Dow Chemical as a Commodity Play
Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Despite the recent news that second quarter GDP growth was revised up from 1.5% to 1.7%, global economic weakness and the threat of another round of quantitative easing by the Federal Reserve have made commodities an increasingly attractive place to invest. This has led investors to focus primarily on areas like precious metals and agricultural products. Another area that is worth considering as a method to get exposure to commodities is in the chemical space. While manufactured chemicals are at least one layer removed from the pure commodities level of the supply chain, they should have inflationary pricing power and may be an overlooked area that will benefit from current economic conditions.
Within this industry, The Dow Chemical Company (NYSE: DOW) makes an interesting option, not because it is the most attractive on an absolute basis, but because its wide diversification gives investors broad exposure. Within various niches, companies like Huntsman Corp. (NYSE: HUN), E. I. du Pont (NYSE: DD) and BASF SE (NASDAQOTH: BASFY.PK) have certain advantages, both in term of product focus and financial results. Overall, the combination of Dow’s diversification and its strong income element – plus one other “x-factor” – make it the stock of choice in the industry.
While Dow experienced some constriction in revenues over the past quarter, net operating cash flow increased by 85% on a year-over-year basis, rising to $1.47 billion. The company’s outlook for revenue and earnings growth is mixed, but this is a company that pays a 4.3% dividend yield at current levels. Huntsman, the smallest company of those mentioned with a market capitalization below $4 billion, has become a very strong player in the polyurethane space, specifically in MDIs. The company was able to grow its volume, while still pushing through a price increase; in this targeted area, Huntsman owns a larger share of the market than Dow. At its smallish market cap, the company may become an acquisition target.
To make the chemical company to commodity connection a little more straightforward, consider the increase in the price of titanium dioxide. This substance is a critical element in the manufacturing of paint, serving as a whitening agent. While all of these companies have a hand in the manufacture of the pigment, DuPont plans to open a new plant dedicated to this purpose within the next year. The company’s division is one of the largest in the world and is a part of DuPont’s diversified approach to its business.
BASF is the proverbial odd duck in the group. While it has a strong presence in the chemical space, it also has more direct exposure to consumer products. Additionally, the company does not offer a dividend, which penalizes it within this group. Huntsman’s dividend yield is 2.8%, DuPont’s is 3.4% and Dow’s is a group-leading 4.3%. That said, BASF is a solid company with a different risk profile that is worth considering in a different context.
The Dow X-Factor
In addition to offering the most aggressive dividend and being very well diversified, Dow’s water and filtration division is reason alone to own this company. At a time when desalinization is become a growing concern and individuals are becoming increasingly aware of water quality, the division of Dow is unrivaled within the industry in both its efficiency and by the quality of its products. A look at the company’s income statement reveals the strength of this division and its role in Dow remaining profitable. In leveraging on various extras, yet overcoming uncommon catalysts, handsome returns in several top industry niches exist.
Investment Thesis Overview
For some investors, the idea of playing the chemical segment as a proxy for the commodities markets may be a stretch. But the general message is that during periods of inflation concerns, moving up the supply chain is one way to insulate one’s portfolio. As the price of raw materials climb, the products that become the raw materials for so many other companies should also appreciate significantly in value.
In the case of Dow, the strong dividend yield gives investors a compelling reason to hold the stock while they wait to see how the story unfolds. Lastly, with a critical division like the water and filtration group at the company, Dow looks to be strongly positioned. Regardless of whether one likes Dow as an income play or sees the wisdom of categorizing it as a pseudo-commodity play, Dow is solid and priced to perform.
Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.