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Diversifying: The Chemicals Sector
Posted by: Vanina Egea (IP Logged)
Date: September 26, 2013 09:11AM

Some say that specializing in one product is the path to success. Others argue that diversifying is a policy against economic recessions. Time has proved that neither strategy is wrong, and that each one has an expiration date. Here are two chemical companies that started with one product and have eventually diversified: DuPont (DD) and Air Products & Chemicals (APD). Let's take a look into their prospects for the years to come.

Adjusting the Scheme

At the moment, DuPont continues to experience weakness at end markets for titanium dioxide and photovoltaic products, resulting in lower sales volume. Also, sales have been negatively impacted by performance chemicals and electronics franchises, offsetting positive results displayed by the agricultural segment. Despite holding a solid balance sheet, management has leaked information concerning the future sale of performance chemicals.

DuPont continues to feed its R&D pipeline with enough cash to develop and introduce new products in the short term. Most efforts are currently focused on the photovoltaic, agriculture, alternative energy and other materials. During the last quarter alone, the company introduced 465 new products, setting a high bar for competitors. Also, the firm has entered the food ingredients and enzyme markets with the recent acquisition of Danisco, and expanded its presence in the biotechnology and biofuels industry.

A great plus for DuPont, in order to reduce negative end markets trends, has come from a committed cost-cutting strategy focused around fixed costs, personnel adjustment, work schedule restructuring and working capital improvements. Additionally, great performances for the agricultural segments in the Latin American region continue to push growth in booked orders. In the long term, the company expects a 7% growth for total sales and 12% growth for earnings per share, making a strong statement about future performance.

Currently trading at 23.1 times its earnings and packing a 19% premium to the industry average, the stock is overvalued. I still remain bullish about DuPont´s future, and several gurus do too. James Barrow, Jean-Marie Eveillard, Steven Cohen and PRIMECAP Management, the gurus with the largest holdings, have all increased their position within the last quarter. Most impressive are the increments seen on Evelliard and Cohen's position, well above the 1,500%.

Under Construction

Today, Air Products is looking at a downturn on performance. Higher taxes and the sequester have impacted growth in the U.S., while the European economic environment continues to struggle, and reforms in China are expected to cut growth short. At the same time, energy costs related to delivery methods continue to rise, further pressuring margins. At last, the company has yet to take decisive steps to reduce an already high debt.

When compared to industry peers, Air Products' return on capital and profitability remains behind. Analysts argue that excessive investment in industrial gases and a low-margin chemicals segment are at the root of the issue. They also point out that its strongest competitor, Praxair PX, has achieved better results by integrating all three distribution methods on-site, bulk and packaged gases. Management is fully aware of the advantages derived from an integrated structure, but has failed in its attempt at completing such business configuration.

A new attempt is expected to occur if current management for Air Products is displaced. The replacement is at the hands of guru Bill Ackman. After deceiving the market, the guru has increased the position of Pershing Square Capital Management to the very top of the major shareholders list with a total of 20,545,284 shares. If the board changes its composition, a new run at Airgas ARG to finally integrate product offering, and placed the company toe to toe with the industry leader Praxair PX.

Finances for Air Products are moderate. Trading at 22.3 times its earnings and carrying a 20% premium to the industry average, the stock is slightly overvalued. I see with good eyes a change in management, because it may very well bring much needed fresh air. At the same time, a new opportunity to further strengthen the company may be opened with a new bid for Airgas ARG.

Last Thoughts

I have no option but to prefer DuPont. Air Products is going through some troubled times, and future direction is not clear. As I said, Ackman may give Air Products the push it needs to turn around current performance, but I still prefer to stay on the sidelines until a decision is taken.

Disclosure: Vanina Egea holds no position in any of the mentioned stocks.

Guru Discussed: Bill Ackman: Current Portfolio, Stock Picks
James Barrow: Current Portfolio, Stock Picks
Stocks Discussed: DD, APD,
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