Is a Low-Fiber Dupont More Appetizing?

Most everyone knows DuPont for its familiar synthetics -- Lycra and other fibers that have become ubiquitous in carpets and clothes. Soon, though, DuPont will be out of those lines. Its Textiles & Interiors segment brings in more revenue than any other, but DuPont disclosed in August that it hopes to sell T&I to privately-held conglomerate Koch Industries.

For DuPont, this is good news, and the reason why is no mystery. T&I has delivered far less profit than the 201-year-old giant's other businesses. The puzzle for investors now is whether the stock, which has climbed $10 since March, to 45, on hopes for an economic recovery, already reflects potential for better profitability. My bet is it does. If I'm right, I'll take no glee in it. Long-term investors have already suffered plenty, with the stock topping out in 1998 above $84. Just the same, if you take management at its word and look soberly at DuPont's remaining lines, you'll find small reason to view the stock as an odds-on market-beater.

Naturally, DuPont has its bright spots. While it's keeping mum about how much it might get for the T&I segment, I estimate it may bring $5 billion or more. That would strengthen DuPont's already strong balance sheet and enable a larger stock buyback program. Moreover, from the company's 80-some business units, hot products pop up all the time. Today, these include the critical membrane it makes for hydrogen fuel cells, a new insulating label for soft-drink containers called Cool2Go, and energy-saving organic light-emitting diode (OLED) displays. One of these just reaching consumers can be seen in APED, Evolution Technologies' $280 MP3 player.

Yet DuPont's future remains anchored to some mature, cyclical businesses. Even as it shrinks its exposure to the textile and carpet industries, DuPont's reliance on sales of paints, plastic parts, and more for autos will rise. Ditto its big position in construction materials and in the agricultural seed and chemical markets. Farm products hold the potential for much bigger sales if bioengineered foods overcome the resistance of many consumers. But such a great leap forward remains over the horizon.

DuPont's stated goals are, in fact, notably modest: annual revenue growth of 5% to 6% and earnings-per-share growth averaging 10%. It reckons that per-share profits can grow faster than sales through productivity gains, by selling enough new products each year that average prices and margins rise, and by using surplus cash to buy back shares. If DuPont hits these targets, what might an investor expect, say, in the next three years? DuPont pays dividends of $1.40 a year, good for a fat yield of 3.1%. A spokeswoman told me that despite this year's reduction in taxes on dividends, no hike in DuPont's payout is likely soon. So assume that three years of dividends will come to $4.20.

Next, note that Wall Street's forecast of DuPont's 2003 earnings is $1.80 a share. Because T&I is on track to contribute little to this year's earnings, $1.80 a share is a reasonable base for forecasts of DuPont's earnings in the future, when the segment is out of the mix. Let's just say DuPont piles up 10% growth in profit each year. Then by 2006, it would be earning $2.40 a share. Today, DuPont trades at 25 times 2003 earnings -- or 2.5 times its long-term growth rate. If the stock were still to command this premium multiple in 2006, the shares would go for $60. With dividends, this works out to a total return of more than $19 on a $45 stock.

What's wrong with that? Nothing, but it assumes that management makes good on its promises and that the stock keeps trading at a premium multiple. Dial back the earnings multiple to a more middling 20, and the 2006 profit makes for a $48 stock and, with dividends, a three-year total return of just 16%. DuPont's good news is already in the stock.

By Robert Barker

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