Dow’s Earnings Expand On Thicker Plastics Margins

by Trefis Team
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The Dow Chemical Company
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The Dow Chemical Company’s (NYSE:DOW) third quarter earnings rose on growth in the performance plastics business and lower interest expenses. However, weak demand and volatile raw material costs in some of the performance material segments dampened earnings growth. The company therefore decided to expand its intermediate divestiture target aimed at reducing exposure to slow-growth, commoditized end markets. Dow’s third quarter earnings per share (EPS) adjusted for one time items grew ~19% y-o-y to $0.50. [1]

Our $37 price estimate for Dow will soon be updated to reflect the third quarter earnings announcement.

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Performance Plastics Outperform

The performance plastics division outperformed all other divisions in Dow’s diverse portfolio on both the top and bottom line. While sales from the division were up 6.5% on higher demand for food and specialty-packaging products, EBITDA grew more than 30% over last year on higher prices and lower feedstock costs. Although the division that sells elastomers, polypropylene and other products used in electrical, telecommunication and packaging industries contributes around 25% to the company’s total sales revenue, its EBITDA contribution is more than 45%. This is primarily due to Dow’s extensively integrated plastics operations with differentiated end products and growing feedstock advantage in the U.S. [1]

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 such as 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. (See: Dow Continues Its Expansion In The Gulf Coast On Favorable Feedstock) During the third quarter, Dow’s performance plastics EBITDA margins improved by more than 500 basis points y-o-y. [2]

Extension Of Divestiture Agenda

Dow has been pursuing divestment of slow growth, low-margin businesses over the last several years in order to focus on more profitable, less volatile segments where it sells more differentiated end products. Having completed the divestiture of businesses generating more than $8 billion in revenues over the last several years, in March, the company announced its plan to raise around $1.5 billion from further divestments. [3]

However, looking at the volatile demand scenario in emerging markets and continued slowdown in the developed ones, during the third quarter earnings call, the company announced an extension of its divestiture target to $3-4 billion over the next couple of years. Dow officials said that their focus would be on businesses that fall under the chlorine value chain, such as chlorinated organics and epoxy businesses that generate single digit EBITDA margins, which compares to more than 20% EBITDA margin that the company earns on its performance plastics business. [1]

As a part of its divestment plan announced in March, Dow recently agreed to sell its polypropylene licensing and catalysts business to W.R. Grace & Co. for $500 million. [4] However, the company decided not to sell its plastics additives business after failing to find a buyer willing to pay the desired price. Dow restated its intent during the earnings call that while actively pursuing these deals, it will not sell out any business at low valuations. (See: Dow Halts A $500 Million Divestment Amid Valuation Concerns)

Going forward, we expect these divestments to unlock greater value for shareholders as Dow diverts cash proceeds towards investment in more profitable segments that leverage its integrated value chain and innovative end products for better margins. Not only this, the company also plans to reduce its interest costs by paying down high-interest debt. As a result of the recent debt reduction steps taken by the company, the interest expense during the third quarter was ~17% lower than last year, which greatly helped Dow in posting impressive double-digit EPS growth. [1]

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Notes:
  1. Q3 2013 The Dow Chemical Company Earnings Release, dow.com [] [] [] []
  2. Dow’s Performance Plastics Advantage, dow.com []
  3. Dow Accelerates Portfolio Management Actions to Divest Non-Core Businesses; Targets More Than $1 billion in Proceeds, dow.com []
  4. Dow to sell polypropylene catalyst business to W.R. Grace, reuters.com []
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