Dow Chemical’s Cost Cutting Plans And Profit Focus Buoy Outlook

Dow Chemical (NYSE:DOW) reported its third quarter earnings on October 24. The chemicals giant saw a mixed quarter with volume growth in a number of major divisions including Agriculture and Performance Plastics & Materials offset by pricing declines and adverse currency conditions. The overall result was a 10% y-o-y decline in net sales and a 35% decline in net income. However, Dow’s stock rose almost 5% on the day of the earnings release, buoyed by the announcement of initiatives that are expected to result in substantial cost savings going forward.

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Volume growth more than offset by price declines

Adjusted revenues fell 7% due to a combination of weak demand in Europe, lower net pricing across divisions and a strengthening dollar. A slowdown in China, attributed to a weak trend in the country’s manufacturing base, also contributed to the decline. However, the company expects the region to stabilize going forward.

An overall adjusted volume increase of 2% (excluding acquisitions and divestitures) was more than offset by net price declines of 9%. Around 4% of this was due to the impact of adverse currency conditions. The rest was either to offset declining consumer demand or due to lower feedstock prices.

Performance Plastics boosted by cheap shale gas prices

The prices of natural gas feedstocks in the U.S. have seen a sharp decline lately due to the shale gas boom in the country. This has led to a decrease in product prices, which in turn led to strong demand for the company’s plastics in the U.S. Plastics derived from Ethylene, a chemical produced from ethane feedstocks, saw a 5% y-o-y growth in volumes. The company is looking to expand its operations in the US Gulf Coast where easy access to low priced shale gas feedstocks are expected to further boost plastics production and volumes.

Strong consumer demand for NORDEL™ IP Hydrocarbon Rubber and ASPUN™ Fiber grade non-woven resins, and growing volumes for Performance Packaging products in Asia Pacific and North America also contributed to the volume growth. Adjusted volume for Performance Plastics grew 5% y-o-y.

Agriculture growth in line with overall market growth

Agricultural Science Products is currently one of Dow’s best performing divisions, delivering record sales and income growth over the past few quarters. This quarter, net sales for the division grew 8%, with volumes and prices growing 7% and 1% respectively. Growth was primarily driven by growing farmer demand for new technologies, particularly in North America and Latin America. This largely mirrors the growth of the overall market for these products. We project the global market size for agricultural products to grow at an annual rate of 4.4% over the course of our forecast period.

Cost savings to improve EBITDA

Dow announced that it is eliminating 2,400 jobs, around 5% of the workforce, and closing 20 plants in order to reduce costs amid deteriorating macroeconomic conditions. This is estimated to result in annual cost savings of $500 million. However, this will not halt expansion plans in the US Gulf Coast and Saudi Arabia where the company is looking to take advantage of lower feedstock prices.

The company will also curtail total capital spending by $800 million in 2012 and 2013, and halt $200 million of new business growth related spending, amounting to a $1 billion decrease in capital expenditures. Together with the cost saving plans, these initiatives are estimated to save $1 billion in 2013 compared to 2012.

Dow is involved in a number of programs to reduce costs. In 2011, it announced the Efficiency for Growth (EFG) program, which focuses on the reduction of debt and the better management of costs and working capital with the aim of generating $2-3 billion in cash flows by 2015. This program has accelerated in 2012, and has helped the company expand its EBITDA margins this quarter.

Together with the newly announced programs, Dow expects to save over $2.5 billion going forward, which is in line with its short term EBITDA target of $10 billion. The company reported total EBITDA of around $7.8 billion in 2011.

We will be updating our $31 price estimate for Dow based on the earnings release.

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