Du Pont Payout Ratio

RECOMMENDATIONS: We recommend that Du Pont should abandon the 25% debt ratio target and focus towards target of 40%. The target of 40% generates a larger EPS, and ROE. There is an increase of risk due to higher leverage, but Du Pont was the nation’s biggest manufacturer and their services are to be used in future to focus at target of 40% instead of 25%.

BACKGROUND: E.I. Du Pont de Nemours founded in 1802 is one of the biggest chemical manufacturing company. It is known for its financial policy amongst competitors, it had low debt to equity ratio while be able to provide cash needs for new projects. After acquiring Conoco Inc., one of the biggest oil company in 1981 Du Pont started breaking away from its financial policy. It now faces with decision to reduce its debt to capital ratio to 25% or maintain 40% debt ratio.  

KEY ISSUES: We incorporated the following issues in our discussion:

● Issue 1: Dividend Policy- Du Pont payout ratio averaged about 71%, and the more debt was issued there was huge drop in payout ratio. In 1970’s payout dropped to 45%. Du Pont should decrease the dividend to decrease its debt ratio.

● Issue 2: Capital Structure Policy 1965-1975- Company was rated AAA, had low debt ratio, able to finance projects without debt. Around 1975 they faced three main issues that caused them to change its financing policy: Inflation caused a project’s budget to increase by 50%, increase in oil price, recession decreased fiber demand and income fell by 33% and earnings per share by over 50%. Du Pont started issuing debt to meet financial stress after cutting dividends and NWC. Short term debt increased to $540 million, issued $350 million long term bonds and $150 million 7 year notes. Their debt ratio increased to 27% and interest coverage also decreased to 4.6.

● Issue 3: 1976-1979- Net income tripled and CAPEX decreased due to energy price increase and economic uplift. In 1979 debt ratio decreased to 20% and interest coverage increased to 11.5.

● Issue 4: Conoco Inc. 1981-1982- Acquired Conoco for $8 billion in 1981. Market responded negatively due to relevancy of the company to Du Pont and over paying. To cover the cost Du Pont issued $3.9 billion in common stock, $3.8 billion in debt and $1.9 billion in Conoco debt. Thus their debt ratio went to 40% and rating to AA. In 1982 recession hit and oil prices decreased which caused income, EPS, total capital to fall. Change floating rate debt to fixed rate.