Is DuPont focusing too much on agriculture? Image source: Getty Images.
Continue Reading Below
Chemical giant DuPont (NYSE: DD) is optimistic about the future these days. True, its merger with fellow chemical titan Dow Chemical (NYSE: DOW) is still under regulatory review, but the company is expressing confidence that it will be approved by the end of the year.
In the meantime, though, DuPont still has a business to run...or rather, multiple businesses. However, it seems like its agriculture unit is getting the lion's share of the company's resources.Here's how that could be bad for DuPont investors -- and great for investors in rival 3M (NYSE: MMM).
The seeds of discord
For much of its lifetime, DuPont was strictly a materials-science company. The brand-name substances its labs created became household names all over the globe: products like nylon, Teflon, and Kevlar.
However, in recent years the company has been branching out into more lucrative sectors like nutrition and agriculture. It spun off many of its materials businesses -- including Teflon -- into a new company, Chemours (NYSE: CC), last year.
Now, the company plans to merge with Dow and then split into three separate companies. One will focus on agrochemicals, one on performance chemicals, and one on materials science. In an ideal world, DuPont would work to ensure the continued success of each of the three companies after the split. Recently, however, there have been troubling signs that the company may be focusing primarily on its agrochemical research and development while its other businesses fall by the wayside.
Growing the business
Healthy R&D spending is essential for any manufacturer, but particularly for a chemical company. And DuPont, even up until last year, was the gold standard, spending a higher percentage of its revenue on R&D than its competitors:
Data source: Company 10-Ks.
However, in the first half of 2016, DuPont cut its R&D spending to $850 million, from $975 million in 2015. CEO Edward Breen indicated in the second-quarter earnings call that it was likely to stay that way: "We're running around $1.7 billion in total spend, and that feels about appropriate."
With the company's guidance suggesting comparable sales to last year, that would equate to about 6.8% of revenue: still higher than its peers' 2015 percentages, but down historically. And once the company merges with Dow, even if the merged companies don't cut their combined R&D spending, the overall percentage will be even lower due to Dow's lower R&D expenditures. That should concern long-term investors.
You reap what you sow
Statements by the company seem to indicate that in addition to spending less on R&D overall, DuPont plans to concentrate its R&D spending on its agriculture business. In the Q2 earnings call, Breen had this to say about R&D and growth:
Zorvec, Leptra, and CRISPR-Cas genes are all agricultural products. Breen also references "increasing capacity" for existing materials like Tyvek and medical wrap, but not any R&D investment in those areas.
Lest you think that this was just an oversight on Breen's part, later in the call, he was asked specifically about the reduced overall R&D spending and replied (emphasis mine):
These statements, coupled with recent reports of layoffs and project cancellations at DuPont's materials-science research lab, paint a picture of a company focused on agricultural R&D to the exclusion of other areas.
If true, this would be fantastic for DuPont's major materials-science rival, 3M. Its total annual R&D spending would be larger than DuPont's, in numeric terms -- but since 3M isn't involved in agriculture or nutrition, it could also devote more money to developing materials. With labs in 36 countries, including a state-of-the-art research lab opened in Minnesota just last year, 3M employs 8,300 researchers worldwide.
When one of your main rivals starts spending less than you on R&D, and focuses its remaining R&D efforts on areas where you don't compete, that's a very positive development for you. Investors in 3M should be cheered by this news.
DuPont investors, on the other hand, have good reason to be concerned. If DuPont's merger-and-split with Dow goes as planned, DuPont investors will be holding shares in three separate companies, only one of which involves agriculture. It would be smart to keep an eye on details of DuPont's R&D spending in the coming quarters. If this trend continues to worsen, the long-term thesis for the company could change...and not for the better.
A secret billion-dollar stock opportunity The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in-the-know investors! To be one of them, just click here.
John Bromels has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.