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Agricultural Growth Pushes New Business Strategies in the Chemical Sector
Posted by: Vanin Aegea (IP Logged)
Date: October 28, 2013 05:28PM

Every once in a while market synergies push companies to reassess current business strategies. Shifting customer preferences, a troubled macroeconomic environment, or potential growth at specific geographies has been found to be important influences over a company´s behavior. Two companies that are implementing a shift in their business approach are DuPont (DD) and Dow Chemical (DOW). Let me show you how the two companies have refocused their business, and gurus’ response.

Agriculture Pays for New Strategy

DuPont holds one of the widest portfolios in the industry including products for the agriculture, feed and nutrition, electronics and communication, construction and transportation, and safety and protection industry. However, recent acquisitions and divestitures aim at focusing the company towards on specialized products. The new business strategy can be evidenced on the 2011 acquisition of Danisco and announced divestiture of the performance chemical segment. This last move is expected to improve overall performance, since in recent times represented a weight for growth.

The agriculture segment is the most important for DuPont, and growth is expected to be driven by the North and South American regions. In the first region, the company expects to continue experiencing demand growth for corn hybrids and crop protection products. For the other region, much of the growth will be attributed to Brazil’s corn production. However, the introduction of new soybean insect-protected is expected to reduce demand for crop protection products. Also, high international presence is expected to continue impacting earnings. The effects have been compounded by stable product prices and rising energy costs.

Research and development is very important for DuPont, and has concentrated efforts on agriculture, photovoltaic, alternative energy and materials, increasing food supply, reduce environmental footprint, and security products. At the same time, management has put in place a cost-cutting policy aimed at reducing fixed costs, retrenching employees, restructuring work schedules, and improving working capital productivity. This initiative is expected to offset negative trends seen on rising energy costs to avoid price hikes.

Financially, DuPont is moderate-to-strong as debt level decreases and cash flow rises. Trading at 21.4 times its trailing earnings, the stock packs a 10% premium to the industry average. Throughout 2013 the largest gurus holding a position in the company, have all increased their stakes. James Barrow, Jean-Marie Eveillard, and Steven Cohen think the company is a good investment, and I share their sentiment. I think the company´s strategy of raising developing countries contribution to total revenues will continue to pay-off as planting area increases and greater technology is incorporated.

Shifting Strategy to Pay Debt

Dow, like DuPont Chemical is focusing growth on developing countries and technology-driven end markets. Amid differences on size, Dow is present in a great number of industries worldwide through its wide variety of segments and products. Nonetheless, its portfolio is under a restructuring with the final goal of focusing on specialty materials to achieve a competitive cost advantage. Hence, third quarter results for 2013 have shown a 2% decline in sales volume year-over-year, offset by a 27% increment in cash flow.

With the goal of refocusing activities and increasing presence in developing countries, Dow Chemical has signed an important agreement with ARAMCO to build an integrated chemical complex. The complex is also expected to secure low energy costs for the long-term, and avoid the volatility that characterizes the sector. Another evidence of the new business strategy is the divestiture of the polypropylene licensing and catalysts business. Additionally, management has deemphasized low-growth, commoditizing businesses, exemplified on the announcements made for the chlorine value chain.

On the downside, Dow Chemical continues to face some headwinds due to lower pension discount rates, and slow performing electronics and construction end-markets. Another risk derives from the asset divestiture strategy of non-core businesses initiated to pay-off debt. In short, should management wait for a fair priced offer, overall performance may suffer. And if assets are sold at a discount, debt may remain an issue after divestiture strategy is complete.

The balance sheet for Dow Chemical is moderate because debt remained high while cash flow declined over the last three years. The stock trades at 16.6 times its trailing earnings, carrying a 14% discount to the industry average. However, the two largest gurus holding a stake in the company, Steven Cohen and Primecap Management, have registered no changes since December of 2012. In opposition to them, I would prefer to take advantage of the discount and recent stock price drop.

Discount and Declining Stock Price

I like both companies but this does not mean that I have no preferences. In the cases when the companies are very much alike, and this is an obvious case, I like to look at stock price. Hence, I prefer Dow Chemicals to DuPont at this time because of the discount offered and declining stock price. In short, I think an opportunity has opened to begin a long-term investment on Dow Chemicals, because DuPont is currently trading very close to the 52-week high.

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

Guru Discussed: Steven Cohen: Current Portfolio, Stock Picks
Jean-Marie Eveillard: Current Portfolio, Stock Picks
Stocks Discussed: DD, DOW,
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