Wall Street has been fascinated by the emergence of generative AI for almost two years. But as DuPont prepares to split into three separate companies, one of the company's surprisingly fascinating businesses has to do with something we could never have done without: water. In late May, the chemical and materials maker announced plans to split into three publicly traded companies: a water business, an electronics-focused company that would benefit from AI, and a new DuPont serving the healthcare, mobility, construction markets, and more. DuPont's ability to benefit from the introduction of artificial intelligence was what attracted us to the stock a year ago. But since the split was made public, the company's water division, which sells filtration and purification products, has attracted extraordinary interest. “I believe this water company will be acquired at a much higher price than it is currently valued at within the diversified DuPont,” Jim Cramer said last week, reacting to Club Holdings' better-than-expected earnings report. “When this is over, a $35 billion company (DuPont) could be worth $50 billion.” But for now, DuPont’s market value and stock price are essentially the same as they were when the separation process publicly began. This is not at all surprising, given the 18-24 month timeline, given that some investors would only become interested once a resolution was near. Still, at this point, Wall Street is not valuing DuPont enough. Our combined analysis after the separation was announced put DuPont’s stock price at $100. This is an intentionally conservative projection for the company’s stock, which currently trades at about $78 per share. If DuPont were to abandon its conglomerate structure, the individual business segments would almost certainly command higher valuations as standalone companies. Or, perhaps, they would become acquisition targets from rivals. Both options are being considered, with the water business in particular reportedly attracting interest from industry peers. DuPont CEO Lori Koch said she has not yet discussed an outright sale of the water business, but the reason this business is attracting so much attention is simple: it’s a really good business in an industry that is increasingly attracting investor attention. In fact, the business stands out as a “crown jewel” among DuPont's entire business line thanks to its organic growth prospects, KeyBanc analyst Alexei Yefremov said in a recent CNBC interview. Analyst growth forecasts are currently in the mid-single digits, but could accelerate to the high single digits over the long term, he said. Our focus on DuPont's water business, in a way, shows exactly why the company wants to spin it out. Hidden among the larger companies, the business is just a small slice of the pie. As it stands, investors wanting access to the water theme, which is increasingly seen as a promising opportunity on Wall Street, may not turn to DuPont for that exposure. Why own DuPont today when you can own water companies Xylem and Ecolab? Why own DuPont, which also sells Great Stuff foam insulation, when you can own Veralto and Pentair? It's not that DuPont's other divisions are undesirable. Its electronics business, for example, is growing due to surging demand for AI chips. Some investors are specialists and just look for more narrowly focused opportunities. In its current form, DuPont is so diversified that its water business may never truly stand out and be fairly valued. That disconnect is why a split could be so beneficial for shareholders. Water matters Growing concerns about water quality around the world, increased regulation and an overall rise in sustainability have elevated water’s status as an investment opportunity. Products that make water safe to use and consume – products that DuPont offers – are key to economic growth. JP Morgan estimates that the economic value of freshwater for homes, agriculture and industry is close to $60 trillion. But billions of people around the world live in water-scarce areas. And the World Bank estimates that water-related losses could stifle economic growth in some parts of the world for decades to come. “Given the current water crisis, investments in water solutions are urgently needed,” Barclays analysts wrote in an April research note. “The economic benefits of addressing water scarcity and water quality issues are underestimated and could have implications at both the macro and company levels,” the analyst argued. DuPont's water business fits that bill. Some analysts see the division offering a triple threat that sets it apart from its peers. They tout the unit's technology leadership, brand strength and track record of innovation as attractive qualities to drive growth as a standalone company. Indeed, DuPont's water business has been caught in a cyclical downturn recently, due to excess inventory at distributors and weakening industrial demand in China, which is struggling with an economic downturn. But second-quarter results released last week beat expectations, thanks to an early recovery in the all-important Chinese market. The third quarter is expected to be comparable to the April-June period, but executives have said the fourth quarter will be more upbeat. Stepping back and looking several years ahead, there's a lot to like. DD 1Y Mountain DuPont stock performance over the past 12 months. DuPont's Water Business DuPont is considered a leader in purification and specialty separation technologies that produce clean water for industry, governments and communities. RBC Capital Markets analyst Alan Viswanathan described DuPont's water business' next-generation products as the “top of the technology pyramid.” The company's technologies, which consist of large, established brands such as FilmTec, IntegraTec and Amber Series, “demand a premium in the marketplace,” Viswanathan said. To position its brands as premium-quality products, DuPont invests heavily. RBC's Viswanathan said the company's research and development expenses are about 6% of sales, compared with about 4% for peers, which allows the company to continue to develop premium products. Apart from its growing North American business, Viswanathan said DuPont has “very well-positioned operations” in emerging markets where water pollution is a serious problem. DuPont's reverse osmosis membranes, for example, are used for filtration in areas with limited access to clean water. He cited Asia, the Middle East, Africa and Latin America (which he estimates represents 60% of the total portfolio) as sources of future growth. Meanwhile, KeyBank's Yefremov sees Asia, in particular, as a continuing area of expansion. DuPont's water business is the smallest of the three companies resulting from the separation. The water business generated about $1.5 billion in revenue in 2023, while the electronics business generated about $4 billion in sales. The businesses that make up DuPont after the separation had revenue of $6.6 billion in 2023. But most importantly, DuPont's water division had sales of about 24% operating EBITDA margin for the full year. The division's EBITDA margin is higher than that of Xylem, a publicly traded company that provides a broad range of services to the water industry. It will end 2023 with an EBITDA margin of 18.9%, according to FactSet, and analysts expect it to rise to 20.3% in 2024. EBITDA (earnings before interest, taxes, depreciation and amortization) is a measure of operating profitability. A look at the 2023 EBITDA margins of peers highlights the attractiveness of DuPont's water treatment business. Ecolab was at 19.9%, Pentair was at 22.3% and Veralt was at 24.1%. Generally, companies with higher margins command higher valuations than their peers. As this analysis shows, DuPont's water treatment business as a standalone would certainly deserve its valuation relative to other companies. However, given the way the market currently values diversified DuPont, it is unlikely that the water treatment division is appropriately valued within the conglomerate, which would not justify a decision to spin it out. Or help justify the interest of potential suitors. Potential M&A It is also possible that DuPont's water treatment business will never reach standalone status. In an industry where consolidation is not uncommon, DuPont's management could consider a sale to a peer, especially if the market continues to suppress the company's stock price and management wants to see it soar higher. Efremov also believes DuPont management may be open to such a scenario, given that the company's water business is the smallest of the three. Still, Efremov said management has “high expectations for the price” because water is a “very unique asset.” “They will try to get a premium if they can. If not, they will probably continue with the spinoff,” he added. DuPont's water business has reportedly attracted interest from Xylem and Berart (formerly part of Club Holdings' Danaher Corp.), but it remains unclear whether either company will move forward with a deal. On last week's earnings call, CEO Koch said DuPont “has not had any discussions about selling the water business. So our intention remains a spinoff.” But we also know that management's desire is to maximize returns for investors. So we're confident to hang on to the stock. “If there's an interest in the water business, of course we'll look at it and study it diligently. If there's a better way to create value for our shareholders, we'll obviously do that,” Executive Chairman Ed Breen added during Wednesday's earnings call. “We'll leave it at that for now.” (Jim Cramer's charitable trust is long DD. See the complete list of stocks here.) Subscribers to Jim Cramer's CNBC Investment Club receive trade alerts before Jim makes a trade. 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DuPont's sign hangs at its world headquarters in Wilmington, Delaware.
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Wall Street has been fascinated by the emergence of generative AI for nearly two years, but as DuPont prepares to split into three separate companies, one of the company's surprisingly fascinating businesses has to do with something we'll never be without: water.
