DuPont's Cyclicality Seems Overpriced

By Stephen D. Simpson, CFA | April 23, 2013 AAA

It seems like there is a segment of the investment community that is committed to believing that DuPont (NYSE:DD) will eventually figure out the right mix of businesses that will let it transcend its historical cyclicality and volatility. To be fair, management at DuPont has always been willing to move into higher-potential areas like agriculture, performance materials, and nutrition, but these efforts have never managed to decouple the close correlation of the company's performance and global GDP growth. Accordingly, I'm not sure I'd want to pay a premium to buy these shares.

First Quarter Results Mostly On Target, But Sluggish
DuPont reported 2% growth this quarter, with underlying volume improvements of 2% and 1% better pricing. Unusual for a company this size, there weren't huge surprises on a business by business basis. Agriculture was the big grower again, with sales up 14%, while nutrition was up 7% and the other business were flat to down. Performance chemicals were notably weak (down 17%) on a double-digit sequential fall in titanium dioxide prices, while electro-comm sales fell 9% on ongoing weakness in PV demand.
Even with decent volume, DuPont's margins were mediocre. Gross margin slid almost one point, and reported operating income fell 8%. Segment profit performance wasn't much different, falling almost 8%. Not surprisingly, agriculture was also the profit leader this quarter as income rose 13% and margins exceeded 32%. Performance chemicals saw significant margin erosion.
Ag Taking On More Of The Load
DuPont's seed and ag chemicals business continues to be a major profit source for the company. While quarter-to-quarter benchmarking can be a little tricky, the fact remains that DuPont's seed business (up 14%) outgrew the seed business of Monsanto (NYSE:MON) this quarter, and DuPont seems to have enjoyed a very strong corn planting season in South America.

SEE: Analyzing Corporate Profit Margins

It will be interesting to see if DuPont can continue this momentum. Monsanto has generally been outperforming DuPont in the field and in the lab as well, with Monsanto recently winning a significant IP case (and a settlement from DuPont). On the other hand, DuPont has an interesting drought-resistant corn out this year and I wonder if the company reaps any benefit for Monsanto being the face of the advanced seed industry – Syngenta (NYSE: SYT), DuPont, Bayer, BASF, and Dow (NYSE:DOW) are all in this business as well, but most of the hysteria and psuedoscience centers on Monsanto.

Will TiO2 Take Away The Ag Leverage?
DuPont has a lot of good things going on in the agriculture business, not just with modified seeds, but with biobutanol and cellulosic ethanol. Likewise, the nutrition business looks like a steady, high-quality growth opportunity.
I wonder, though, whether the dynamics of the titanium dioxide industry will strip away some of that leverage. Price and volume has been weak lately, though the recent trends in volume seem incrementally better for other players like Huntsman (NYSE:HUN). DuPont is the market leader, though, and the company will have to work hard to keep the negative margin spillover from hitting estimates.

The Bottom Line
DuPont gets a lot of credit for its value-added businesses, but sometimes I wonder if it gets a little too much credit. In particular, it seems like DuPont has to often go back to the M&A market to supplement its growth or market exposure needs. While DuPont's trough returns on invested capital are better than most other chemical or advanced material companies, I do still wonder if investors are too happy to pay up for these shares.
As the economy improves, I expect DuPont shares to head higher. With that, though, I do wonder about the long-term returns that are available at this price. Accordingly, I think there are better plays in specialty chemicals, agriculture, and materials.

At the time of writing, Stephen Simpson owned shares of Monsanto Company.

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