Why This Stock Could Disappoint You Next Week

Neha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

DuPont’s (NYSE: DD) shares have traded in a pretty narrow range since its last earnings announcement, and there are valid reasons behind it. To start with, its second-quarter numbers were anything but impressive even as rivals like Monsanto (NYSE: MON) rocked the Street with stellar numbers. To make matters worse, DuPont lowered its full-year earnings outlook. Just a few days later, a bigger blow came in the form of a billion-dollar lawsuit that went in Monsanto’s favor.

Next week, DuPont reports third-quarter numbers. Here's what to expect.

Fading green

Brace yourself for a bad third quarter from DuPont. Analysts are expecting its revenue to be around 11% lower from the year-ago period and earnings per share to slump by almost 32%. Sigh...

You see, DuPont derives its highest sales from its agriculture business, which has just come out of a quiet period. The months from June to September are typically weak for agriculture companies as purchases for both U.S. and Latin American planting seasons are still some time away. DuPont had already dropped hints in its last call when its outlook for agriculture division read “large seasonal losses” for the latter half of the year. Monsanto confirmed the weakness by reporting a 10% drop in in its fourth-quarter top line. Sales of corn seeds and traits (which account for nearly half of its largest division, seeds and genomics) fell more than 12%.

The only market that could save the day for DuPont will be Latin America -- if farmers started making purchases earlier than usual, that is. They have the incentives to do so – high crop prices and low U.S. crop yields. But there’s a problem – both companies fear Latin American farmers will plant less corn and more soybean this time, which could put pressure on margins as both companies focus more on corn. DuPont’s 2011 third quarter was particularly good as agriculture division sales climbed a whopping 41% from the comparable period in 2010. So year-over-year comparisons might turn out pretty sour this time. In short, I am prepared for disappointment next week.

Bland white

Things aren’t any better for DuPont’s second-largest business, performance chemicals. Prices of key pigment titanium dioxide (TiO2), of which DuPont is the largest producer, continue to remain flat, and sales volumes are still low. I am expecting both revenue and operating income from the division to be significantly lower than last year for two reasons – first, TiO2 prices were very high that time, and two, raw materials didn’t cost as much.

Peer Huntsman (NYSE: HUN) clearly stated how it expects cost pressures to be greater in its third quarter as low-cost inventory bought last year gets exhausted to make way for fresh purchases at a high price. Huntsman expects low selling prices plus high costs to dent its TiO2 margins by almost $350 per ton. The company is even thinking of gradually reducing focus on the TiO2 business in the years to come. Likewise, TiO2 specialist Kronos Worldwide (NYSE: KRO) expects its total TiO2 cost per metric ton (for full year production) to be as much as 50% to 60% higher from last year, which is huge and could hurt profits significantly. Kronos isn’t expecting selling prices to improve much either for at least the next two quarters.    

Finally some hope!

DuPont’s electronics and communications division could be one of the brightest among all divisions as customer destocking, which hurt sales in the past few quarters, comes to an end. Volumes could still be low compared to the year-ago quarter, but things are improving sequentially as demand for photovoltaic materials pick up and the demand for gadgets remains strong. Dow Chemical (NYSE: DOW), which runs a similar business (electronics and functional materials division) that accounts for around 10% of its total sales, expects weakness to continue during its third quarter. Revenue from the division was down 4% in the second quarter on low volumes. But Dow believes the destocking phase is about to end and expects the division to start showing year-over-year earnings growth from the fourth quarter onwards.

DuPont’s third-quarter numbers should make things more clear. If it indeed confirms the end of the phase, that would be great news for both companies.

Things to watch out for

The past three months might not have been too great for DuPont from an operational point of view, but the period interestingly was witness to two major events that are likely to be discussed in length in its forthcoming earnings call – while one was good, the other was equally distasteful.

Private-equity giant Carlyle Group agreed to take over DuPont’s performance-coatings business in a deal valued at around $5 billion. The deal, which is likely to be completed in the first quarter of 2013, leaves us with some key takeaways.

One, exiting this business (which mainly dealt with auto paints) will enable DuPont to focus more on key growth areas such as agriculture. This is also the main reason why CEO Ellen Kullman decided to do away with the weak-profits-slow-growth division.

Two, it will considerably reduce DuPont’s exposure to the troubled European region. Currently, the company derives more than 40% of its sales from the Europe, Middle East and Africa region.

Three, DuPont will use the proceeds to ease its debt burden, which means we should soon be able to see its total-debt-to-equity ratio improve from the current high of around 145%, thereby further strengthening its balance sheet.

Four (and more relevant in present context), expect DuPont to update its full-year guidance in its third-quarter call to accommodate the effects of this transaction. It had earlier projected full-year earnings to be between $4.20 and $4.40 per share, but from the third quarter onwards, performance coatings results will be reported under discontinued operations. The updated guidance will reflect earnings from continuing operations only. I am looking forward to details about how DuPont plans to capitalize on the deal in its upcoming earnings release.

Okay, now for the bad news. In August, DuPont lost a major lawsuit to arch rival Monsanto that could cost it $1 billion in damages. DuPont was found guilty of unlawfully mixing Monsanto’s Roundup Ready trait with its own. Naturally, DuPont is not going to give up so soon, and will appeal the verdict. The upcoming earnings call should throw more light on the matter.

The Foolish bottom line

An earnings beat could give DuPont’s shares the much needed push, though I am not too sure if the company will be able to pull it off, particularly after the weak agriculture season. Nevertheless, the third quarter should give us an idea of how the company could end its full year, and how well it is poised to meet its forecasts. To make sure you do not miss its earnings release, news and analysis, click here to add DuPont to your personalised stock watchlist.  

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Neha Chamaria has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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