DowDuPont Inc. (DWDP: Buy, $80 PT)
Ample 4Q EPS Upside, More Synergies, Faster Spins, Lower Tax Rate
• DowDuPont posted impressive 4Q results. In its second quarter as a merged entity, DWDP reported $0.83 on a cash adjusted EPS basis, i.e. adding back the full effect of deal-related amortization expense of $0.09 per share. This reflects growth of 41% y-y and compares favorably to our $0.71E and consensus of $0.67 on an apples-apples basis. Sales grew 13% y-y to $20.1bn, outpacing our $19.0bn. Operating EBITDA grew 24% to $3.9bn, comfortably ahead of our above-consensus estimate of $3.72bn. Volume accelerated from +4% in 3Q17 to a pro forma rate of +6% led by EMEA at +10%. On a segment basis, Industrial Intermediates & Infrastructure (II&I) grew fastest at +13%, while Agriculture and Nutrition & Biosciences lagged at +2%. Segment earnings exceeded our forecast in Performance Materials & Coatings, II&I, Electronics & Imaging, Transportation & Advanced Polymers, Nutrition & Biosciences, while Agriculture and Safety & Construction trended in line and Packaging & Specialty Plastics came in light.
• Cost synergy target increased 10%, while “speed to spin” accelerates. Cost synergies ended the year at an annual run-rate of $800mn, so the company has achieved 27% of its prior target of $3.0bn in the first four months post-closing on 1 September. Based on progress to date, management is raising its synergy target by 10% to $3.3bn from the prior goal of $3.0bn. Meanwhile, after having attenuated the timeline to spins last quarter, DowDuPont re-accelerated the speed to spin to “14 to 16 months from today” with management targeting Material Science as the first to go in 1Q19. This equates to roughly 17-19 months on the old basis, about equal to the low end of the prior timeline of 18-24 months.
• 2018 EPS guide looks a bit light/conservative; tax relief looks broadly in line. For 2018 management put forth new guidance of EPS growth at a “mid-to-high-teens” rate. Using a pro forma EPS base of $3.40A, growth of 14-19% would imply a range of $3.88 to $4.05, which compares to our $4.27E (again, adding back deal-related amortization) and consensus of $4.16E. Regarding the 2018 tax rate, DowDuPont estimates the new US Tax Cuts and Jobs Act will result in a reduction of 100-200bps, which brackets our estimated reduction of 120bps to 23.3% from 24.5%, resulting in a tailwind of $0.06. On the macro front, management described global economic activity as having “gained momentum – driven by robust fundamentals in consumer and business confidence” and “strong leading indicators of broad-based growth” in developed economies in particular. Looking forward, we expect the combination of USD weakness and recent strength in crude oil to support earnings. We also anticipate that the reduction in commissioning costs and subsequent profit generation from Dow’s Sadara JV (Saudi) and Texas-9 will represent a meaningful tailwind to 2018 performance.
• Balance sheet leaves ample room for capital deployment. Net debt declined by $2.25bn on a pro forma basis in 4Q to $19.7bn or 1.0x our 2018 EBITDA estimate of $18.9bn. This leaves DWDP with half of the leverage of the average US chemical company (2.0x). Heading into the quarter we had anticipated rather sizeable cash generation given the seasonal reduction in working capital however, it appears cash flow from operations declined modestly following a nearly $900mn contribution to the company’s pension plan. That said the company was still able to de-leverage the balance sheet again. In this context, we continue to see ample room for a moderate re-capitalization of the balance sheet in due course. 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.
• We affirm our Buy rating. Based on our preliminary read prior to the conference call at 8:00AM eastern, we continue to favor DWDP as an attractive core, large-cap “cornerstone” investment in the chemicals space, notwithstanding the share price ascent of 24.5% in 2017 and 6.1% YTD. Our pre-call target of $80 suggests total upside potential of 8%, inclusive of a dividend yield of 2.0%. 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 19.1x, or a 12% premium to the median of our 18 chemical companies under coverage. Likewise, DWDP trades for 10.5x our 2018 EBITDA vs. a median of 10.7x for the sector. We continue to consider 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 sector average.
