DuPont, Huntsman Both "Buys" Against This Competitor
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Chemicals rank amongst some of the most volatile assets. The degree of risk they carry, however, often results in the equity trading well below intrinsic value. I believe that DuPont (NYSE: DD) and Huntsman (NYSE: HUN) represent compelling buying opportunities while Dow Chemical (NYSE: DOW) is too expensive to merit an investment.
What makes me particularly attracted to DuPont is its leverage towards natural gas. Low energy costs from a surplus of shale gas unable to meet emerging market demand have granted domestic producers a price advantage over global competitors. While the company has significant FX headwinds, it has a large economic moat to weather macro storms. In fact, over the past 5 years, the company generally outperformed the market under the worst economic crisis since the Great Depression.
Perhaps nowhere is the company's ability to weather macro storms best shown than in the recent quarterly performance. For 2Q12, the company saw robust activity in agriculture as sales rose 7% despite a 3% FX headwind. In addition, the company's decision to increase scale have paid off. The Danisco acquisition has beaten expectations and been since complemented by two other attractive takeovers.
In terms of innovation, DuPont is also a leader. Well over 30% of sales has come from new products launched over the last 4 years. For example, the performance polymers business addressed a global shortage of PA-12 in the auto market by introducing new grades of Zytel to the market. While the impact on the bottom-line may have been relatively small, it once again increased DuPont's visibility and will help win future contracts.
Huntsman similarly offers a favorable risk/reward. As I predicted, the stock has taken off for the YTD - more than doubling from the 52-week low. Even now, the firm is still relatively cheap at a respective 11.3x and 7.9x past and forward earnings. By contrast, the historical 5-year average PE multiple for the firm is 16x - a period that included the Great Recession. Multiples have fallen drastically from the 2009-2010 high and are likely to elevate with increasing optimism over the economy. Profit margins have also been on the rise - increasing by almost 300 bps from the average to 10.4% in 2Q12.
Going forward, analysts forecast 13.5% annual EPS growth over the next 5 years. Assuming Huntsman meets expectations, 2016 EPS will come out to $3.04. At a 16x multiple, the future value of the stock is then $48.64 - well above the current valuation. Discounting backwards by 10% yields a present value of $30.20 - almost double the current valuation. Combined with the 2.5% dividend yield, Huntsman offers an incredible margin of safety on high upside.
Having illustrated just how attractive of an investment DuPont and Huntsman are, it is important to compare their value against an expensive peer like Dow Chemical. Dow is rated closer to a "sell" than a "buy" and is valued at 20.5x forward earnings. Only 6.8% annual EPS growth is forecasted over the next five years. This weak growth is partially made up for by a 4% dividend yield, but low single-digit ROA, ROE, and ROI will keep the company from outperforming during a recovery.
Poor operational performance has caused the firm to generate half the return of Huntsman over the trailing twelve months. Free cash flow for the TTM ending 2Q12 was $2.6 billion in 2Q12 but $3.2 billion in 2Q10. On the positive side, Dow has an attractive product mix, but I am skeptical about the introduction of POWERHOUSE and EVOQUE. The market has already factored in significant growth from these technologies, which may be inherently offset by an increase in crude to ethane. I thus recommend holding out and buying competitors DuPont and Huntsman.
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