DuPont Maintains Rating on Negative Watch

A report from the Fitch Ratings states that it maintains E.I. du Pont de Nemours and Company's (DuPont) ratings on rating watch negative.

The negative watch reflects the risk that leverage could be elevated following the DowDuPont merger and through the subsequent spin-off (see DowDuPont merger/spinoff).

Fitch expects funds from operations (FFO) FFO net leverage to be generally less than or equal to 1.5x.

The rating watch will be resolved when Fitch has further clarity on the operating profile and capital structure of the successor to Dupont.

Key rating drivers

DowDuPont merger/spin-off

Fitch placed DuPont's ratings on rating watch negative on Dec 11, 2015, following the announcement of the proposed merger of equals between DuPont and Dow Chemical. The merger is to be a share-based transaction scheduled to close August 31, 2017. The merger is projected to deliver cost synergies of around $3 billion and growth synergies of roughly $1 billion.

Subsequent to the merger, DowDuPont Inc is to be partitioned into three separate public companies: Materials Business SpinCo, AgCo Business SpinCo and Specialty Business SpinCo. Dow and DuPont now expect that the first spin-off will be the Materials Business SpinCo assuming that the sequencing allows for the completion of all spin-offs within 18 months of closing of the merger and would not impact the value of the spin-offs to the shareholders.

The boards of directors of Dow and DuPont support a comprehensive portfolio review to capture any material value-enhancing opportunities connected with the intended creation of the three split-cos and have engaged McKinsey & Co to aid in that analysis.

Agricultural business

Fitch estimates that the agriculture segment accounts for 38 percent of DuPont's LTM 6/30/17 segment operating EBITDA. In the short term, this sector is expected to continue to be challenged by low crop prices, and thus farmer income. Longer-term, Fitch expects the segment to show solid growth from the combined companies strong product portfolios and new product launches.

Weather conditions, food prices, and, for corn, ethanol prices, all impact planting and earnings in the short run, resulting in volatility. In addition, the agricultural segment is highly seasonal with most of the cash flow generated in the fourth quarter and most of the earnings and revenue in the first half of the year.

Substantial foreign operations

DuPont has operations in about 90 countries worldwide. While more than two-thirds of 2016 net property by balance sheet valuation was located in US, about 60 percent of revenue is from customers outside of the US Roughly 51 percent of the agriculture segment net sales were to customers outside of US and 71 of the 131 agricultural properties were outside of the US & Canada.

The company does hedge certain foreign currency-denominated revenues and occasionally hedges other foreign currency transactions. DuPont routinely hedges its net exposure related to foreign currency-denominated monetary assets and liabilities by currency. In 2016, net sales were down 1 percent from 2015 from the strengthening of the US dollar.

As of Dec 31, 2016, $5.8 billion of the $6 billion cash and equivalents and marketable securities on the balance sheet was held outside of the US Fitch defines readily available cash as cash on the balance sheet less amounts viewed to be required to run the business or expected to be taxed or distributed to minority interests when repatriated. Fitch estimates $1 billion of DuPont's cash is not readily available.

Pension obligations

The company's defined benefit programs were in aggregate 67 percent funded at the end of 2016; aggregate global under funding was $8.2 billion. US plans with plan assets were underfunded by $6.4 billion as of Dec 31, 2016. The company contributed $2.9 billion to its US pension plan in the second quarter of 2017. Net periodic benefit costs have exceeded contributions over the past three fiscal years. The split of the remaining pension obligations between the AgCo Business SpinCo and the Specialty Business SpinCo will be a consideration of the post-spin rating analysis.

Key assumptions

Fitch's key assumptions within our rating case for the issuer include:

The sale of DuPont's cereal broadleaf herbicides and chewing insecticides to FMC Corporation and the acquisition of FMC's health and nutrition business closes as contemplated in the fourth quarter of 2017 Fitch assumes that Dow and DuPont will not provide cross guarantees, there will be no borrowing at the DowDuPont level, and that DowDuPont will not provide a guarantee of Dow or DuPont debt Fitch assumes the AgCo SpinCo will succeed DuPont and have a credit profile generally consistent with DuPont as of Dec 11, 2015 Top line growth at 2 percent on average EBITDA margins at 20 percent on average Capital expenditures to be less than $1.3 billion annually $1 billion in cash is assumed to be not readily available to repay debt No further portfolio, dividend or capital changes.