DowDuPont Inc. (DWDP: Buy, $82 PT) 
Checking a Lot of Boxes Now; We Add 10c to Cash EPS and Raise PT
• Meaningful progress on three key issues supports our constructive thesis. Entering 4Q earnings we had been focused on: (1) the level and trajectory of earnings growth; (2) the pace and headroom on extraction of cost synergies; and (3) speed to spin(s). DowDuPont delivered on all three counts with meaningful upside to our above-consensus earnings, a 10% bump to the synergy target (our guess not the last) and a re-acceleration of the spin-off timeline with Materials Science now set to be separated by the end of 1Q19. With regard to the under-leveraged balance sheet, DowDuPont repurchased $1bn of shares in 4Q17 and signaled a similar pace for 1Q18, which we would characterize as underwhelming yet unsurprising given the need to cement targeted credit ratings for the three spin companies. So, while the pace may be disappointing to some investors, we view it as prudent and consistent with our thesis, i.e. the potential for EPS accretion of $0.20-0.25 is still there, albeit with more value to be unlocked post-spin vs. pre-spin perhaps. Finally, the company’s earnings guidance for 2018 looks more than achievable, which should set the stock up for a “beat and raise” dynamic down the road. On balance, 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 3.2% YTD.
• Our top 10 takeaways: (1) cash-adjusted EPS of $0.83 (adds back amortization expense of $0.09) grew 41% y-y exceeding our $0.71E and consensus of $0.67 on an apples-apples basis; (2) operating EBITDA grew 24% to $3.9bn, comfortably ahead of our above-consensus estimate of $3.72bn; (3) volume growth accelerated from +4% in 3Q17 to a pro forma rate of +6% led by EMEA at +10%; Industrial Intermediates & Infrastructure (II&I) grew fastest at +13%, while Agriculture and Nutrition & Biosciences lagged at +2%; (4) 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; (5) having ended the year at an annual run-rate of $800mn, management raised its cost synergy target by 10% to $3.3bn split as Agriculture $1.1bn; Materials Science $1.235bn; and Specialty Products $965mn; (6) DWDP re-accelerated the speed to spin to “14 to 16 months from today” with management targeting Material Science as...
• We raise our 2018 EPS estimate by $0.10. We increase our 2018 cash EPS estimate from $4.27 to $4.37, which now adds back an estimated $0.42 of amortization expense vs. $0.32 in our prior model (higher amortization and a lower tax rate). Our revisions also reflect a higher base level for sales and earnings exiting 4Q17, higher crude oil prices, slightly more favorable FX, and a tax rate that is even lower than expected at a midpoint of 21.5% for 2018 vs. 23.3% in our prior model. In partially offsetting fashion, we now anticipate a lower equity earnings contribution from Sadara (Saudi) and a weather-related earnings impact of ~$60mn in 1Q18 for which we now model $1.20E. Our earnings cadence in Agriculture is also more back-end loaded in recognition of timing issues related to seed deliveries.
• We affirm our Buy and increase our price target. We raise our price target by $2 to $82, which suggests total upside potential of 14%, inclusive of dividend yield of 2.1%. Given a pending break-up into three separate companies, we continue to set our target price based on the value of DWDP shares using a sum-of-the parts (SOTP) framework, including synergies and underfunded pension liabilities. For context, DWDP now trades at a 2018 P/E multiple of 18.6x or 16.8x on a cash-adjusted EPS basis, which is in line with the median of our 18 chemical companies under coverage. Likewise, DWDP trades for 10.2x our 2018 EBITDA vs. a median of 10.5x 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. 
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Eastman Chemical Company (EMN: Buy, $108 PT) 
4Q in Line ex Kingsport Incident; 2018 EPS Midpoint Slightly Above Street
• Sales and volume look better than EPS apples-apples. Eastman’s 4Q17 quarter was a messy one, as expected. As previously discussed, the company suffered a substantial disruption to coal gasification operations at the company’s largest plant in Kingsport, TN on 4 October, aka the “incident”. In this context, Eastman’s 4Q17 adjusted EPS of $1.62 adds back $0.55 of net costs related to the incident, whereas consensus of $1.08 does not (for the most part). Therefore, we judge EPS to be essentially in line with the Street and below the $1.41E that we had penciled in. Otherwise, underlying trends appear more encouraging. Sales of $2.36bn exceeded our forecast of $2.22bn on healthy volume growth of 4%, or an estimated 6% as adjusted for the incident. Volume featured impressive contributions from Additives & Functional Products (A&FP at +14%) and Advanced Materials (AM at +6%), counter-balanced by weakness in Chemical Intermediates (CI at -8% or an estimated -2% as adjusted for the incident) and Fibers at -6%. Eastman repurchased $75mn worth of shares in 4Q, a bit less than the 3Q level ($100mn), bringing deployment to $350mn in 2017. Despite the repurchases, net debt declined $259mn q-q to $6.24bn or 2.7x our estimate of 2018 EBITDA. Next up: the company will host an “Innovation Day” in New York on Tuesday February 6.
• Management guides 2018 EPS above Street. Looking ahead to 2018, management expects to grow EPS between 8-12% vs. 2017, implying a range of $8.22 to $8.52. The midpoint of $8.37 is 1.7% above consensus of $8.23 and likewise above our $8.25E. Looking ahead, we think the “incident” was neutral to FCF in 4Q17 as adjusted for (unspecified) insurance proceeds, although the company will likely need to consume cash to rebuild inventory in 1Q18. Regarding the Kingsport facility, repairs to the coal gasification unit were mechanically complete in late December, and the facility resumed normal operations last week.
• Specialties continue to impress. A&FP continues its torrid growth pattern with volumes up 14% for the second consecutive quarter, while EBIT, up 21% y-y, benefited from a modest increase in contribution margins. We had anticipated a deceleration in volume growth towards the mid/high-single digit range given the presence of some one-time sales in 3Q. Thus the continued mid-teens growth rate is a pleasant surprise. Similarly, AM saw encouraging top line trends as volumes on the quarter accelerated to +6% after reporting fairly uninspiring volume prints in 2Q17 and 3Q17. We believe the start-up of the company’s Malaysian films plant in 4Q likely provided headroom for volumes to grow, with the business having spent the last few quarters constrained. However, this additional volume and associated start-up costs come at a price, and incremental margins of 8% may indicate unabsorbed fixed costs. Looking forward in AM, we see additional capacity coming online in films in 1Q18 and in Tritan in 2Q18. This could lead to additional unabsorbed overhead, but Eastman should have an opportunity to benefit soon from price increases as PVB film contracts tend to be annual in nature.
• Fibers legs down again. EBIT, ex the facility outage costs of $49mn, came in at $51mn, well below the $66mn reported in 3Q and the $73mn reported in 4Q16. Sales declined 13% y-y as price and volume were down 7% and 6% y-y, respectively. While price down 7% is consistent with recent quarter trends, a volume decline of 6% compares to the +/-2% rates of 2Q and 3Q17. The volume reduction comes from lower sales in China, which we believe reflects the ongoing trend of EMN’s exported volumes to China slowly being displaced as those local volumes decline. 
• CI sales lag though lost sales impact weighs. Sales volumes for CI declined 8% y-y as reported, however we believe that nearly all of the $40mn of lost sales due to the Kingsport facility outage were within the CI business. Thus we see a more comparable volume number as down 2-3% y-y. Reported EBIT of $53mn thus perhaps looks more like $56-57mn after adjusting for lost revenue. While propane prices remained elevated throughout the quarter, we suspect that the remaining commodity hedges helped to dampen some of the earnings impact. Looking forward, propane prices have finally receded from recent highs, while propylene prices have seen price support, which should bode well for earnings in 1Q18 and perhaps beyond.
• We rate EMN shares Buy with a price target of $108. Our price target of $108 suggests upside potential of 12% including a dividend yield of 2.3%. As a reminder, we value Eastman based on an average of three methodologies; DCF analysis, a relative P/E framework, and a relative EV/EBITDA framework. Our DCF suggests a warranted stock price of $114. Using our relative valuation framework, our P/E multiple implies a fair value of $109 while our EV/EBITDA implies a fair value of $101 per EMN share.
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