DuPont may have won the battle, albeit by a small margin, but in our view it is still very much in danger of losing the war. Beating Trian in the recent proxy fight may be a cause for celebration in the DuPont board room, but if the board does not address a couple of key issues raised by Trian, it may be the last celebration for a while. DuPont’s complexity is hindering the company and is likely causing excessive optimism, resulting in misplaced allocation of capital and broad underperformance both on the earnings front and from a total shareholder return perspective. Broadly, complex companies fail to achieve meaningfully lower earnings or return on capital volatility, but they do a fairly good job of underperforming their less complex peers, as shown in the chart below.
DuPont has to address two issues that, in our view, arise from complexity, and impact many other companies as well as DuPont; an inflated cost structure, and undervalued specialty businesses. The cost issues, again in our view, stem from the difficulty of trying to pursue a growth strategy and a low cost strategy under one roof. More commodity focused competitors push the low cost agenda and drive down the cost curve – this has happened to DuPont in TiO2 and to Dow in ethylene and polyethylene and we can come up with countless other examples. The erosion of these cost curves and many others have drowned any R&D/”growth initiative” driven gains.
The undervalued specialty business problem is currently acute for DuPont and possibly Dow, as we may be seeing the beginnings of a game of musical chairs in the Ag chemicals space. Neither DuPont nor Dow can compete in the bidding for Syngenta because their multiples are too low because of the diversity of the portfolios and the additional complexity stock multiple penalties they have been given. An attempt to buy Syngenta from DuPont today would be a highly dilutive move for shareholders – had DuPont management listened to Trian on day 1, DuPont “Growth Co” would be an independent company today and a much better suitor for Syngenta than Monsanto.
If DuPont returns to business as usual and pays no heed to the advice offered by Trian, we fear that it will be a case of more of the same – poorly thought through investment, both R&D and M&A, leading to more earnings disappointments. It this scenario there is no reason to own the stock today as it is already expensive on a “business as usual basis”. Our positive stance on DD relies on the board and management making some major changes to the cost base and major changes to focus, resulting in a more appropriate strategic path or strategic paths.