DuPont – A Reminder of the Opportunity
The July 17th movement in DD was driven by a disclosure that activist investor Nelson Peltz was building a stake in the company. In our research on DD earlier in the year, we highlighted a general discount in the stock versus its long-term history, relative to the stronger market. The stock has closed much of that gap since, but still has around 10% to move on a relative basis to get to what we would consider “normal”.
It is highly unlikely that Mr. Peltz has bought the shares for an opportunity to make 10%!
In the same research we identified the portfolio restructuring opportunity at DuPont, by separating the cyclical and relatively slow growing basic chemicals business, from the core R&D driven materials, nutrition and agriculture segments. These businesses have much higher potential growth, much greater product uniqueness (leading to value in use based pricing) and much less volatility of returns and earnings. In the research we used the transformation at Eastman as an example, but we have also used PPG as an example post the divestment of its basic chemicals piece.
Our view has been that if DD truly believes in its R&D driven strategy, then the ultimate divestment of the chemicals business (mainly TiO2) is inevitable – it is just a matter of timing. It may also be a matter of sequencing if there are other acquisitions in Ag or nutrition on the horizon.
The opportunity in our view is for DD to get the benefit of a change in direction in its Return on Capital, without the distraction of the volatility – see chart and focus on the apparent improving trend since 1998/9.
Of course it is possible that Mr. Peltz may know (or be betting on) something that we do not know about the paint industry and may be expecting a recovery in TiO2 pricing in the near term, which would drive the cyclical part of DD’s portfolio; in which case he will likely win with this investment. Or, he may be interested in the split, in which case he will likely win more.
DuPont remains one of the lowest valued stocks in the large cap Industrials and Materials arena, but it is highly complex – which the market does not like – and it has high exposure to the regions of the world that have declining economic expectations today.