, the stock would hit $23.87 for 87.4% upside. This comes on top of a dividend yield of 2.7% and all 10 of the last revisions to EPS being made upwards for a net change of 20.8%. I remain highly confident on the firm's leadership, fundamentals, and growth story.