Running Hard Out of the Gate
• DowDuPont posted strong results, despite numerous challenges in 3Q. The company had to contend with a mega-merger, numerous natural disasters, several large-scale productivity initiatives, establishing architecture for three new companies and executing substantial portfolio actions. Notwithstanding these challenges, DowDuPont managed to deliver encouraging results in the company’s first quarter out of the gate. Adjusted 3Q17 EPS grew 12% on a pro forma basis to $0.47A in line with the company’s pre-release on 26 October (click here). On a cash adjusted EPS basis, i.e. adding back the full effect of deal-related amortization expense of $0.08 per share, DWDP reported $0.55, up 10% y-y. Sales grew 8% y-y to $18.3bn, also disclosed in the pre-release and surpassing our prior forecast of $17.4bn. Operating EBITDA grew 7% to $3.22bn, which beat our prior forecast of $3.02bn. Volume growth remains healthy at an even-keeled pro forma rate of +4% in both 3Q17 and 2017 YTD. Electronics & Imaging grew fastest at +13%, while Agriculture lagged at -5%. On a segment basis, earnings in Materials Science exceeded our forecast, while Specialty Products trended in line and Agriculture came in light.
• Outlook/macro commentary reads positive. Management described global economic activity as “robust” across Europe, China and the US, led by the consumer. In this context, Dow DuPont’s “demand outlook is positive”, despite ongoing headwinds in Agriculture, including reduced corn area and late start to the summer season in Brazil.
• We expect Street to re-focus on execution with portfolio composition set (for now anyway). Just yesterday DowDuPont completed on schedule its acquisition of FMC Corporation's Health & Nutrition business (ex Omega-3) as well as the divestment to FMC of a portion of legacy DuPont's crop protection chemical business. Previously, on 12 September DowDuPont shifted more than $8bn in sales and $2.4bn in operating EBITDA from Materials Sciences to Specialty Products. Now, with these shifts in the books, DowDuPont enters a transition period of relative stability for a few quarters until the planned separation of Material Sciences, which we anticipate in 2H18. In the meantime, we expect the Street to re-focus on execution.
• News on synergies and projects looks good. DowDuPont now expects to achieve a run-rate of 70% of $3bn in costs synergies by the end of 12 months, or an implied $2.1bn. This puts the company just a bit ahead of our forecast pace of $1.9-2.0bn, which is part of our estimated 2018 EPS boost of $0.56 from the combination of all parallel paths of productivity initiatives (legacy Dow, Dow Corning, legacy DD and Dow-DuPont). Meanwhile, we expect an EPS tailwind of $0.35 from new projects in 2018 as Dow’s new ethylene and derivatives complex at Freeport, TX ramps in 2H17, along with contributions from all 26 new units at the company’s Sadara JV in Saudi.
• Balance sheet leaves ample room for capital deployment. Net debt declined by $2.0bn on a pro forma basis in 3Q to $21.9bn or 1.1x our 2018 EBITDA estimate of $19.3bn. This leaves DWDP with half as much leverage as the average US chemical company. What is more, we would expect a meaningful harvest of cash in 4Q, when working capital tends to shrink seasonally. In this context, we see ample room for a moderate re-capitalization of the balance sheet. We have estimated in the past that such an action could boost EPS by $0.20-0.25 per share, while leaving plenty of room to achieve management’s desired credit ratings for each of the three companies to be created from DowDuPont.
• DWDP remains our top large-cap pick with a price target of $79. Our target suggests total upside potential of 10%, inclusive of the dividend which is yet to be determined by the company’s new board of directors (Dow’s old dividend was $1.84 per annum, which would imply a yield of 2.5%). Given a pending break-up into three separate companies, we continue to assess the value of DWDP shares using a sum-of-the parts (SOTP) framework for the combined entity, DowDuPont, including synergies and underfunded pension liabilities. DWDP now trades at a 2018 P/E multiple of 18.3x, or a 2% premium to the average of our 18 chemical companies under coverage. Likewise, DWDP trades for 10.1x our 2018 EBITDA vs. an average of 10.5x for the sector. We continue to believe these multiples attractive for a catalyst-rich stock with a forward looking 3-year EPS CAGR of 11%+, or a premium of 400bps vs. the average for the US chemicals sector.
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