You would probably think a wellestablished and profitable company could easily beat the returns of the broader stock market over a long enough market period. Yet, poor old chemical manufacturing leader DuPont (DD) has been running side by side with the S&P 500 when it comes to total returns in the past decade.
DD Total Return Price data by YCharts
Past mediocre performance may not guarantee similar results in the future, but the company does face some unique challenges on its way to creating a more efficient and profitable business -- a scenario we recently evaluated. Today, we'll review three reasons DuPont's stock could fall in the coming months or quarters.
1. Overdependence on agriculture
There's certainly value to betting heavily on the future of agriculture, especially with a growing global population and swelling middle class, but DuPont may be a little too dependent on its Agriculture segment. In 2013, segment sales of $11.74 billion accounted for roughly one-third of total sales. More worrisome, 23% of the company's total sales last year were derived from Pioneer seeds, mostly consisting of corn and soybean varieties -- and the figure has risen 2% in each of the past two years. That statistic and trend are a bit alarming for a leading chemical manufacturer with seven major reporting business segments.
Investors may feel the effects of that overdependence next year, when The Dow Chemical Company begins selling its soon-to-be-approved Enlist corn and soybean seeds in the United States, which could jeopardize over 10% of DuPont's total sales. The seeds are expected to become instant pest-management systems with farmers and will become the first crops sold commercially to resist two herbicides (stacked traits). There isn't much time for DuPont to react or insulate other parts of its business, either. While spinning off its Performance Materials assets later this year could provide a potential cushion, management will have a difficult time making up any potential reduction in seed sales.
2. Cellulosic ethanol market timing
I just sang the praises of DuPont's Industrial Bioscience segment and its potential to piggyback on the amazing growth of the bioeconomy. However, despite having just three major competitors, DuPont's licensing strategy may have already limited its potential opportunity in cellulosic ethanol -- the gateway market for cellulase enzymes, which are used to break down biomass into fermentable sugars for industrial fermentation platforms. That may sound odd given the real progress achieved to date, but investors must consider the fickleness of the industrial enzymes industry.
To be fair, DuPont has been focusing on the construction of its own $200 million, 30 million-gallon-per-year cellulosic ethanol facility, which will be the world's largest when it begins operations later this year. It will also give the company roughly 36% of the domestic industry's production capacity by volume. The technologies are new and expensive now, but costs will come down as processes and enzymes are improved.
Source: DuPont.
So why might DuPont be behind? Each of the company's three major competitors focused on securing partnerships with leading producers early on -- even though their respective technologies weren't economically viable -- to gain early access to networks and new projects. DuPont, on the other hand, decided to pursue the opposite strategy: Build a facility and prove the technology first before approaching partners. That could have the company playing catch-up in the young but quickly moving cellulosic ethanol industry.
For instance, Novozymes has partnered with world-leading engineering firm Chemtex, which wields the coveted PROESA biomass pretreatment technology, and will supply cellulase enzymes to a 20 million-gallon-per-year facility under construction in North Carolina. The industrial enzyme manufacturer has also gained access to additional partners (Beta Renewables), projects (a 25 million-gallon-per-year facility with Canergy in California), and markets (GraalBio in Brazil) by corralling Chemtex.
The same is true for Dyadic International and DSM. Dyadic has bagged world-leading energy partners such as Abengoa and began supplying enzymes to a newly started 25 million-gallon-per-year facility in Kansas, which could open the door for supply deals at current or future Abengoa sites worldwide. Meanwhile, DSM has formed a valuable partnership with POET, America's largest ethanol producer, and will soon begin operations at the joint venture's first facility, Project LIBERTY. The company's industrial biosciences division has its hands in many other projects, too, including the GraalBio project in Brazil -- working side by side with Novozymes, Beta Renewables, and Chemtex.
There are a handful of top ethanol producers in the United States that have yet to formally choose a cellulosic ethanol partner, but DuPont's status as an industry leader may be based on volume alone.
3. Biobased chemical market development
Cellulosic ethanol is only the beginning of a much larger and more profitable opportunity for industrial enzyme manufacturers, who can use the same cellulase enzymes to unlock cellulosic biomass for biobased chemical platforms. There's a relatively small market for ultra-high-value products such as flavors, fragrances, and cosmetics; a very large market for moderately priced products such as oils, lubricants, and materials; and an enormous market for low-priced cellulosic fuels.
Unfortunately for DuPont, many of the same producers currently involved in cellulosic ethanol are also the gatekeepers to these future opportunities. More worrisome, DuPont's Industrial Biosciences segment has only one site in all of Latin America, compared with seven in the United States. That could make it more difficult to cozy up to Brazilian sugarcane and ethanol producers, meaning the company is potentially lagging in the two most important cellulosic ethanol markets. The good news is that a Generation A enzyme from Company A could be running laps around its counterpart from Company B, only to be leapfrogged by the Generation B enzyme from Company B later. In other words, performance is everything -- and superior performance could catapult DuPont to the top of the pack overnight if the right partners are reeled in.
Foolish bottom line
Investors have several good reasons to believe that the nation's second largest chemical manufacturer by market valuation is gearing up for future growth. Of course, there are always headwinds and obstacles that need to be confronted or scaled. It does appear that DuPont is a little too dependent on its Agriculture segment, especially Pioneer seeds, and may have to work a little harder to catch up to potential partners with its industrial cellulase enzymes for next-generation ethanol and chemical production. Overdependence and a low margin for error are good reasons DuPont's stock could fall in the next few months or years.
