Edited By Marianna Avilkina
E. I. du Pont de Nemours and Company (DuPont) (DD) is one of the largest chemical conglomerates in the world, operating in more than 80 countries. Founded in 1802, the company has expanded into extremely diverse markets, from agriculture to apparel. Its business activities include coating and coloring, safety equipment and textiles, as well as genetically-modified seed production. However, the largest share of DuPont's revenue is derived from agriculture.
As of September 20, the DuPont stock was trading at about $52, with a 52-week range of $37.10 - $57.50. It has a market cap of about $48 billion. The trailing twelve-month P/E ratio is 13.9, whereas the forward P/E ratio is 11.3. P/B, P/S, and P/CF ratios stand at 4.6, 1.2, and 10.4, respectively. The operating margin is 11.2% while the net profit margin is 8.6%. The company has significant debt issues as a debt/equity ratio of 1.1 is far above the market average.
DuPont pays solid dividends; the trailing yield of 3.28% is approximately the same as the forward one. Upcoming dividends are expected to be about $0.43 per share in Q4 2012. Over the last five years, the company has been paying the same quarterly dividend, at $.41 per share, amounting to a $1.64 annual dividend. The five-year dividend history suggests that DD is a solid and steadfast dividend payer.
DuPont has a 3-star rating from Morningstar. Out of four analysts covering the company, one has a "buy" rating, whereas three have a "hold" rating. This is good reason to suppose that Wall Street primarily holds neutral opinions about the company's future. The average five-year annualized growth forecast estimate is 9.7%. What is the fair value of DuPont, given the forecast estimates? We can determine DuPont's fair value using the discounted earnings plus equity model, as follows:
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look intimidating for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.
E0 = EPS = ($3.69 + $4.53) / 2 = $4.11
Wall Street holds diverse opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 9.7%. Book value per share is $11.08. The rest is as follows:
Fair Value Estimator
Fair Value Range
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for DD is between $59 and $70 per share. At a price of about $52, DuPont is trading at a deep discount. The stock has at least 15% upside potential to reach its fair value.
While there are many companies in the market segments in which DuPont operates, Dow Chemical Co (DOW) is probably the closest competitor. At the current valuation, Dow Chemical is slightly undervalued. Dow is trading at a relatively higher ttm P/E ratio of 19.7, significantly higher than that of DuPont. Dow Chemical also has the similar debt issues as DuPont. However, Dow's dividend amount has been volatile over the last five years, whereas DuPont has been paying steadfast dividends. While both companies offer respectable dividends, DuPont currently does have a substantially better outlook in terms of profitability and dividend stability.
Return on Equity
Another competitor, Monsanto Company (MON) is trading with at least 4% premium over the fair value and has a relatively higher forward P/E ratio of 20.5. At the same time, Monsanto offers a comparatively poor dividend yield of 1.35%. However, because Monsanto has only minor debt issues and reasonable debt philosophy, shareholders' interests are better protected against a business decline.
Current Economic Outlook
DuPont exited the auto paint industry in August 2012 when it sold its operations to the world's second largest private equity firm, The Carlyle Group (CG). While DuPont aims to focus on biofuel and food industries, the company is reallocating its resources by eliminating low margin products. Recently, DuPont was hit with a $1 billion settlement by a federal jury stemming from a patent infringement lawsuit. This sum was awarded to the company's competitor Monsanto.
Courtroom troubles aside, DuPont expects its future earnings to stabilize as economic volatility continues to hurt the industries it operates in. In the second quarter of 2012, sales fell for all of its products except those in the food sector. Analysts expect a profit of $4.25 billion for the company by this year's end, which I think is a bit conservative.
An uncertain industry climate, decreasing sales and less-than-anticipated revenue point to a disappointing future outlook. However, much of DuPont's loss in revenue can be attributed to the market conditions, as its competitors face similarly dwindling sales and revenues.
Nevertheless, based on historical valuation metrics, the DuPont stock is undervalued, with at least 15% potential to reach its fair value. Even though the company has faced damaging lawsuits that negatively affect profits, DuPont remains a nifty investment. This is evidenced by the fact that DuPont trades on par with its competitors and has been paying steadfast dividends over the years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.