One of the more popular tools of activist investors these days — aside from turning everything into an MLP or REIT — has been forcing targeted firms to spin off “less than ideal” businesses as separate standalone companies.
Case in point: venerable chemicals giant E. I. du Pont de Nemours and Company (DD), or DuPont, as it’s more commonly known.
DuPont has been the target of several activist investors led by Trian Fund Management. The culmination of Trian’s efforts has been to force DuPont into solely focusing on faster-growing specialty chemicals businesses while shedding some of the commodity/basic chemicals assets it owns.
The spinoff of these assets — now known as Chemours (CC) — will officially start trading as a detached firm on July 1, but so far, CC’s “when issued” shares have been a real dog.
The question for investors: Is it worth snagging or holding CC stock in the wake of the spinoff?
High Yield With a BIG Asterisk
Over the past 10 years or so, DD has spent much of its time pursuing growth avenues, specifically in the agricultural, health and nutrition, and industrial biosciences businesses. These areas have much higher revenue potential as well as growth prospects.
As such, DuPont has begun shedding much of older and more boring assets. It already had sold its paints and coatings division, and with some activist prodding, its commodity chemicals business is off to the races.
Chemours will hold DuPont’s titanium dioxide (TiO2) and fluorochemicals divisions. TiO2 is used in a variety of products, from paint pigments to potato-chip bag coatings. It’s about as much of a commodity as a chemical can get, and CC will be the world’s leading producer of it. Meanwhile fluorochemicals include a whole host of products used as lubricants, resins, refrigerants and Julia Child’s favorite non-stick pan coating, Teflon.
All in all, Chemours has the makings of a really boring company. So, why has CC stock already been so volatile?
It all has to do with pricing, debt and cash flows.
The cool thing about advanced bioscience and crop nutrition chemicals is you can charge pretty much whatever you want. Unfortunately for Chemours, the TiO2 markets are very volatile, and pricing varies wildly as demand ebbs and flows. Right now, there’s a huge supply glut of TiO2 — bad news for the Chemours division’s earnings.
Also, DuPont is chucking about $4 billion in debt onto Chemours books, so CC stock will be highly leveraged the second it hits the markets as a standalone company. And a falling price environment for your major product doesn’t exactly help out the cash flows you need to pay down debt.
That brings us to another issue — Chemours’ massive initial dividend.
DuPont (through Chemours’ management) has agreed to pay an initial quarterly dividend of $100 million in September. That works out to be 55 cents per share, or $2.19 annually — which would give CC stock an initial yield of more than 14%! For comparison’s sake, Chemours’ closest publicly traded TiO2 competitor, Tronox (TROX) yields “only” 6.6%.
However, based on lower TiO2 pricing, a multitude of analysts have suggested that CC won’t have the kind of free cash flows to pay that dividend. Chemours will either have to cut it or borrow more debt to pay it.
And if that wasn’t enough, Chemours will saddled with some hefty legal liabilities.
Chemours will now be on the hook for environmental fines due to the production of fluoropolymer products like previously mentioned Teflon. According to documents filed with the SEC, Chemours is facing 2,400 asbestos-related lawsuits as well as 3,500 Ohio and West Virginia lawsuits stemming from perfluorooctanoic acids-related diseases. Also, via the Philadelphia Inquirer:
“Chemours has also identified $274 million in estimated pollution-control expenses under the federal Superfund program at some of the DuPont sites it is taking over.”
Ironically, legal and environmental fees caused competitor Tronox to file for bankruptcy in 2009, a few years after it was spun off from Kerr-McGee.
But Maybe CC Will Have Some Value
While CC stock might be a lousy bet in the short-term, it might be worth putting Chemours on your watch list for later on.
Analysts at Jefferies estimate that by the end of July, index funds should be done selling about 20% of all the CC shares outstanding, which will drive shares down. We also should get a decision on Chemours’ lofty dividend — JPMorgan, for instance, thinks we’ll see just 55 cents per year.
That should provide enough downward pressure to make CC stock worth thinking about.
While it is a commodity chemical, Chemours is the largest producer of TiO2 and sector is consolidating. Last year, Huntsman (HUN) purchased Rockwood’s TiO2 businesses for $1.1 billion. Fewer players means more pricing power. And while TiO2 is currently in a depressed market, trends still point upward for pricing.
Indeed, Jefferies believes CC stock should double in the next four to five years, and eventually support a dividend of $1.20 annually.
CC stock is going to be a volatile train wreck for a few quarters until it can get its act together as TiO2 pricing remains weak. However, for longer termed investors, that could provide a buying opportunity for one of the strongest players in the sector. Chemours deserves to be on your watch list, just don’t pull the trigger yet.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
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