JUN 24, 2015 @ 12:11 PM
Investors are taking a decidedly skeptical approach to DuPont’s spinoff of its performance chemicals division, Chemours, a key piece in CEO Ellen Kullman’s strategy to re-position the Dow Industrial giant away from cyclical earnings and into businesses like agriculture and nutrition, advanced materials, and industrial biosciences with stable growth prospects.
Since Chemours shares began trading on the New York Stock Exchange on a ‘when issued’ basis on Friday, they’ve fallen nearly 18%. That drop has cut into DuPont’s stock, which is off nearly 4% since Thursday’s close. DuPont investors are poised to receive one Chemours share for every five of their shares in the parent, as of June 23. Chemours will begin regular trading on the NYSE under ticker ‘CC’ on July 1.
Investor skepticism about Chemours is somewhat expected.
The company is heavily exposed to volatile Ti02 markets and it carries both a high amount of leverage, and expectations of large quarterly dividend payments that could be hard to fund with operating cash flows if commodity markets remain depressed. DuPont saddled Chemours with roughly $4 billion in debt, and said it would maintain the total size of its dividend, putting the spinco on the hook for roughly $100 million in quarterly dividend payments.
Those balance sheet constraints wouldn’t have been a problem for Chemours in 2011 when the division earned $2 billion in pre-tax operating income. But a downturn in Ti02 pricing amid a supply glut has meant earnings at the division are down over 75% from peak levels. In the first quarter, DuPont’s now re-named Chemours unit earned just $129 million in operating earnings, a 37% year-over-year drop. Analysts believe Chemours may have to revisit the size of its dividend payments in the first few quarters after its DuPont spin.
“[The] first few Board Meetings will likely debate heavily about cutting the dividend to more normalized levels (post the already declared July payout) so that they can have a more balanced approach to debt reduction and dividends,” Credit Suisse analyst John McNulty, wrote in a Monday note. He believes that at current earnings levels, Chemours will struggle to generate half the cash it needs to meet dividend expectations.
Chemours is also saddled with large legal liabilities, mainly from production of fluoropolymer products such as Teflon, which faces suits and environmental fines of $295 million in remediation accrual, according to Credit Suisse, with the prospect those environmental liabilities rise by more than double.
The prospect of further downside to Ti02 markets this summer means support for Chemours shares could well fall to the low-teens, according to Jefferies analyst Laurence Alexander. That would be a far cry from the $21 a share initial trading price of ‘when issued’ Chemours shares on June 19, which valued the company’s equity at nearly $4 billion.
But, there’s also reason for DuPont shareholders receiving Chemours shares on July 1 to take a longer-term view.
Chemours, like the rest of DuPont, is in the grip of a major restructuring that’s aimed at finding operating cost efficiencies and ways to thin layers of upper management. Since the division will now stand on its own, those expense savings could actually drive the stock.
Jefferies’ Alexander believes Chemours management can begin delivering on $80 million in planned run rate savings, as early as the third quarter. Capital needs and supply/demand balances in key markets may also soon turn from a drag on earnings —something that weighed heavily on DuPont during its fight against activist fund Trian Partners — are into a tailwind starting in 2016.
Currently, Chemours is spending heavily to build out its $600 million Altamire site in Mexico, which will expand its Ti02 capacity and help bolster earnings over the long term. Eighty five percent of the project will be complete by the end of 2015, giving Chemours the ability to pare back annual capex to between $300 million and $350 million. Altamira is expected to generate as much as $70 million in cost benefits, leading to earnings growth. That coupled with reduced capex could help the company begin repaying debt, according to Credit Suisse’s McNulty.
The upside case for Chemours beyond cost cuts and a better scale of production rests on a recovery to Ti02 markets. DuPont, after all, didn’t try to spin the business at a cyclical high.
That could be achieved by stronger supply and demand dynamics in the event global economic growth begins to pick up, or it could be driven by consolidation in the chemicals industry. In 2013, Huntsman HUN -0.53% acquired Rockwood, and this year Asian producers Henan Billions and Lomon announced a merger. Both deals could give producers a better ability to control pricing, positively benefiting Chemours.
DuPont investors are probably most interested in seeing how CEO Ellen Kullman’s re-organization of the company begins taking shape in the second half of 2015. The cold reception Chemours shares have received since being spun, perhaps, is indicative of just how much of a drag the business was on DuPont over the past 24-months.
Nonetheless, the spun off division could eventually prove enticing, either for value seeking investors later this year, or long term DuPont holders.
Jefferies’ Alexander expects Chemours to earn $6.1 billion in revenue, $924 in EBITDA and $1.55 in earnings per share by 2017, and puts an optimistic $24-a-share price target on the business. Were cost cutting, consolidation and a cyclical upturn to all play to Chemours’ favor, Alexander believes the company could earn as much as $5 in peak EPS, pushing its stock price north of $50 by the end of the decade.