DuPont (DD) is a conglomerate in the truest sense: it has sold everything from genetically modified seeds to water barriers for construction. Despite the breadth of their operations, it appears that DuPont has performed as well if not better than its competitors in their respective markets. There are numerous factors that should allow DuPont to continue to prosper in comparison to its competitors, even with headwinds from recent court cases. These factors, combined with a valuation profile suggesting the stock is likely undervalued, fair at worst, make DuPont an attractive investment.
As a major conglomerate, understanding DuPont requires an understanding of its major businesses; as such the report will discretely analyze each of DuPont's businesses. More attention will be paid to the larger segments. Pharmaceuticals will not be analyzed because this makes up a small and declining percentage of sales, and once royalty licenses expire, pharmaceuticals revenue will be zero. After an industry analysis, risks and certain negative events will be discussed. Finally, a valuation profile will be provided.
Agriculture represents the largest portion of revenue for DuPont. Principal competitors in this area include Monsanto (MON), Syngenta (SYT), and to a lesser degree, Dow (DOW). Before continuing with the analysis, note that a significant amount of this analysis comes from data from the various companies' most recent 10Ks. The exact timings are not all the same but they are close. Although past data does not predict the future, much of this data counters many commonly held beliefs about DuPont and its competitors and illustrates other still applicable points. DuPont had, for a while, lost market share to Monsanto due to the advent of Monsanto's seed with Roundup herbicide integrated, which was superior to DuPont's offerings. DuPont's more recent offerings are much improved and have allowed them to improve their sales
|DuPont: Agriculture||Volume||Price||Portfolio/Other||Net Change|
|Monsanto: Seeds And Genomics||Volume||Price||Currency||Net Change|
|Monsanto: Agricultural Productivity||Volume||Price||Currency||Net Change|
|Syngenta: Seeds||Volume||Price||Currency||Net Change|
|Dow: Agricultural Sciences||Volume||Price||Net Change|
|Operating Income: Agriculture||2011||2010||2009|
|Operating Income Growth Rate: Agriculture||2011||2010|
DuPont has been able to grow its revenue the most, indicating the most gain in market share. This contradicts the conception that Monsanto is the industry behemoth gobbling up the market. DuPont has outcompeted Syngenta. Thus, DuPont has beaten two competitors that focus on agriculture. This reflects DuPont's decision to sell directly to farmers as opposed to Monsanto's decision to sell through distributors and charge a significant premium. This premium forced them to drop their prices 63% in 2010 in agricultural productivity, while DuPont has been consistently able to raise their prices more than any other company. While Monsanto may still have products that DuPont can not match, DuPont has created a stronger value proposition. The issues of Imprelis and the Monsanto suit will be discussed later. While Dow did not beat DuPont on revenue, they did exceed them in operating profit growth. However, DuPont outcompetes Dow in other areas to make up for this difference. DuPont's policy of selling directly to farmers should continue to pay dividends. There may be an uptick in seed volume next year because the recent drought in America which will deplete inventories. These factors, combined with DuPont's solid position in the market, provide a solid platform.
Performance Chemicals is DuPont's second largest segment by revenue but largest in operating profit. This segment is responsible for producing Titanium Dioxide and Fluoroproducts. Neither product is truly a commodity; however, DuPont's titanium dioxide is relatively more specialized. DuPont is the world's largest single producer of the chemical at around 20% of global supply. Their fluoroproducts will be a solid base for the segment because many products are niche based necessities such as refrigerants that benefit from DuPont's economies of scale. It is not possible to separate out DuPont's performance in the titanium dioxide market but Kronos (KRO), a titanium dioxide producer, and Huntsman (HUN), a titanium dioxide and other chemical producer, provide good comparisons.
|DuPont: Performance Chemicals||Volume||Price||Portfolio/Other||Net Change|
|Kronos Worldwide||Volume||Price||Portfolio/Other||Net Change|
|Huntsman Corporation: Pigments||Volume||Price||Currency/Mix||Net Change|
|Operating Income: Performance Chemicals||2011||2010||2009|
|Huntsman: Pigment (EBITDA)||501||205||-25|
|Operating Income Growth: Performance Chemicals||2011||2010|
|Huntsman: Pigment (EBITDA)||144.39%||NA|
It appears that DuPont has underperformed two smaller competitors which specialize more in titanium dioxide. However, one has to remember that the above data includes fluorochemicals, which likely brought down revenue growth figures because it is a more stable market than that of Titanium Dioxide. Additionally, the smaller companies are just achieving economies of scale allowing their operating profit to grow quite rapidly. This will inevitably slow down. Additionally, 2011 are the first years these companies have achieved positive free cash flows while DuPont has for years, making DuPont the safer play in the space. DuPont is best positioned to absorb future market growth. Kronos is currently operating at beyond 100% capacity. How that is possible is unclear, but they have not undertaken any expansion of facilities to accommodate increases in demand. DuPont on the other hand is currently upgrading facilities and has already started a new $500MM plant to be completed in 2014. With continued growth in this sector, DuPont once again appears well positioned.
It is worth noting that together these two segments make up over sixty percent of DuPont's pre-tax operating income. For the company to succeed moving forward, DuPont must do well in these segments.
Performance materials makes up about 18% of revenue and 17% of pre-tax operating income. This division sells specialized chemicals and products to industries such as automotive, oil, electronics and photovoltaics. While relying on numerous commodities, DuPont's end products are far from commodities; many of their products are patented and require advanced facilities for production. Evidence for this comes in the fact that DuPont has consistently been able to raise prices on these goods. Given the diversification of this product line, there are few direct comparable companies. Dow Chemical's performance materials segment provides a suitable comparable. Although not all of their products directly compete, their products are similar in composition (resin, elastomers, etc) and operate in similar markets. Revenue and operating profit comparisons are as follows:
|DuPont: Performance Materials||Volume||Price||Portfolio/Other||Net Change|
|Dow Chemical: Performance Materials||Volume||Price||Net Change|
|Operating Income: Performance Materials||2011||2010||2009|
|Operating Income Growth: Performance Materials||2011||2010|
On a revenue basis, the companies have performed equally, but on an operating income basis, DuPont has far exceeded Dow. 2011 numbers in this segment are nearly reversals of revenue and operating income figures in the agricultural industry for the two companies. When one looks at these two sectors together, DuPont's relative outperformance in performance materials overshadows Dow's outperformance in agriculture. DuPont had slightly superior revenue growth and significantly better operating profit growth. This industry is cyclical making it somewhat risky, especially given that DuPont's inventory levels are not particularly low, although not relatively high either. However, it will remain an important industry and DuPont should do well.
Safety and Protection represents about 12% of revenue and pre-tax operating profit for DuPont. Key products in this sector include Kevlar and Tyvek among other patented or branded products. These products have few substitutes and benefit from DuPont's economies of scale, providing them with a stable revenue base. There are two important developments in this area. A court found Kolon, a South Korean company, infringing upon DuPont's Kevlar patent, banning the company from producing any similar product for 20 years, increasing barriers to entry. Additionally, DuPont is building a new $500MM Kevlar facility. DuPont has significantly increased investment in this area, spending about 20% of their R&D budget in this area while increasing their overall R&D budget. These factors provide growth opportunities.
Electronics and Communications involves the sale of materials and parts for photovoltaics, consumer electronics, and advanced printing. Photovoltaics could become a promising industry, but when is difficult to predict. However, DuPont is a primary producer for materials in higher end LED (AMOLED) TVs which should generate significant profits when consumers begin to replace their LCD TVs with more advanced LED TVs in the coming years. Even without this future growth, DuPont has outperformed competitors 3M (MMM) and DOW in the area as seen by revenue and operating income figures below.
|3M: Display And Graphics||Volume||Price||Currency/Mix||Net Change|
|DuPont: Electronics and Communications||Volume||Price||Portfolio/Other||Net Change|
|Dow Chemical: Electronic And Functional Materials||Volume||Price||Net Change|
|Operating Income: Electronics And Communications||2011||2010||2009|
|Operating Income Growth: Electronics And Communications||2011||2010|
Even though part of the outperformance can be explained by the relative maturities of the companies in the industry, DuPont's performance is still nonetheless impressive. It continues to illustrate how DuPont can outcompete competitors across a variety of industries.
Industrial Biosciences and Nutrition and Health are being grouped together because they are primarily dependent upon the Danisco acquisition and have generated little in the way of profits through fiscal 2011. It does appear that they paid a significant premium of $7B including debt for a company that has not generated any profit for them yet. However, in the first 2 quarters of this fiscal year, which have higher sales than the other 2 quarters due to agricultural seasonality, these two have added 7.5% of pre-tax operating profit ($280MM) at almost a 13% operating margin. While some skepticism about this acquisition is still required, these 6 months are promising.
Last is Performance Coatings, or paint. This has been DuPont's lowest margin business with a pre-tax operating margin consistently below 7% over the past 3 years. Yet the company has been able to sell this business to Carlyle for $4.9B plus $250MM of unfunded pension liabilities. The deal makes tremendous sense for DuPont. They were able to spin off their lowest margin business for about 70% the purchase price of Danisco, even though it only had about 50% the prorated operating profit of Danisco. DuPont can focus on higher margin businesses. The deal shores up their balance sheet. Although DuPont already had a healthy EBITDA/interest payment ratio of 13x, they do operate in a somewhat cyclical industry and have fixed costs which create issues if business falters. Additionally, DuPont did see a spike in other liabilities on their balance sheet principally due to rise in pension costs due to market declines and lower discount rates. This deal should help prevent either of these issues from significantly affecting the company.
Two more pressing issues are the Imprelis and Monsanto situations. The Imprelis situation is worrisome on a couple of fronts. The losses threaten the company's profitability, as the company has already experienced costs of $315MM YTD and these could go as high as $575MM. This does not include class action lawsuits that have been filed. Although payment directly to those affected would appear to reduce this risk, legal boundaries are hazy. The company states that they are seeking reimbursement from their insurance for claims above $100MM; this area is once again hazy, given that they are trying to get reimbursement for making a faulty product. The Imprelis situation contradicts DuPont's strong record of chemicals across industries. Management's handling of the situation is also troubling, as they just recognized the problem in their 10Qs and said nothing in their recent 10K. I don't think there is any way to spin this positively. Long term, I do not think this is a major cause for concern. This amount of money does not jeopardize their long term cash flows significantly, especially given the possibility of insurance claims and the ability of their lawyers. Lawsuits for faulty products are somewhat commonplace in the agriculture industry. DuPont has experienced them before, and Monsanto has been in numerous suits and has still prospered. Yet one should keep an eye on this.
The Monsanto suit is troubling for many of the same reasons: loss of even greater cash ($1B) and indicative of an inability to create superior products. This decision is going to make it next to impossible for DuPont to create a product as good as Monsanto's top of the line Roundup seeds in the near future. Yet, DuPont was without this technology for the past 3 years and was still able to gain market share from Monsanto. Although this does not help DuPont, it does not prevent them from competing effectively. At the same time, this industry still represents only part a fraction of their business overall.
Again, these are major negatives. Were issues like this to continue to reoccur, it may be indicative of a risky business model with questionable management. However, until this happens, DuPont's track record overshadows these issues in my mind.
DuPont is exposed to environmental remediation costs. They currently have a $416MM liability on their balance sheet that could be 3x as large given the uncertainty of remediation. Dupont has numerous facilities producing a wide range of chemicals; one accident could create significant costs, and much is still unknown about many chemicals. However, DuPont has already been proactive and successful in reducing potential toxic chemicals such as perfluorochemicals, which the company is going to stop producing by 2015 and is ahead of schedule in converting to similarly performing products. Additionally, they produce environmental remediation chemicals providing them with expertise to contain pollution.
Other risks inherent to DuPont are the cyclicality of the industries in which it operates, the risky nature of R&D, foreign currency risk, and commodity risk. Cyclicality and R&D are part of the industry's fabric simply. The benefit of exposure to faster growing markets outweighs the volatility of foreign exchange effects; additionally, the company does hedge a significant amount of FX risk. The company is relatively successful at passing along material costs, as evidenced by its ability to consistently raise prices on their products each of the past two years. They only have difficulty passing along oil costs.
DuPont has outperformed a variety of competitors across a diverse range of industries. Moving forward, it is reasonable to assume, given the above and certain factors moving forward, that DuPont will perform at least at par with competitors. It could easily continue its outperformance but equal performance is a good base case. With that in mind the valuations for all of companies heretofore mentioned are:
There appears 3 ranges of valuations: agricultural companies (Syngenta, Monsanto), Titanium Dioxide Producers (Kronos, Huntsman), and diversified chemical producers (DuPont, Dow and 3M). Although Dow and DuPont compete more directly, 3M's business model is still very similar. To simply say that DuPont is undervalued in comparison to agriculture companies and overvalued compared to Titanium Dioxide producers is inaccurate because these industries are extremely different. A major reason for the difference is that the agricultural companies have much high ROICs than the titanium dioxide producers. Huntsman operates in a few other industries similar to titanium dioxide resulting in slightly higher valuations. These companies appear to be trading at a discount because of the volatility of their earnings and that they have had recently had periods of negative free cash flow. These companies are intriguing in their own right, but that is the subject for another investigation because there is more risk. I think it's clear that Syngenta is overvalued. DuPont is significantly undervalued compared to Monsanto on all accounts to the point where it can not be explained by simply industry differences, especially given DuPont's outperformance. Dow's, 3M's and DuPont's valuations are much more tightly grouped although it appears DuPont may be slightly undervalued. Even if the valuation differences are not substantial, DuPont's relative outperformance warrants some premium. It is possible that the Monsanto and Imprelis lawsuits have brought down the valuations. Regardless, it appears that DuPont is trading at a discount to what it should be trading.
In summary, DuPont has performed well in comparison to its competitors across the industries in which it operates, and has numerous opportunities to remain successful. The company has certain risks such as lawsuits and somewhat large debts, but they are overshadowed by the company's strengths. Yet the company trades below or at par with competitors that it has beaten. This makes DuPont a strong investment at this point in time.