Dow Shows A Slow Recovery For Plastics Though Agriculture Stands Out

The Dow Chemical Company (NYSE:DOW) reported fourth quarter earnings of  $0.33 per share on an adjusted basis, up 32% from the same period last year. Full year earnings on an adjusted basis were down 25% at $1.90 per share. Sales declined in all operating segments of the company except for Agricultural Science. The decline in sales of 3% y-o-y on an adjusted basis led by Western Europe, was a net effect of lower prices (down 4%), largely due to unfavorable currency impact and higher volumes (up 1%). ^[1]

Agricultural Science Business Stands Out

Dow Chemical’s agricultural science business posted strong 13% sales growth for the full year as compared to 2011, led by a 10% jump in volume and 3% hike in prices due to strong industry fundamentals. The sales from seeds, traits and oils grew 27% y-o-y, led by strong farmer demand for SmartStax® corn hybrids. EBITDA for the full year grew 7% as compared to 2011 for the segment, partially offset by increased R&D and SG&A expenses.

The agricultural science industry is in an uptrend as all the major players like DuPont (NYSE:DD) and Monsanto (NYSE:MON) are seeing growth in this segment. The segment is flourishing on rising demand for genetically modified seeds and better crop protection techniques. Extraordinary rise in the demand for GM seeds has been driven by their technological advanced characteristics like higher yield and increased protection, coupled with specialized traits such as drought tolerant seeds. Moreover, the growing demand for bio-fuel as an alternative to the traditional fuel has increased the demand for corn and oil seeds as well. In addition, a growing population, shrinking arable land and rising food prices have all been working in favor of this industry. Backed by strong fundamentals, we expect the strong growth to continue in this segment in the coming years as well.

The success in the agricultural science segment is highly dependent on new innovative products as the industry is fast evolving. Hence, R&D investments and successful new product launches are key in this segment. Dow reported an increase of $135 million in R&D and SG&A expenses on a full year basis of which agricultural sciences division represented $128 million, reflecting increased spending in the key growth sector by the company. We see bright prospects for Dow in this segment as we forecast increased penetration of its SmartStax hybrids, Refuge Advanced (a convenient, single bag solution for refuge compliance) and other new products, including Enlist weed control system that has been approved in Canada, but is pending approval in the U.S.

Weak Demand Offsets Feedstock Advantage

The performance plastics segment reported 1% higher sales y-o-y for the fourth quarter led by 2% price increase and was partially offset by a 1% decrease in volume. However, EBITDA margins for the segment improved significantly from 18.2% to 22.5% y-o-y driven by positive U.S. shale gas dynamics. Dow also restarted its previously idled St. Charles ethylene cracker in December to further leverage the advantage of cheap natural gas in the U.S. (see Dow Restarts Louisiana Plant Amid Gulf Coast Expansion). Hence, we expect the positive trend in EBITDA margins for the segment to continue in 2013 as well.

However, sales for the full year were down almost 11% and 7%, for the performance plastics and performance materials segments respectively as compared to the previous year. These sectors are largely dependent on growth in infrastructure, construction, automobile and transportation industries. Amid continuing economic uncertainties in the European region and slower growth from the emerging economies, especially China, these sectors have witnessed minimal growth during the last year, which has led to the sharp decline in sales. In the long run, however, we expect Dow to benefit from its unique feedstock advantage and the U.S. shale gas dynamics as the market conditions improve with higher growth coming from the emerging economies.

Restructuring Charges, Geographical Mix, Lower Equity Earnings Impact Bottom Line

In the wake of macro-economic uncertainties, Dow Chemical took several restructuring actions during the year aimed at reducing structural costs and prioritizing growth investments. The company recorded pretax restructuring charges of almost $1 billion for the fourth quarter of 2012, that included asset write-downs and costs associated with exit or disposal activities. As a result, the company expects to realize $2.5 billion in cost reductions and cash flow improvements in the coming years with $1 billion expected in 2013 itself. The company’s net income was also impacted as the effective tax rate increased significantly to 34%, versus 23% in 2011, driven in part by a change in the geographic mix of earnings as well as lower equity earnings from Dow Corning, an equally-owned joint venture between Dow Chemical and Corning.

We will soon update our $29 price estimate for Dow, based on the fourth quarter earnings.