DowDuPont (NYSE:DWDP) has been a writhing mass of conglomerates on conglomerates for years, and that's about to change. Activist investors -- namely the hyper-experienced Ed Breen -- concocted a plan that'll split the amalgamation that is DowDuPont into three much more focused, streamlined companies. That plan's about to come to fruition.
In this week's episode of Industry Focus: Energy, host Nick Sciple and Motley Fool contributor Lou Whiteman dig into everything we know about the split so far: what these three new companies will do, what risks and bright spots investors should watch, how cyclicality factors into potential, which one looks like the best long-term play, and more.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.
This video was recorded on April 11, 2019.
Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, April 11, and we're talking DowDuPont. I'm your host, Nick Sciple, and today, I'm joined by Motley Fool contributor Lou Whiteman via Skype. How are you doing, Lou?
Lou Whiteman: I'm good! How are you?
Sciple: I'm doing great, Lou! We're going to talk about DowDuPont today. Before we dive into that, I follow you on Twitter. You like to talk about Tesla a little bit. We've got a little bit of Tesla news today. Today, news came out that Tesla and Panasonic have agreed to cease further expansions of the Gigafactory. What's your reaction to that, as someone who likes to follow Tesla in their free time?
Whiteman: It's hard to spin this well. Either they don't have the money to do it or the demand isn't there. And so much of the stock's valuation is based on the expected growth in the company and deliveries. Even in the best case, that they have the money and they could expand this factory if they wanted to, it implies it's not the lowest-cost option or they don't have the need for all those batteries.
At this point... we'll see what happens with it, but I don't think anyone can say down the line there were no signs, let's just put it that way.
Sciple: Yeah, the hits keep on coming for Tesla these days. We'll see how it plays out. They do have the Chinese Gigafactory, trying to get up and running. They do have a different battery agreement there with a different supplier. We'll see if that works out. But, again, the hits keep on coming.
Lou, let's talk a little bit about DowDuPont. First, I want to give a little bit of history on where we are and how we got to where we are today. The company, DowDuPont, as it exists today traces back to a merger back in 2015. From the beginning, the goal was to divide into three companies -- bring these companies together, create some synergies, then sub-divide into three companies. We have started to see that just in the recent weeks. On April 2, the new Dow began trading on the markets. We're going to have some more splits coming on down the line.
Before we dive into those new companies, Lou, can you just give us a 10,000-foot view history lesson on how we got to where we are today with DowDuPont?
Whiteman: Sure. You have to go back to the early part of this decade. Both Dow and DuPont separately were the product of years and years of bolt-ons and consolidation in the chemicals. We had two sprawling chemical conglomerates, two companies that were in a range of different businesses. Some they were good at, some they weren't so good at. They had the feel, the stink, of an old company that just can't quite fire on all cylinders.
Both had activists get involved. There was a lot of talk -- are they going to be split up? Are they going to do divestitures? Asset sales? Both were companies that were in need of a catalyst, and that catalyst came in the form of Ed Breen, who took over at DuPont. Ed Breen, for us old-timers... it depressed me to look back. Let's go back 15 years, when it looked like Tyco International was going to just implode under the weight of scandal. Ed Breen did a masterful job of picking out what's good, what's not, putting it all together, splitting apart, and really creating value. One of the most impressive jobs I've ever seen by a transformational CEO, by an industrial.
He comes to DuPont. He says, "Dow has this that we could use. We have this that Dow could use. We'll never be able to do a trillion different transactions. The way to do it is, let's put these two businesses together, take out the costs, reorganize things, combine things that are similar." The plan is now almost to completion. As you said, we're going to have three independent companies that all should be more streamlined, more focused, that don't have those little bits that just drag down the hole, if it goes right.
Sciple: Yes. Streamlined is definitely the buzzword management seems to be coming back to over and over again. You mentioned how it's been tough to own the whole basket of these companies. There's always a part that somebody can complain about. There's always something that puts a stink on the investment. Now that we can split these off and isolate them out, you can really realize the value of making them appealing to a broader swath of investors.
Lou, I want to move on and talk about these new companies piece by piece. I mentioned off the top, the first one of these companies to emerge is new Dow, trading under ticker DOW. It's actually replaced DowDuPont in the Dow Jones Industrial Average. Again, as I mentioned earlier, management is hammering the table on this as a new, streamlined company. The older Dow had 15 companies. This new business has six.
Lou, what can you tell us about what we're going to get with this new Dow company, and what investors should be thinking about it?
Whiteman: Sure. This is going to be the largest of the three siblings. About $40 billion in annual sales. Most of that is from the old Dow. They've gotten rid of some of these businesses that we'll talk about in a second. They've added maybe $5 billion worth of revenue from DuPont.
This is the old-fashioned chemicals industry. This is the raw materials, the building blocks for coatings, for industrial products, for packaging. This is in some ways a commodity play. It's not the finished products, so it can be cyclical. The good news is, it doesn't necessarily have the forward R&D that you get with a finished product business.
Dow is everywhere. These chemicals, I think seven in 10 cans of residential paint. You use this stuff all the time. These are the commodity products that go into so many of the plastic coatings of things. This is the stuff that you don't think of that you use. It's a very good business, but it is what it is. You don't necessarily innovate in the same scale that you can innovate in some of these other areas that we'll get to.
Sciple: Yeah, you're right, Lou. You mentioned, and I want to pull the thread on it, how this part of the business doesn't need as much incremental investment in R&D to develop the company. The new Dow has made a firm commitment to spend no more than depreciation and amortization over the next three years. They want to focus on cheaper products. They're really going to focus on returning capital to shareholders and not investing as much into new developments at the business. Going to realize some cost synergies.
When you look at this strategy for the new Dow, to keep as tight a lid on spending as you can and pump money back to shareholders through dividends and buybacks, what are your thoughts on that strategy as it fits into the context of the business they're going to be doing?
Whiteman: Part of this, this is the case for that original merger. Neither company was running at 100%. If you put Dow together with the DuPont assets, you have capacity to produce more product without the massive capital spending that you may normally need to expand. That's only going to last for so long, obviously. It depends on the cycle. But you can look out the next three years and say, "We have room to expand with the economy without massive capex projects." On the cost side, which you always talk about when a deal comes together, there seems to be a real potential for revenue growth, whether you call it revenue, synergies, whatever, as they use the combined capacity of the company. I think this is a pretty easy target for them to hit. I expect they should be able to run the business with growth without the capex to some extent for a while.
Sciple: Management says they're going to target 65% of net income returning to shareholders via dividends and buybacks. 45% of that being dividend, 20% at least in the near-term being buybacks. Wall Street has responded very positively to this stock. Its first day of trading, it popped 7%. It seems to be getting a lot of the love relative to the remaining parts of DowDuPont. As you look at Wall Street's initial reaction, what are your thoughts on how folks have reacted coming out of the gate?
Whiteman: For one thing, I think it's interesting to contrast that to how DowDuPont has been a real underperformer while all this was going on. I think this speaks to, again, the logic of the deal. There are different parts of the market, maybe, that'll be interested in these different companies. But there is demand for a Dow company profile type of stock without the other things. I think it speaks well to, hopefully, the bigger plan down the line.
There's a lot going on. You mentioned that Dow replace DowDuPont in the Dow index. I would think that some of what we're seeing could be noise right now, where it's just people buying in because it's part of the index, things like that. But this is a good company. Again, I do believe that for a certain profile of investment, where you're looking for this stable, predictable company, without the baggage or upside, even, of some of these other businesses, that yes, there is a demand for it. And yes, this is to the point of what they were trying to accomplish. This is our first chance to see how it may look out in the wild. And so far, so good.
Sciple: Yeah, Lou. Now, let's talk about these companies that we haven't yet seen in the wild, but that we will see in early June of this year. The first one I want to talk about is Corteva Agriscience. This is the company that's going to be produced out of the two agriculture arms brought together from Dow and DuPont when they merged. When you take a look at this company, what it's going to look like when it's put together, what should investors know about Corteva Agriscience?
Whiteman: Corteva's broken into two main areas, and they're about equal size. Part of it is seeds. Part of it as the chemicals, the nutrition, the products that help grow. This is an important business. This is an industry that was consolidating, I think you brought up a real good quote from Breen. This is a business that was consolidating. Bayer has bought Monsanto. The Chinese own a lot of assets here. The Big Six has gone to a Big Four, Big Three. Part of the DowDuPont deal was to make sure that these two businesses that, both had promised, but both were just niche players in a bigger industry that needed scale, this was a way to quickly accomplish that scale for them. That is part of a broader play. The world is growing, the world needs more food, the world is developing. There is more opportunities and markets.
There's been issues for this business short-term, which I'm sure we'll get to. But of the businesses in the DowDuPont, this is the intriguing long-term play. If you want to look at huge global macro trends, this is the company that hits on those trends. Together, with the scale they have, the resources they have, they are much better able to, hopefully, get at those trends. And either one of them would have been an afterthought -- an important afterthought, but an afterthought -- inside the portfolio of Dow and the portfolio of DuPont.
Sciple: When I was reading about this company, we mentioned earlier with the new Dow, the way they would invest the profits of the business is more to redistribute the capital back to shareholders because there's just not a lot to do from R&D, at least in the near term. Whereas when you look at this agriscience business, it seems the investment cycle, the development cycle for their new products, you're looking at five, 10 years to bring these new things to the market. When you can bring this business out on its own with that different type of investing priority, and to really focus around that business, you can really see how you can squeeze more juice out of that business, when you can make that a priority.
You did mention, there's been some near-term weighing on results. They've taken some impairment charges, had some issues with slowdowns in China as well as the tariffs, and some currency issues. This is a company that's going to be affected by macroeconomic movements when you're moving and touching the agriculture space. How should investors think about that if and when this company's on the market and it's investable, how that cycle is going to shake out? You have a long-term investment cycle for the products you're going to sell, as well as a market in agriculture that can be very susceptible to supply and demand and things like that.
Whiteman: This is the one business that can accurately blame the weather. But, you make a great point. I don't think it's something that investors necessarily think about with this business, the threat of tariffs and trade war, that whole macroeconomic picture has been a real weight on them. Soybeans are such an important product and U.S. soybeans have been one of the real victims of the tensions between the U.S. and China. That has caused a shift in production of soybeans with China looking to South America. That changes the profit. That that gets us into, you're more exposed to foreign currency. Honestly, the margins aren't quite as good all the time in emerging markets as you'd get in the U.S. So in any given quarter or year, there's a lot of risk, especially, as you say, this is a business that is going to have, for the foreseeable future, large R&D needs. You have to look at this as a long-term play. You have to judge this company based on the quality of its products, its ability to innovate over time. Any one given year if you have a poor planting season, if you have bad forex exchange, if you have, who knows how long these trade tensions will last? This is a business that will be volatile. But as long as they are on track with products that fit the needs of the customer, we can also pretty reliably say that demand for these products, the need, is not going away.
Again, you need to monitor this, not so much quarter-to-quarter. You need to try your best to ignore the quarter-to-quarter and just look at long-term. Is this a business that's doing what its customer needs better or as well as others? If it is, it should be in good shape over time.
Sciple: Yeah, Lou. I think this business is one of those, you see it with a lot of cyclical business, where you have to separate the short-term cycle from the long-term cycle. In the short term, there's going to be volatility with things like tariffs, and there's bad weather one year and another. But over the long term, as you mentioned, food needs are moving up globally and they're going to continue moving that direction over the long term. That need is going to be serviced by companies like Corteva.
Again, we don't know a ton about how their business strategy is going to shake out yet. They do have an investor day coming May 9, where we'll learn some more. Definitely an interesting company to watch. Again, like I said earlier, bringing it out on its own, maybe can allow them to prioritize their investments in a more strategic way that fits that business.
Lou, let's move on now to DuPont. This is the specialty products part of the business there. That's the part of the business that Ed Breen is coming along with to run. What should investors know about this new DuPont and what it's going to look like?
Whiteman: This is more of a finished product business. They have exposure to a lot of different industries. Nutrients, from your protein smoothies to just supplements in packaged products. Electronics, transportation, adhesives, safety, construction, imaging. This is the applied chemistry business that, again, was part of both companies, but not necessarily a dominant part of either. Again, the logic is, create a larger, better company that has more scale and more exposure to different businesses.
They're going to have some higher R&D than, say, the commodity business. They also, hopefully, are more profitable. Of the three businesses, they are by far the most profitable in terms of EBITDA margins. Margins, I think, 32% in the fourth quarter, compared to maybe 8% to 10% on the ag and mid-teens on the Dow, from memory.
There's a lot of different cyclical exposure here because they are in so many different businesses, but that also can be a plus for them because, barring a global recession, as long as there is growth somewhere, they can ride out storms. I think in the last quarter, the margins on electronics were something north of 50%, but that wasn't growing that fast, safety construction, lower margin, but it was a huge grower. This is a business that is set up, at least, to have a lot of different ways to win, and exposure to a lot of different markets. Again, it's now going to be a larger portfolio of products. You can spread the R&D over a larger base than you could either for Dow or DuPont as an independent and make a run at it that way.
Sciple: Yeah, Lou. With Ed Breen coming along, we mentioned as we prepared for this show that we could see some further splits. That's something that Breen did at Tyco -- splits, then subsequent splits thereafter. What opportunities might there be for the company to realize value there from additional splits within this new DuPont?
Whiteman: Right. And Tycho was a master ... well, involved in everything. 'Master of everything' may be too much to say. But, yeah, he actually split that business three ways, then split the part he stayed with three ways. There were all sorts of divestitures and merges from there.
I don't know if we'll see another three-way split. But, definitely, some of the activists that were involved -- Dan Loeb was involved with this. He was hoping for more of a split of DowDuPont, maybe six ways or so. A lot of that extra stuff that he saw as maybe being viable candidates on their own came from this portfolio. I think the nutrition business, I would almost bet that we'll see an IPO or split of that sometime the next couple of years. That nutrition business is sort of a stand-alone, and it's growing. It's got some of that same potential we talked about with ag.
I would be shocked if this portfolio isn't revamped over the next couple of years. Hopefully for the best. Again, at that point, you have to trust the managers. Hopefully with Breen's experience, he can do it again. But this business is, just by the nature of it, with its different areas of expertise, and there's not necessarily synergies between a nutrition add-on and the electronic displays, there's a lot of logic in trying to create more value over time by breaking this down further.
Sciple: OK, Lou, now that these new companies are coming onto the market in June, we'll have access to invest in all three new Dow spin-outs, how should investors think about investing in these companies once they come onto the market?
Whiteman: You hit the nail on the head there with 'once they come on the market.' The first advice is just to let down DowDuPont go right now. You go back a couple of years, I had no desire to own either Dow or DuPont. I had no desire to own the combination. And that worked out well. Last I checked, since the merger, they trailed the S&P 500 by almost 30%. Unless you really, really, right now, looking into that June split, want exposure to both an agtech company and special materials, maybe then you get in just so it's done. But there's really no reason to buy in now.
Once they go independent, just like with Dow, we'll see who's added to what index. I'm personally not going to rush into any of these businesses. I think anytime you have something that's complex, there's going to be a lot of volatility, there's going to be a lot of different investors either exiting positions or institutional people getting in. You're going to see housekeeping in the first couple of quarters. You can be off on earnings because the analysts are winging it more. If you're patient enough, you can get in and enjoy it if any of these businesses really appeal to you. But I see more harm in jumping than waiting. I'd like to look at these later in the year. Hopefully, by the end of the year, we'll know what we have, we'll know what the economy's like, we'll know what exposure they have. You have three large, interesting businesses with three different profiles that... you can get a much better handle for what they are and what their outlook looks like.
Sciple: Yeah, I agree with you, Lou. I think we need a couple of quarters to see how these strategies are going to play out. We're just getting the early kernels of what these businesses are going to do now that they're on their own. I'd really like to see a quarter or two of management really laying out to us what their vision is for the business and where they see their opportunities are going forward as an independent company.
As you look at three companies, as they become available on the market, which one, if any, is most interesting to you as a potential investment?
Whiteman: I've already exposed my crush on Ed Breen, [laughs] so I think that may be a hint to where I'm going. If you look at the new DuPont, the margins they're able to generate, the exposure to different businesses that hopefully can make it less cyclical, or less tied to one industry and the ups and downs of construction. I like that profile. I like that portfolio. And I really like the jockey. I did. I'm always reluctant to buy a company just on the CEO, and especially this, this is going to be a chairman now. Breen is going to be sort of just the wise man whispering over the shoulder. But I really have faith that there are things to do, and that he's the right person to extract value in that business.
Again, as you say, it's going to be later in the year because I want to see how it goes. But I'm going to be looking very closely at DuPont. I would like to own that business, I think.
Sciple: Yeah, I tend to agree with you, Lou. It's got the fatter margins, it has the management that has the track record of being successful, has the potential for additional split-offs that could create more value for us. That's the one I'm going to look at.
But I think all these, even if they're not something you want to invest in, they're going to give all investors a good look-through into how the economy is moving from a cyclical point of view, because they just touch so many parts of the global macroeconomy. These are companies I'm probably going to be paying a little bit of attention to regardless of whether I invest in them.
Lou, got any big plans for the weekend? You're down there in Atlanta. It's Masters weekend.
Whiteman: Is there a golf tournament this weekend?
Whiteman: Yeah. First of all, Jason Moser says, this is Rory McIlroy's year. I heard that on another podcast. I'm here to add value. I'm going to I'm going to add value by just saying you should listen to Jason. But yeah, this is a very big deal around here. There's a lot of worrying. We could have some real bad storms on Sunday coming through. It may make for great TV. We'll see how the tournament goes this year.
Sciple: [laughs] I see you're way out on a limb there, picking Rory there, Lou.
Whiteman: That's Jason! That way I have plausible deniability if it doesn't go well.
Sciple: [laughs] You know, I'm going to be out there rooting for Tiger. I think the story would be great for him to finally get that last major. The end of last year, he finished strong. I'd like to see him come out. But Rory's a good pick. We'll see. Hopefully we don't get too bad of storms on Sunday. If not, worst case scenario, we get golf in the office on Monday. You have to look for the silver lining.
Lou, thanks so much for coming on the show! Always enjoy having you on!
Whiteman: Thanks, Nick!
Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass. For Lou Whiteman, I'm Nick Sciple. Thanks for listening and Fool on!