Buy DuPont as Dow combination to create high-growth chemical giant, Nomura says

Published Wed, Oct 19 201610:34 AM EDT

Nomura initiated coverage of DuPont with a buy rating on Wednesday, citing strong earnings potential from the proposed combination with Dow Chemical . "We expect the DuPont-Dow merger to generate above-trend growth in earnings and FCF [free cash flow] for the next three years — exceptional in a macro environment where growth is scarce," wrote equity analyst Aleksey Yefremov in a research note. In December, DuPont and Dow Chemical announced a proposed all-stock merger of equals, which is expected to close before the end of the year. "Even as a stand-alone company, DuPont is attractive investment opportunity, we believe," said Yefremov. Here are the catalysts that could take the stock to new highs, according to the investment research firm: 1. Significant cost savings from the synergy Management at both Dow and DuPont predicts up to $4 billion in potential savings from the synergy. That figure amounts to about 27 percent of the combined earnings before interest, taxes, depreciation and amortization (EBITDA) expected in 2016, according to Yefremov. "The merger of Dow and DuPont will create the world's largest chemical company by sales, with $74bn of sales expected in 2016. We believe the $3bn cost synergy target from the merger is broadly achievable through 2019, with potential for incremental upside hinging on successful execution," he wrote. 2. Value creation through business sales and spinoffs Apart from reducing costs, Yefremov explains that management's intention to separate three of a combined Dow-DuPont's businesses into individual companies would generate value. "We expect spinoffs and asset sales to reduce the historical conglomerate discount and the valuation for separated businesses to rise. Ultimately, we see DD compounding equity value at a 16 percent CAGR [compound annual growth rate] in 2017-2019, offering approximately 45 percent total upside from the current price before dividends," the analyst forecasts. 3. Earnings power Yefremov believes that if the merger is completed, the potential for earnings growth significantly increases, a trend that's "impressive in a low-growth world." "Over the course of 2016 to 2019, DowDuPont EBITDA will grow at a 13.8 percent CAGR, with free cash flow growing at 33 percent, we estimate. Synergies totaling $3.5bn will be the primary drivers of earnings growth, as both Dow and DuPont are merged, translating to 50 percent of EBITDA growth during this period," he predicted. The analyst thinks the "above-trend growth" is not currently reflected in Dow-DuPont valuations. In the next 12 months, Nomura predicts shares of DuPont could trade as high as $78, implying a gain of 12 percent from Tuesday's close. Earlier this month, analysts at Citi also advised clients to buy both chemical stocks. PRO members can read that story here .

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Nomura initiated coverage of DuPont with a buy rating on Wednesday, citing strong earnings potential from the proposed combination with Dow Chemical.

"We expect the DuPont-Dow merger to generate above-trend growth in earnings and FCF [free cash flow] for the next three years — exceptional in a macro environment where growth is scarce," wrote equity analyst Aleksey Yefremov in a research note.

In December, DuPont and Dow Chemical announced a proposed all-stock merger of equals, which is expected to close before the end of the year.

"Even as a stand-alone company, DuPont is attractive investment opportunity, we believe," said Yefremov.

Here are the catalysts that could take the stock to new highs, according to the investment research firm: