Dow Chemical Further Extends Divestiture Plan 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 $2.5 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 in 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. In March this year, Dow further expanded its divestiture target to $4.5-6 billion without disclosing much about the nature of the businesses that were added to the divestment plan. With the most recent announcement that came as a part of the Investor Forum presentation, Dow is now targeting to raise around $7.5-8 billion from the sale of non-core assets by mid-2016. We believe that the ongoing divestment actions will unlock greater value for Dow shareholders as the company continues to divert its resources towards investing in more profitable segments and boosting its share buyback. The company announced a $5 billion share buyback program to be executed over the next 3 years. ^[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 and adjusted net income of around $2.9 billion. Based on the most recent earnings announcement, we have updated our price estimate for Dow to $51/share, which is 16.6x our 2014 full-year adjusted diluted EPS estimate of $3.07 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 March this year, 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. (See: How Does Dow Chemical Plan To Expand Its Performance Materials Margins?) Last month, Dow announced that it is actively marketing three of its non-core businesses for divestment and expects proceeds of more than $2 billion by early next year. ^[3] Most recently, the company further raised its divestiture target by $2.5 billion as it plans to cut its stake in two Kuwaiti joint ventures, MEGlobal and Equate Petrochemical. Andrew Liveris, the company’s CEO, said that Dow will still retain a substantial share in both the joint ventures and that the pull back is primarily aimed at freeing up some capital for new, more lucrative investments. ^[1]

Through these divestments, Dow is diverting 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. Most of the products sold by the Performance Plastics division are derivatives of the simplest unsaturated hydrocarbon, ethylene, which is most commonly derived from the 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 more than $2.5 billion (on a run rate basis by 2017) by ramping up its plastics operations in the U.S. Gulf Coast region. Just to give some perspective, the company’s consolidated EBITDA stood around $7.8 billion last year by our estimates. (See: Cheap U.S. Natural Gas Is Attracting Huge Investments From Chemical Companies)

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1. The Dow Chemical Company Investor Forum 2014 Presentation, dow.com [↩] [↩]
2. Q3 2013 The Dow Chemical Company Earnings Release, dow.com [↩]
3. Dow Chemical To Divest Three More Businesses, wsj.com [↩]