Why Jefferies Upgraded Dow Chemical, DuPont to Buy

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Late last month the news that the European Union (EU) was prepared to approve the $60 billion merger between Dow Chemical Co. (NYSE: DOW) and E.I. du Pont de Nemours and Co. (NYSE: DD) sent shares of both stocks soaring. The deal is on track to be approved this month, but other approvals remain outstanding, including approval from the United States.

Analysts at Jefferies now believe the merger has a 90% chance of concluding and has raised its ratings on both stocks to Buy with a price target of $75 a share on Dow and $96 a share on DuPont. The analysts now believe that Dow-DuPont “will have an opportunity to show how scale creates optionality.”

Jefferies said that its base forecast for Dow-DuPont calls for earnings per share (EPS) growth of 19% through 2020 with 40% coming from cost synergies, 25% from leveraging new investments in the U.S. Gulf Coast region, 15% from the ramp-up of Sadara, 10% from the agricultural cycle and 10% from share buybacks. Sadara is a joint chemicals manufacturing project between Dow and Saudi Aramco located in Saudi Arabia.

The analysts note five levers the merged company may apply that are “nebulous now” but that may coalesce in the three-year period beginning next year:

  • Improving competitor discipline in China due to more stringent regulations, credit conditions and return targets
  • More room to upgrade olefin mix
  • Better application of analytics to reduce slippage, improve commodity margins with lower volatility and greater back-office simplification
  • Clarity on free cash flow leverage and portfolio strategy to widen the investor base
  • Resolution of expected cultural differences between the two companies that would help reduce the risk premium included in the share price

Jefferies did not change its EPS estimates for either Dow or DuPont, sticking with 2017 estimates of $4.00 and $3.90 per share, respectively. For 2018, the estimates call for Dow to post EPS of $4.05 and DuPont to post EPS of $4.25.

Dow’s stock traded up about 0.6% early Monday morning, at $63.62 in a 52-week range of $47.51 to $64.36. The consensus 12-month price target on the stock is $67.76.

DuPont traded up about 0.5%, at $79.97 in a 52-week range of $61.12 to $80.66. The consensus 12-month target on the stock is $84.00.

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