There may not be many quarterly earnings reports left for DuPont (NYSE:DD) -- at least not in its current form. The company plans to merge with Dow Chemical (NYSE:DOW) and split into three separate companies, if regulators approve.
But while questions about the regulatory status of the deal came up during the company's Jan. 24 earnings call, the big story was the massive earnings beat.
DuPont absolutely destroyed analysts' expectations, reporting per-share operating earnings of $0.51 for Q4 2016. That not only trounced the consensus estimate of $0.42, but it was almost double the prior-year quarter's $0.27 per share. For the year, operating earnings were up 21% to $3.35 per share.
As for next year's earnings, the company declined to issue its traditional full-year earnings outlook, but that's only because it expects its merger with Dow to close in the middle of next year. The company did project numbers for the next quarter, during which it expects operating earnings to rise about 8%. However, the company expects merger-related expenses will eat into net income.
All told, a solid earnings report.
The long and winding road
Surprisingly, these big earnings increases were coupled with sales declines. Sales were down 2% year over year for both the quarter and the year. Declines in the company's agriculture segment offset gains elsewhere. Management blamed "timing of fourth-quarter seed sales primarily due to the southern U.S. route-to-market change."
What does that mean? Earlier in 2016, the company moved some of its regions -- including the southern U.S. -- to an agency sales model from a direct sales model. On the earnings call, CEO Ed Breen defended this decision as "the right thing to do," citing improved customer relationships and a strengthened competitive position.
One unfortunate side effect of this sales model shift was that it delayed some seed shipments -- about $200 million worth -- into Q1 2017 from Q4 2016. The company estimates that without this issue, sales would have increased in Q4 by 2%, instead of declining by 2%. For the year, DuPont estimated that sales would have declined only 1% instead of 2% without this change. Investors should remember this when the next earnings report rolls around, since this change will probably skew the year-over-year numbers in that quarter as well.
It's important for investors to remember that, at this point, the fate of DuPont's proposed merger with Dow Chemical is far more important to its long-term fortunes than any quarterly -- or even annual -- report.
The fate of the merger was called into question on Monday, when EU regulators granted the companies a 10-day extension to a prior final review deadline of March 4. DuPont and Dow requested the extension to finalize a concessions package. EU regulators had previously expressed concerns that the merger would stifle innovation, particularly in the areas of crop protection and pesticides.
On the earnings call, Breen expressed confidence that the merger would go through as expected, probably in the second quarter of 2017. Because the EU's concerns revolved mostly around innovation in crop protection, he said the combined company would not be reducing the number of scientists working on new product development. Furthermore, the company would be willing to sell some of its crop-protection assets as part of a concessions package, and would anticipate an easy sale with multiple bidders.
This must have reassured the market, because DuPont shares had jumped 4.6% by the end of the day. And certainly, while other countries' regulators will also have a say -- including the U.S.' -- it sounds as though the companies have a plan in place to deal with this particular potential pitfall.
The picture is starting to solidify for DuPont, which -- if all goes according to plan -- will officially become DowDuPont within six months. Eighteen months later -- so, by the end of 2018 -- the company should split into three separate entities. This merger-and-split is looking more and more certain, so current investors should feel more comfortable holding on to their shares, which would almost certainly drop in value if the merger is called off.
For investors considering buying in now, DuPont's performance this quarter and year indicates that it's still a strong company. Price gains since the merger announcement, though, have pushed its P/E ratio to astronomical levels compared to Dow and other chemical peers. And while quality comes at a price, this price may simply be too high, especially considering how much change is coming for the company in 2017.