Last week marked the one-year anniversary of the long-anticipated breakup of the world's largest chemical conglomerate, DowDuPont. Executed in the hope that each of the three new businesses -- DuPont (NYSE:DD) Dow (NYSE:DOW) and Corteva (NYSE:CTVA) -- would operate more efficiently by themselves, the break-off couldn't have come at a worse time.
Given DuPont's 50% year-to-date (YTD) decline, it's a good time to gauge whether DuPont is a buy or if its headwinds are too severe to look past.
Although the DowDuPont breakup is probably for the best over the long run, its timing only complicates the many issues DuPont is facing unrelated to its structure.
Falling commodity prices, from oil and natural gas to more impactful commodities to DuPont's business like nylon, severely impact DuPont's earnings. Before the widespread outbreak of the novel coronavirus, DuPont had already anticipated a slow start to 2020. Headwinds in nylon were expected to reduce the company's 2020 earnings by $0.23 per share. That blow is significant when you factor in another $0.28 per share reduction from other discrete items, such as the costly and ongoing dispute over environmental issues that DuPont is handling with Chemours (NYSE:CC)
DuPont is entering a challenging 2020 on the backs of a difficult 2019. To put it plainly, "the past year was a challenge given macro conditions negatively impacting about 40% of our portfolio, which led to weaker results versus our expectations going into the year," said DuPont CEO Marc Doyle during the company's fourth-quarter 2019 conference call.
Even worse 2020
As one of the oldest industrial conglomerates with a rich legacy that helped define the industrialization of the 20th century, DuPont is no stranger to market cycles. But what DuPont is a stranger to is the combination of lower commodity prices, a structural turnaround with synergies that are expected to take the entire year to payout, production constraints from COVID-19, and a massive drop in discretionary spending throughout the global economy. DuPont's business is exposed to the transportation and industrial sectors, slowing auto sales, lower home builds, and several of the many side effects of a slowing economy.
DuPont's forecast for 2020 was bleak even before the onset of COVID-19. Challenges with commodity prices and other items counteract all of the organic growth, efficiencies, divestments, and cost actions that DuPont was expecting in 2020. When the dust settles, DuPont was forecasting $3.70 to $3.90 earnings per share (EPS) in 2020, which represents no growth compared to $3.80 of actual EPS in 2019.
The coronavirus's severity is painfully apparent in the way it has altered all of our daily lives. One can only imagine how much it's going to hurt a company like DuPont, which was already dealing with a lot of problems before the coronavirus even began. One of the few positives for DuPont had been its strong free cash flow (FCF). DuPont reported more than 100% FCF conversion for the third and fourth quarters of 2019 and expects greater than 90% FCF conversion for 2020. FCF conversion is a percentage expressed as FCF over net income. It's essentially how much of a company's net income could be converted into valuable FCF that can be used to pay down debt and grow dividend distributions, among other things.
The problem is that DuPont's FCF is inconsistent, sometimes exceeding and sometimes well under dividend obligations. Assuming that DuPont's free cash flow will be weaker this year than last, it's likely the company's dividend will be strained. Pair the hit to FCF with the company's $18 billion in debt, and DuPont is likely to have another rough year.
In many ways, DuPont's timing, more than its strategy or efficiency as a business, is what's hurting it in 2019 and 2020. The decision to spin off from DowDuPont added unnecessary headache to DuPont in the midst of falling commodity prices. Now, with production likely to slow and discretionary spending falling by the wayside, DuPont's organic growth and cash flow improvements from 2019 can do little to protect the company from a hard 2020. Even though DuPont's stock has taken a beating, the risk-reward just isn't there right now, especially when you consider its dividend could be in jeopardy if the global economy faces a prolonged slide.