Note to Readers: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 2Q17 Earnings Update.
Previous Edition: Jul 27, 2017; Flash Update: 2Q17 Earnings Update.
Brokers’ Recommendations: Positive: 70.00% (7 firms); Neutral: 30.00% (3 firms); Negative: 0.00% (0) Prev Ed: 7,3,0.
Brokers’ Target Price: $69.86 (↑ $3.36 from the previous edition; 7 firms) Brokers’ Avg. Expected Return: 10%
Aug8, 2017
Portfolio Manager Executive Summary
The Dow Chemical Company (DOW or the company) is a diversified chemical manufacturer that utilizes an innovative combination of both science and technology. Dow is among the world’s largest manufacturers of several globally produced and traded commodity chemicals, including ethylene, polyethylene, polystyrene, ethylene glycol, chlorine and caustic soda among others. The company’s management aims at realizing the value of its world-class, market-leading assets, reducing earnings volatility, growing the business over time and taking appropriate actions to benefit shareholders.
Dow’s growth drivers are:
- Expansion into faster-growing geographic markets.
- Creation of a vertical company, which will lower raw material costs.
- Increasing volume growth and efficient capacity utilization rates.
- To offer its innovative chemical, plastic and agricultural products and services to diversified consumers and markets.
Out of the 10 firms in the Digest Group covering the stock, seven rendered positive ratings, threeprovided neutral ratings and noneassigned a negative rating.
Positive or equivalent stance (7/10 firms or 70.00%) – The bullish firms are encouraged by the company’s focus on strategies to optimize its portfolio. Moreover, with a number of potential growth catalysts in the near term, the company's shares remain attractive. Additionally, Dow is aligning its portfolio with improved focus on key growth areas, along with cost-saving strategies and its historic merger announcement with DuPont. The company’s synergies related to Dow Corning have already exceeded expectations. Also, its expansion plans remain on track.
After merger closure, DowDuPont (“the combined company”) intends to break up into three separate companies via tax-free spinoffs (Agriculture, Material Sciences, Specialty Products).The firms think that having three separate businesses will help both companies to better leverage the business and drive sales through improved cross-selling of products to existing customers worldwide.
Neutral or equivalent stance (3/10 firms or 30.00%) – These firms believe that the DowDuPont merger is an effective strategy for the company’s business as it will result in competitive advantages, higher margins and reduced volatility, thereby creating value for its shareholders. Also, the firms are hopeful about the future of the combined company owing to the cost savings plans and focus on three separate businesses. Additionally, Dow has been pursuing an effective cash deployment strategy, which includes share buybacks and dividend payouts. Further, the shale gas boom in the U.S. has resulted in abundant gas supply at low prices. Ethane – which is plentiful in shale gas – is thus a low-cost raw material for Dow and provides the company with operational advantage. However, the ethylene chain margins remain under pressure.
Aug 8, 2017
Overview
Key investment considerations as identified by the analysts are as follows:
Key Positive Arguments / Key Negative Arguments- The proposed merger with DuPont.
- Dow has strong cash generating ability and a sturdybalance sheet.
- The company has an efficient management team, which tailors innovative products and services to suit the needs of its diversified consumers.
- Dow is progressing well with its cost reduction and synergy goals.
- The cost of purchased feedstock and energy (major raw material) remains volatile.
- Continued pressure from oil & gas end markets.
- Integration of large acquisitions and the merger of different corporate cultures can inhibit the realization of expected synergies and undermine the value obtained from transactions.
- Commodity margins are inherently volatile and market turns are sudden in commodity chemicals.
Michigan-based Dow Chemical Company (DOW or the company) is a diversified worldwide manufacturer of basic and performance chemicals and plastics, and agricultural products that are primarily used by customers as raw materials to manufacture a diverse range of products that serve various consumer markets. The company serves the following industries: appliance, automotive, agricultural, building and construction, chemical processing, electronics, furniture, house wares, oil and gas, packaging paints, coatings and adhesives, personal care, pharmaceuticals, processed foods, pulp and paper, textile and carpet, utilities and water treatment.
On Nov 12, 2014, Dow announced that it is realigning its external reporting segments to better reflect its strategy to be low-cost and fully integrated across key value chains, while adding value through shared technology and end-market orientation. The company expects this new structure to improve modeling and peer-to-peer comparison capabilities.
The new operating segment structure maximizes Dow’s integration benefits – either through molecular and value chain alignment, such as the company’s acrylic, chlorine, ethylene and propylene envelopes, or through the benefits derived from an enhanced, innovation-driven market focus.
The operating segments include the following:
- Agricultural Sciences – Will continue to operate under the same structure, comprising Crop Protection and Seeds.
- Consumer Solutions – Previously part of Electronic and Functional materials, this will include Consumer Care, Dow Automotive Systems, and Dow Electronic Materials.
- Infrastructure Solutions – Formerly named Coatings and Infrastructure Solutions, this consists of Dow Building & Construction, Dow Coating Materials, Energy & Water Solutions and Performance Monomers.
- Performance Materials & Chemicals – IncludesChlor-Alkali and Vinyl, Chlorinated Organics, Epoxy, and Industrial Solutions and Polyurethanes.
- Performance Plastics – Comprises the company’s previous Performance Plastics business groups, and will now also include key raw material inputs via the energy and hydrocarbons business groups that were formerly included in the Feedstocks and Energy segment.
Further information on the company can be found at
Note: The company’s fiscal references coincide with the calendar year.
May 18, 2017
Long-Term Growth
Dow’s long-term growth plans are focused on developing high-growth, sustainable business platforms that complement its existing products and business applications. Dow, like other chemical and specialty chemical providers, experienced a severe downturn in global demand in Dec 2008. Since then, management has focused on cash generation and capital preservation.
Dow aims to develop its non-cyclical businesses by building its market-facing product lines and augmenting its Performance segments. Roughly, one-third of Dow’s business that is considered non-cyclical is Specialty Chemicals.
According to the firms, Dow continues to focus on diligent cost, capital and working cash flow management, which should lead to impressive margin expansion across the specialty chemical businesses as demand recovers. The specialty chemical businessesnow overwhelm the company’s smaller commodity chemical platform. They believe that Dow will utilize most of its free cash flow to repay significant amounts of debt.
Dow intends to reduce costs and improve productivity. Management seemed focused on the simple strategy of driving synergies and cost reduction, and generating cash flow to pay down debt, rather than moving on to other potential acquisitions or ancillary projects.
The merger with DuPont is also expected to create significant synergies.Following the completion of the merger, the combined entity would eventually split into three individual, publicly traded companies, namely, Agriculture Company, Material Science Company and Specialty products Company. Each of these companies will be capable of allocating capital more effectively, innovating and increasing products and solutions for their global customer base. In the long term, the three-way split is expected to provide shareholders as well as customers with greater value and opportunities to tap the global challenges in each of the segments.
Dow also declared the start-up of its investments on the U.S. Gulf Coast and in Saudi Arabia in 4Q15, and that these projects would ramp up to full production by the next two years. Also, with the completion of large investments and capital programs, Dow’s capital expenditures will be reduced.
Moreover, Dow announced that its portfolio initiatives will be more focused on Dow Agro-Sciences. The company will review all the opportunities and strive to create new synergies in a consolidating agricultural market. Dow will focus on core assets which ensure high returns to shareholders.
Dow intends to undertake these strategies to grow its business as well as return attractive cash to its shareholders. Higher cash flows from growth initiatives would be channelized to dividend hikes and share buyback programs.
Dow has also divulged its next phase of comprehensive investments plans for the next five years to enhance its long-term competitive advantage and deliver earnings growth and shareholder value. The planned investments are expected to spur economic activity, mostly in the U.S., and create significant number of jobs. The projects will expand Dow’s U.S. growth investments to more than $12 billion over a 10-year period and are expected to create around 5,500 jobs at peak activity and 300 permanent jobs. The planned investments are expected to come onstream in a phased manner, starting in 2020, at estimated capital expenditures of roughly $4 billion spread over the next five years.
Aug8, 2017
Target Price/Valuation
Provided below is a summary of target price/valuation as compiled by Zacks Research Digest:
Rating DistributionPositive / 70.00%
Neutral / 30.00%
Negative / 0.00%
Avg. target Price / $69.86↑
Digest High / $75.00
Digest Low / $60.00↑
No. of Analysts with Target Price/Total / 7/10
Risks to the achievement of the target price are the global economic slowdown, inability to price ahead of commodity cost inflation, high level of debt, and/or a large dilutive acquisition. Other risks include raw material volatility, the success of restructuring actions and plant outages.
Recent Events
On Jul 27, 2017,Dow reported its 2Q17 results. On a reported basis, the company logged aprofit of $1.3billion or $1.07 per share in 2Q17,downaround 58% from a profit of $3.1billion or $2.61 per share recorded a year ago.
Adjusted earnings (barring one-time items) were $1.08 per share for 2Q17.
Dow’s revenues rose roughly 16% year over year (y/y) to $13,834 million in 2Q17.
Revenues
Dow’s revenues rosearound 16% y/y to $13,834 million in 2Q17 owing to sales gains across all operating segments and geographic areas in the reported quarter. Volumes (excluding acquisitions) rose 3% in the quarter, reflecting gains across all operating segments and geographic areas, led by Africa and the Middle East (up 17%), India (up 14%), Asia Pacific (up 6%) and Europe (up 4%).
Segment Revenue Details
Agricultural Sciences
Sales roseroughly 3% y/y to $1.6 billion in 2Q17and volume went up6% due to double-digit gains in seeds business. Crop protection volume increased on higher demand for insecticides and herbicides, more than offsetting lower demand for fungicides.
Consumer Solutions
Revenues from the division were roughly $1.7 billionin 2Q17, up around 32%. Sales gains were driven by the contributions of the silicones business. Volume climbed9%, driven by gains across all businesses.
Infrastructure Solutions
Sales from the division jumped around 34% to $2.8 billion in 2Q17on the back ofcontributions from the silicones business. Volume rose3%, mainly due to gains across all geographic segments and in most businesses. The segment recorded a 4% increase in pricing.
Performance Materials and Chemicals
Revenues went up 13% to $2.6 billion in 2Q17 on gains across all geographies. The segment saw volume growth of 3% and price rose 10% with gains in all geographic areas.
Polyurethanes salesrose double-digits with gains in all geographic segments owing to continued demand for downstream, higher-margin systems applications and higher merchant sales of methylene diphenyl diisocyanate.
Sales rose in Industrial Solutions in all geographic areas owing to continued demand from crop defense, lubricants, electronics processing applications, and ethylene oxide (EO) catalyst sales in Asia Pacific.
Performance Plastics
Sales rose 8% to $5.1 billion in 2Q17, achieving fourth consecutive year-over-year increase in sales.The segment recorded volume growth of 1%and a 7% increase in pricing.
Dow Packaging and Specialty Plasticsregistered sales volume gains, driven by double-digit increase in Asia Pacific and EMEAI. Volume increased in most end markets, especially in industrial and consumer packaging and food and specialty packaging. Dow Elastomers also logged a gain in sales volume in most geographies, owing to double-digit growth in EMEAI due to demand growth in infrastructure and automotive applications.Dow Electrical andTelecommunications volume fellin the quarter due to extended turnaround activities.
Outlook
Dow is witnessing improved global economic activity with strong momentum in manufacturing, investment and trade. While strength of the consumer is driving expansion in the U.S., improvement in Europe is expected to remain on a steady track. The company is also seeing signs of stabilization in Latin America, especially in the agriculture market. Dow also believes that it is well positioned to capture demand in consumer-led markets.
Dow is moving ahead with its proposed merger with DuPont. The companies have received all required regulatory approvals and clearances for the merger. The companies expect the closing of the merger to take place on Aug 31, 2017.
Margins
Dow’s operating EBITDA went up12% y/y to $2.8million in 2Q17 on the back of broad-based growth of demand, cost reduction and productivity measures, contributions of Dow Corning’s silicones business, new product introductionsand higher prices, more than offsetting startup and commissioning costs at Sadara and in the U.S. Gulf Coast, higher feedstock costs, and scheduled maintenance spending.
Segment EBITDA Details
Agricultural Sciences: According to the company, operating EBITDA for the segment increased to $326 million in 2Q17 from of $232 million in 2Q16, mainly driven by strong demand for its novel Seeds and Crop Protection technologies and also from gains from lower operating costs obtained through productivity actions.
Consumer Solutions: According to Dow, operatingEBITDA rose to a second-quarter record of $541million in 2Q17 from $341 million in the year ago period, due to contribution from the silicones business, market share gains, new commercial wins and one-time gain related to the sale of the company’s share in a non-core joint venture in Dow ElectronicMaterials.
Infrastructure Solutions: According to the company, operating EBITDA for the segment was $556 million in 2Q17, up from $432 million in the year-ago quarter with contributions from the silicones business and volume growth more than offsetting margin compression.
Performance Materials & Chemicals: According to Dow, operating EBITDA was $347 million in 2Q17,up from $295million in 2Q16.The improvement reflects broad-based demand growth and pricing momentum more than offsetting higher cost of raw materials.
Performance Plastics:According to Dow, operatingEBITDA for the segment was $1.1billion in 2Q17, a decline from $1.2billion in 2Q16. Pricing gains were more than offset by commissioning and start up costs related to the new ethylene unit and derivative facilities in the U.S., higher energy and feedstock costs, and planned maintenance activity.
Earnings per Share
On a reported basis, the company logged a profit of $1.3billion or $1.07 per share in 2Q17, down from a profit of $3.1billion or $2.61 per share recorded a year ago. The results in the reported quarter include costs related to transactions and productivity actions. Moreover, profit in the year-ago quarter was boosted by gains related to Dow Corning ownership restructures.
Adjusted earnings (barring one-time items) were $1.08 per share for 2Q17.
Aug7, 2017
Aug8, 2017
Analyst / Nilanjan GuptaCopy Editor / Subhojoy Ghosh
Content Editor / Anindya Barman
Lead Analyst / Anindya Barman
QCA / Anindya Barman
No. of brokers reported/total brokers / 10/10
Reason for Update / Earnings Update
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