Dow Expands Divestiture Target To Boost Profitability

The Dow Chemical Company (NYSE:DOW) recently announced the expansion of its near-term divestiture plan to include non-core assets worth $1.5-2 billion more. The company initially planned to raise around $1.5 billion from divestments when it first revealed its intentions to divest into two of its non-core businesses, Plastic Additives and Polypropylene Licensing and Catalysts, during the first quarter of 2013. However, December last year, it extended the divestiture target to $3-4 billion by adding low-margin commodity businesses, mainly chlorine and epoxy, to its initial plan.

With the most recent announcement that came as a part of a strategic update, Dow is now targeting to raise around $4.5-6 billion from the sale of non-core assets. We believe that the ongoing divestment actions would unlock greater value for shareholders as Dow continues to divert its resources towards more profitable segments. ^[1]

Dow is a diversified chemical industry giant operating in specialty chemicals, advanced materials, agro-sciences and plastics business segments. It delivers a broad range of technology-based products and solutions to customers in approximately 160 countries, and in high growth sectors such as electronics, water, energy and agriculture. Last year, Dow reported annual sales of approximately $57 billion earning adjusted net income of around $2.9 billion.

We currently have a $47 price estimate for Dow, which is ~16x our 2014 adjusted EPS estimate of $3.00 for the company.

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Dow has been pursuing the 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 past several years, in March 2013, the company announced its plan to raise around $1.5 billion from further divestments.

However, looking at the volatile demand scenario in emerging markets and continued slowdown in the developed ones, during the 2013 third quarter earnings call, Dow announced an extension of its divestiture target to $3-4 billion. The company officials said that their focus would be on businesses that fall under the chlorine value chain, such as the chlorinated organics and epoxy businesses that generate single digit EBITDA margins, which compares to the more than 25% EBITDA margin that the company earns on its Performance Plastics business. ^[2]

In October last year, Dow agreed to sell its polypropylene licensing and catalysts business to W.R. Grace & Co. for $500 million. ^[3] However, it 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 2013 third quarter 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)

Most recently, Dow further expanded its divestiture target to $4.5-6 billion. The company officials did not disclose the specific nature of the businesses that were added to the divestment plan. However, they did mention that these would be some smaller units from its Performance materials division, which has an adjusted EBITDA margin of around 10%, compared to the company wide average of over 15%, by our estimates. ^[4]

We believe that through these divestments, Dow aims to divert its resources towards more profitable segments, especially the Performance Plastics division, which best leverages its integrated value chain for a low-cost advantage and differentiated end products for higher margins. According to our estimates, the division’s adjusted EBITDA margin stood at around 26% last year, well above the company wide average. This was primarily due to lower feedstock costs in the U.S.

Most of the products sold by the Performance Plastics division are derivatives of the simplest unsaturated hydrocarbon, ethylene, which is most commonly derived from steam cracking of either naphtha or ethane. 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 pursuing huge investments (more than $4 billion) in the U.S. Gulf Coast region to tap into this opportunity. The company expects to generate incremental EBITDA of $2.5 billion by ramping up its plastics operations in the U.S. Gulf Coast region. ^[5]

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1. Dow Chemical Raises Asset Sale Target By $1.5-2 Billion, reuters.com [↩]
2. Q3 2013 The Dow Chemical Company Earnings Release, dow.com [↩]
3. Dow To Sell Polypropylene Catalyst Business To W.R. Grace, reuters.com [↩]
4. Dow Strategic Update, dow.com [↩]
5. Dow’s Performance Plastics Advantage, dow.com [↩]