The Dow Chemical Company (NYSE:DOW) recently announced further details on its plans to boost investment in the U.S. Gulf Coast region. Unlocking of the shale gas resources has created a supply glut in the U.S. As a result, natural gas prices in the country are sharply lower compared to the rest of the world. This has provided manufacturers like Dow with an opportunity to expand their operating margins on lower feedstock costs. The company is therefore pursuing huge investments (more than $4 billion) in the U.S. Gulf Coast region to tap into this opportunity. The chemical giant expects to generate incremental EBITDA of $2.5 billion by ramping up its plastics operations in the U.S. Gulf Coast region. 
- Dissecting Dow And DuPont Deal: Why Merge And Split?
- Dissecting Dow And DuPont Deal: Are The Synergy Expectations Reasonable?
- Dissecting Dow And DuPont Deal: Does The Merger Make Sense?
- Dow Q2 Earnings: Higher Margins Offset Revenue Decline, Dow-Dupont Merger On Pace For Year-End Close
- Dow Q1 Earnings: Higher Margins Offset Revenue & EBITDA Decline, Management Confident Of Dow-Dupont Merger Synergies
- What Has Led To A ~9% Decrease In Dow Chemical’s Revenues In The Last Five Years?
Ethylene, one of the most important feedstock in the plastics value chain, is used in the manufacture of polyethylene, also called polythene, which is the most widely used plastic in the world. Dow Chemical is one of the largest ethylene producers in the world, as this provides the company’s differentiated performance plastic manufacturing capacities with a low-cost advantage.
The simplest unsaturated hydrocarbon is most commonly derived from steam cracking of either naphtha or ethane. Naphtha is derived from crude oil (naphtha constitutes around 15-30% of crude oil by weight) while ethane is the second-largest component of natural gas after methane. With the shale gas supply boost in the U.S. resulting in a cheap source of ethane, there has been a divergence in operating margins between naphtha and ethane based ethylene production plants in the U.S.
Dow is therefore growing its ethylene capacity in the U.S. while improving feedstock flexibility of its existing ethylene production facilities to leverage the favorable feedstock scenario. The company currently has 70% of its ethylene production in cost-advantaged regions. Last year, the company restarted its St. Charles Olefins 2 plant in Louisiana, in a bid to lower its operating costs by reducing the amount of ethylene purchased. Dow plans to increase its ethylene production capacity by ~20% over the next three years. 
Furthermore, in order to take full advantage of the low feedstock costs, Dow also plans to expand its capacity on the other end of the plastics value chain. The company will be increasing its capacity for Elite brand enhanced polyethylene resins and Affinity brand polyolefin plastomers at its Freeport, Texas facility. It will also be expanding its capacity for low-density polyethylene materials like the ones sold under the Agility brand and for specialized hydrocarbon rubber (mEPDM: metallocene ethylene propylene diene monomer) sold under the Nordel brand at its Plaquemine, Louisiana facility. 
Dow derives almost ~25% of its sales revenue from selling elastomers, polypropylene and other products used in electrical, telecommunication and packaging industries. However the company’s extensively integrated performance plastics operations contributed ~45% to its total adjusted EBITDA for the fist half of the year.  We estimate the company’s performance plastics and materials EBITDA margins to expand by ~600 basis points in the long run on increased investments in the U.S. Gulf Coast region. Our $37 price estimate for Dow is almost in line with the current market price.Notes: