Tuesday, August 28, 2007

The Right Chemistry

It has been a long time in coming but in June 2007 DuPont Company (DD: NYSE) and its partner, Tate & Lyle, pl (TATE: London), finally started shipping a new corn-based polymer from a plant in Tennessee. DuPont distills its modified e.coli bacteria with Tate & Lyle’s corn sugar. The result is “bio-propanediol” that can replace petroleum-based ingredients in cosmetics, detergents, ski boots and carpet.

A DuPont spokesman says the propanediol accomplishment is as significant as his company’s invention of nylon back in 1935. DuPont calls it Bio-PDO and says it is even better than petroleum-based chemicals. Others call it Liquid Diamonds because the final product is a crystal clear liquid. It takes dyes better and resists stains. Even more importantly it is 100% biodegradable and takes 40% less energy to produce.

Before you start calculating saved kilowatts or the reduction in landfill use, there is one more hurdle - cost. DuPont’s Bio-PDO is priced near nylon, an accomplishment afforded by energy efficiencies in the distillation process compared to using petroleum feedstock. However, price pressure on agriculture products like corn presents cost risk for DuPont and its partner.

Corn prices probably do not have DuPont too worried. The company has a natural hedge, since DuPont has an invested interest in corn through its Pioneer brand of corn seed. DuPont scientists are working on increasing yields and the company expects to sell more seeds in coming years.

Business risks aside, it appears the Bio-PDO product has the potential for long-term use…just like nylon. The American Chemical Society thinks it is a big deal also because it is the first fully biodegradable synthetic. The Society awarded the scientists involved in the development of Bio-PDO their
2007 Heroes of Chemistry award.

That makes DD shares look quite interesting at a PE of 13.9 times. Granted the PEGY ratio (price earnings ratio to growth plus dividend yield) is 1.60. However, return on equity just over 30% helps justify a premium price. Investors with long-term investment horizons could also benefit from DuPont’s $5 billion share repurchase plan, although there is only $1.1 billion (approximately 22 million shares or 2.4% of outstanding shares) remaining on the current authorization.

DD shares are trading 11% off the 52-week high and appear to have lost some momentum in recent trading sessions. The consensus recommendation for DD shares is Hold with an average price target of $53.70. The stock recently bounced off an apparent support level at $46.00 and may test that level again in the coming weeks.

There may also be a level of support at $40.00. However, it might take the injection of a negative development to press the stock down to that very compelling price level. At the June 2007 quarter, DuPont missed the consensus earnings estimate for the first time in a year. Analysts held estimates steady following the June quarter release, suggesting some confidence the DuPont’s chemistry will be right in September.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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