Why I'm selling DuPont

The company is the world's largest producer of titanium dioxide, but is seeing a huge increase in raw materials costs.

By Jim J. Jubak Feb 23, 2012 2:07PM
I said in my Feb. 21 post that for the first half of the year, earnings growth would come under pressure as companies find that, while the cost of raw materials rises, demand isn't strong enough to pass those increases to customers. Keep an eye out for companies facing that problem, I advised, and when you find one in your portfolio, sell it.

Which is why I'm selling DuPont (DD) out of my 12-18 month Jubak’s Picks portfolio Thursday.  (I still like the longer-term picture for DuPont, so I'm keeping it in my Jubak Picks 50 portfolio -- especially since the rules of that portfolio only allow selling once a year in January.)

There are lots and lots of reasons to like DuPont for the long term -- its seed business and its enzyme business to name just two sources of long-term growth. And with natural gas, a major feedstock for many chemicals, stuck in a very long-lasting slump, DuPont doesn't face rising raw materials costs for many of its products.

Except for titanium dioxide. And that's a huge problem.

DuPont is the world's biggest producer of titanium dioxide, the white pigment crucial to making paint in all colors. DuPont's performance chemicals segment makes up 20% of the company's sales and titanium dioxide accounts for 44% of that. The long-term prospects for sales of titanium dioxide are great since as incomes rise in developing economies, those countries use more paint. Currently, for example, China uses less than one kilogram of titanium dioxide per capita compared to four kilograms in developed economies.

The problem is that the world is experiencing a bit of a titanium dioxide squeeze because the supply of mineral sands with high concentrations of titanium dioxide, such as rutile and ilmenite, hasn't kept up with supply. In 2011, the cost of rutile climbed 77% while the price of titanium dioxide climbed just 38%.

Can you say margin squeeze?

In its long-term guidance for Wall Street analysts in December, DuPont said that margins for the performance chemical unit would come in at 24% for 2011 as a whole, but projected a drop to 18% to 20% in 2012 and after.

It didn't trouble me greatly when DuPont gave that guidance in December because the stock was still relatively cheap then. But DuPont's shares have climbed 13.6% in 2012 through Feb. 21, and that means the margin squeeze in titanium dioxide matters more.

What else has changed since I last updated this stock on January 30?

I've learned more about the mineral sands mining industry. Not only is there a current lack of rutile and other mineral sands with big concentrations of titanium dioxide ore, but also there aren't many mining companies with plans far enough along to add to supply soon. For example, Rio Tinto (RIO), which mines about 25% of the world’s ilmenite, will spend $60 million to study expanding mines in South Africa, Canada, Madagascar, and Mozambique. If the study plays out, the company would be able to add new supply in 2017.

Just about the only mineral sands miner with new capacity coming on line now is Kenmare, an Irish company that trades in London. As you might imagine under this kind of tight supply scenario, shares of Kenmare have been the subject of endless acquisition rumors. The most recent is a rumor of what looks like an unlikely acquisition by Rio Tinto. The combination would put together so much of the world's supply of titanium dioxide minerals that, the skeptics say, the deal wouldn’t pass anti-trust muster. That skepticism hasn’t stopped shares of Kenmare from climbing 87.5% from Nov. 22 through Feb. 22.

With the tight supply and rising cost of titanium dioxide raw materials likely to persist for quite some time, and with DuPont customers pushing back on titanium dioxide prices, I'd like more than the 13% potential gain I forecast for DuPont's share price in 2012. (DuPont also makes auto paint, but that business is much smaller -- 12% of sales versus 20% for performance chemicals -- and much, much less profitable, with 5% of pretax operating income versus 22%. Titanium dioxide is the big dog here.)

The risk/reward ratio just isn’t all that attractive right now (even with the stock’s 3.2% dividend yield -- by the way the record date for the next dividend payment was Feb. 15), so I'd take profits here from this rally. I'm selling Thursday with a 7.8% gain since I added the stock to Jubak's Picks on Nov. 2, 2011.

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. The fund did own shares of DuPont as of the end of December. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here. 
Feb 23, 2012 7:51PM
I think most large companies will be either selling or down sizing, the price increases can't be sustained by today's consumers, they will need to pinch pennies and anything they can do without they will, and the things they really need will be cut back till the economy shows a strong turn around, the gas companies are pushing the consumers because of the pipeline they want to build but honestly that wont do a damn thing for the people of America, and unless the people of America has something to gain why should we be put at risk .........
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