A Fundamentals Brief of E.I. DuPont De Nemours (DD, Financial)
Performing a fundamentals analysis of a company involves an assessment of the strength and stability of its balance sheet health, earnings power, earnings quality, and cash-generating ability. It is useful to look for companies that have above average and consistently growing sales, margins, and earnings. It is useful to look for companies with above average stockpiles of cash and below average and consistently falling short-term and long-term debt. It is useful to look for companies that have inventory-buildup and operating costs under control, have above average and consistently growing operating and free cash-flows, have high earnings quality, and consistently earn above average returns on equity and reinvested earnings. A fundamentals brief on E.I. DuPont De Nemours is presented below along with a financial grading summary. Exceptional performance along any dimension of analysis earns DD an above average (Average = C) financial grade.
DD’s revenues for the 2004-2013 period clocked in at an average annual rate of growth of 3%. This is acceptable for a mature firm and mostly aligned with RGDP growth. Year-over-year DD has made substantial money off revenues after subtracting costs of goods sold rising from $7,597M in 2004 to $13,596M in 2013, reflecting an annual growth rate of 7%. Growth in cost of goods sold have been kept well under control rising at an average rate of only 1% over the period.
The competitive nature of DD’s sector has resulted in a gross profit margin of about 30% over the last 10 years. As a general rule, we want to see consistent gross profit margins above 35-40% for firms in the sector. Companies with gross profits margins consistently above 35-40% have either a strong and durable competitive advantage or face a lower level of competitive intensity.
Over the last 5 years DD spent over 30% of gross profits on hard costs associated with selling expenses, advertising, management salaries, payrolls, advertising and legal fees. We consider spending over 30% of gross profits on SG&A quite high and is a further sign of heavy competition in the sector. Going from spending 41% to 27% of gross profits on SG&A over the last 10 years is, however, a positive trend that could rewarded shareholders. With revenue growth trending at an annual rate of 3% and SG&A growth trending at a rate of 2%, it could further be is a sign that management has gotten costs under control.
DD has maintained strength in its operating earnings picture over the last 10 years. The long-term trend has been generally upward—a result we attribute mostly to emerging market growth and tighter cost controls—though the ride has shown some volatility, rising from $2,882M in 2004, falling to $1,460M in 2008, only to rebound to $3,937M in 2013. DD has earned on average about 10% in operating earnings on total revenues over the last 10 years. DD carries a moderate amount of debt on its books and, consequently, pays out more than 11% of operating income on interest payments annually. This is reasonable given DD's size.
Net earnings have shown a historical upward trend, growing at an average rate of 12% since 2004, with some volatility. DD’s competitive strengths have allowed it maintain net margins of on average 9% over the last 10 years. With continued margin compression these are not particularly great results. They further reflect the intensity of competition in the sector. DD’s per share earnings figures for the last 10 years, growing at an annual rate of 13%, provide an indication of how the company has benefited from greater cost controls and some, though minor, share repurchase activity.
DD continues to produce high returns on equity, averaging 33% over the last 3 years and 28% over the last 10 years. This is, however, being partially driven by it use of debt and is evident in its substantially lower ROA, averaging 7% over the last 3 and 10 year periods. All considered, ROI remains strong averaging 16% over the last 10 years.
DD’s stockpile of cash and short-term investments total close to $9,086M. Traditionally, DD has used a significant portion of cash to expand operations and for R&D. That used for share buy-backs has been minimal and the portion flowing through to dividends has remained stable. Typically, DD socks away about $4,500M in cash equivalents to support business operations and to protect itself from any unanticipated economic shocks.
As a general rule of thumb we like to see receivables of less than 5% of revenues. DD’s receivables have been about 15-20% of revenues over the last few years, which is well above our target level. DD’s receivables have, however, been growing at a slower rate than revenues which is a sign that its cash collection efficiencies remain intact.
Inventory build-up remains a definite point of concern, growing at an annual rate of 10% over the last 3 years and 7% over the last 10 years. This is well above DD's revenue growth. This could reflect declining overall product demand, an extended deferral of costs, or a fundamental deterioration in earnings quality. Investors are well advised to continue to monitor DD's inventory position.
DD’s current ratio, which is derived by dividing current assets by current liabilities and is an indicator of company liquidity, has consistently trended above 1.5 over the last decade and came in at about 1.8 in 2013. Though nothing spectacular, DD shouldn’t face any difficulties fulfilling its short-term obligations to creditors and suppliers.
Net property, plant and equipment make up only a moderate percentage of DD’s asset base (25%). Because it faces intense competition, however, it is required to constantly update facilities to remain competitive, which helps keep expenses up. R&D costs typically account for 16% of gross profits and capital expenditures consume more than 50% of net earnings.
DD is a moderate borrower of debt with a long-term debt load of $10,741M. DD’s long-term debt position has seen substantial growth over the last 10 years rising by 8% and outstripping revenue growth by 5%. This growth is somewhat concerning and deserves continued monitoring. DD's long-term debt-to-equity ratio trended from 3.6 in 2004 to 2.6 in 2013. For an excellent business in this sector we would like to this to fall below 1.0. Accounting for operating lease obligations and unfunded pension obligations, DD’s debt load could be paid off with about 8x average annual earnings. This is an acceptable result and indicates that, while DD’s debt load has grown undesirably, relative to what it can earn it still has the earnings power to sustain itself through financial trouble.
Over the last 10 years, DD's operating cash flows have remained strong but growth has lagged both growth in revenues and earnings, clear red flags of earnings quality issues.
Taken together across all dimensions, we assign DD an overall financial grading score of "C."
