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What Chemical Hurt DuPont and Dow but Helped Sherwin-Williams?

It's used in everything from sunscreen and toothpaste to food coloring and vehicle coatings. The milk you drink has been enhanced by it and the creme of the Oreos you eat have been brightened because of it. It's applied as an undercoating on planes, trains, and automobiles and is used as a food additive and flavor enhancer in a variety of non-white foods. What it's best known for, though, is as the base pigment for paint.

Whiter than white
Titanium dioxide is the whitest substance on Earth. Global demand has surged in recent years amid greater production of automotives and home appliances in China and India. Coupled with supply disruption at the Japanese producer Sakai Chemical last year as a result of the earthquake and tsunami and no new capacity coming online, and there's a huge supply imbalance that's led to skyrocketing prices.

DuPont (NYSE: DD  ) is the world's largest maker of titanium dioxide with 20% of the industry's capacity, and 2011 was a year of record profits due to rising TiO2 prices. Even as sales volumes fell, DuPont was able to post earnings of $3.5 billion, with the performance chemicals division enjoying a 12% increase in sales on 29% higher prices. It was alone among major manufacturers preparing to bring new capacity online.

Yet those results should also have been a warning that pricing fatigue was setting in. Rutile, one of the main sources for TiO2, simply couldn't maintain that trajectory if demand was ebbing and prices are down 8% in 2012 with them falling back 3% this month alone. Huntsman (NYSE: HUN  ) , tied with Kronos Worldwide (NYSE: KRO  ) as the third largest manufacturer with 10% of the industry's capacity, felt it was just being a realist earlier this year when it suggested it would experience margin pressure from falling prices.

Now buyers say rather than try to buy as much as they can of titanium sponge -- the first stage titanium goes through in processing -- like they did last year as prices leapfrogged ever higher, now they want to see how much they can postpone paying for.

Blood red results
DuPont's adjusted profits fell to $0.32 a share, well below the $0.47 analysts had anticipated as the performance chemicals segment saw demand fall 18%. Dow Chemical (NYSE: DOW  ) suffered a 32% decline in profits driven in part by significantly lower volumes for TiO2 and electronics in Europe and Asia.

Falling prices will likely benefit downstream players in the TiO2 market like paint and coatings makers Benjamin Moore, PPG Industries (NYSE: PPG  ) , and Sherwin-Williams (NYSE: SHW  ) . They've been able to pass along much of the rising costs to their customers, thus shielding themselves from the worst of the price hikes, but some are now trying to wring extra mileage out of the situation by changing the processes used for making TiO2.

50 shades of gray
Without getting too technical, there are two main ways of producing the pigment: a more expensive chlorine-based formulation, which is primarily used in North America to extract pigment from rutile, ilmenite, and titanium slag, and a lower cost, lower grade sulfate-based one that's common across Europe and Asia, which produces both rutile and anatase crystal forms. Some manufacturers like Valspar (NYSE: VAL  ) are adding the sulfate process to their production -- as much as 20% -- to lower their costs further. Sherwin-Williams says while it's not as easy for it to switch over, it's not impossible, and it just won't be leading the charge in converting.

While each method has its benefits -- anatase crystals, for example, are better in specialty applications like cosmetics -- the chloride method developed by DuPont is the most efficient process and probably helps explain why North American plants have been the most profitable.

Covering the world
When you look at Sherwin-Williams' results this past quarter, we see across all its major segments passing along input cost increases benefited the top and bottom line. Most notable was its paint store group, which caters to the professional painter, commercial businesses, and government, enjoyed 10% higher revenues in the quarter along with gross margins that widened 350 basis points. Its consumer segment was weak, as were global finishes and Latin America, though they would all have been worse had price hikes not made up the difference.

Now with the key ingredient for its finishes coming down, and likely no concurrent reduction in the price of a gallon of paint, investors should see margins widen further, though the process takes time to filter down through the channel. At 25 times earnings and 18 times estimates, the paint maker offers a premium to rivals PPG and Valspar, but sporting an enterprise value that trades at 23 times its free cash flow makes me think it's not a bargain stock.

Yet investors may want to instead focus on the paint makers as a sector to profit from rather than those making the ingredients that go into the formulations. Sherwin-Williams likely has a better prospect for profitable growth right now than does DuPont, Dow, Kronos, or even Tronox (NYSE: TROX  ) . It could be a very white Christmas for the coatings specialist as it continues to paint profits black.

Color my world
Global architectural coatings makers would likely benefit from an uptick in infrastructure spending in China. Caterpillar is one company that would be more than happy to take advantage of this. CAT is the market share leader in an industry in which size matters, and its quality products, extensive service network, and unparalleled brand strength combine to give it solid competitive advantages. Read all about Caterpillar's strengths and weaknesses in our brand-new report. Just click here to access it now.

Rich Duprey has no positions in the stocks mentioned above. The Motley Fool owns shares of Sherwin-Williams. Motley Fool newsletter services recommend Sherwin-Williams. 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.

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  • Report this Comment On October 29, 2012, at 8:06 PM, funfundvierzig wrote:

    Readers, It's not only the commodity industrial chemical TIO2 which has hurt DuPont. For years DuPont's Management told us their extraordinarily toxic Teflon chemical C8 or PFOA is perfectly innocent, would not harm a human in any way. Nothing to worry about no matter how much courses through your blood and body. Now we find from extensive medical research that exposure to this insidiously vile Teflon chemical is linked not only to two cancers and extreme high blood pressure in pregnant women, but also to high cholesterol and its concomitant potential risks of heart disease and stroke.

    Recall the class action lawsuit settlement in 2005 brought by 100,000 residents of the mid-Ohio Valley whose drinking water was covertly contaminated by DuPont for decades with C8? As part of the settlement, a C8 Science Panel of three independent epidemiologists was established to research potential harm from this vile industrial chemical used to make Teflon. The Panel has concluded its six-year study, and has found a link between C8 exposure and the following:

    * Testicular and kidney cancer

    * Dangerous extreme high blood pressure in pregnant women.

    * Thyroid disease.

    * Inflammatory bowel disease.

    * High cholesterol

    So much for DuPont's "safe" and "environmentally friendly" Teflon chemical C8. Classic DuPont SHAM SAFETY. DuPont is now on the hook for $235 million in medical monitoring of C8-contaminated residents of the Valley and is subject to individual tort lawsuits for damages from individuals and/or their families.

    Merely the commentary of one individual investor and DD shareholder...funfun..

  • Report this Comment On October 31, 2012, at 4:07 PM, TadpolesUS wrote:

    Author - please fix the title of this article to show the true name of Sherwin-Williams. Hard to take info seriously with such an error in the title.

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