Why This Global Giant is Best Positioned to Profit from Two Major Trends

By Matthew DiLallo - August 31, 2012 | Tickers: CHK, EPD, MON, RDS-A, DOW | 0 Comments

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There are many major trends that I see developing over the next decade and I want to be invested in companies that are investing now to provide solutions to these trends.  Two of these major trends involve food and fuel, always major topics of conversation.  With the drought this summer and the world’s ever expanding population that needs to be fed the importance of having agroscience solutions is immense.  Couple that with the discovery of abundant domestic energy resources and our US manufacturing base is about to witness a renaissance.

One company is on a pathway to deliver solutions to both major trends through their pipeline of innovation which is complemented by a diverse portfolio of integrated businesses.  As these innovative solutions drive future profits Dow Chemical (NYSE: DOW) will deliver strong returns for investors.  For a company that offers both growth and value this makes now a great time to add Dow to my portfolio. 

Overview:

Dow’s business can be summed up into three platforms: advanced materials, agrosciences and specialty chemicals.  It is upon these platforms they are driving future growth with the following four competitive advantages: a diverse and integrated portfolio of business, deep innovation pipeline, world-leading feedstock advantage and a focus on operating and capital efficiency.  I want to focus in on how their business segments are providing solutions which will deliver strong returns for investors. 

Agriculture:

Any backyard gardener knows that gardening isn’t easy.  If you can win the battle of the bugs and weeds, a dry and hot summer can still scorch your plans for a bountiful autumn harvest.  I gave up on my own garden a few weeks ago, what the sun didn’t burn up bugs and disease destroyed.  On a much grander scale Dow offers solutions to farmers to boost crop yields while keeping bugs and weeds at bay.  Agricultural solutions are a $75 billion addressable market and one from which Monsanto (NYSE: MON) generates $11 billion in sales. 

Dow already generates a billion dollars in sales but both companies are just at the tip of the iceberg in terms of a future addressable market.  It’s estimated the world’s population will rise from its current 6 billion all the way to 9 billion by 2050.  However, food production must double in order to feed the population as the rise of the middle class in emerging markets affords people to eat more.  There is plenty of room for both Dow and Monsanto to grow in this market, especially as farmers try to stay ahead of droughts while also contending with insects that are increasingly resistant to pesticides.  Dow’s products such as Enist and SMARTSTAX are only the beginning of their innovation when it comes to addressing this megatrend.

Chemicals and Materials:

The US shale gas revolution is about to spark a renaissance in our US petrochemical industry.  Dow is positioned to take advantage of a compelling feedstock advantage as the country increases production of Natural Gas Liquids.  The nation’s number two natural gas producer, Chesapeake (NYSE: CHK) for example continues to shift their production to their liquids rich acreage.  Liquids now represent 21% of their total production which they’ll boost to 35% by 2015.  As these producers boost liquids production this is creating a cost advantaged feedstock for chemical manufactures like Dow.  Dow is taking advantage of cost advantaged ethane and propane by building new petrochemical plants along the Gulf Coast.

Dow is building both a Propane Dehydrogenation Plant and an Ethane Cracker plant which will come online in 2015 and 2017 respectively.   These two projects alone will drive an additional $2 billion in EBITDA for Dow in 2017.  They’re not alone in their pursuit as Enterprise Products Partners (NYSE: EPD) announced their own Propane Dehydrogenation Plant in the Gulf Coast while Shell (NYSE: RDS-A) is planning an Ethane cracker in the mid-Atlantic.  These plants will use propane or ethane to produce propylene and ethylene which are two of the building blocks for chemical and material manufacturing.  For Dow though, these plants will be the building blocks for a sustainable competitive advantage for their own downstream businesses as they’ll feed these businesses to fuel profitable growth. 

Financials:

These are just two of the areas Dow is addressing which has set their business up for many years of profitable growth.  They recorded $60 billion in sales and $7 billion in EBITDA last year and looking forward they see $15 billion of EBITDA potential from their business.  From this, Dow is committed to returning capital to their shareholders and as earnings improve Dow will keep raising their dividend which is already at 4.25%. 

If there is one drag on the company it’s their $18 billion of long term debt, the company is committed to delevering and are targeting a total debt to market cap of less than 40% while maintaining a two times debt to EBITDA ratio.  Their debt to EBITDA ration has been cut in half over the past four years while their total debt to market cap has gone down from 51%.  By doing this they’ve cut $250 of annual interest expenses which increases their financial flexibility.  Bottom line, Dow is exceptionally run with a very visible pipeline of future growth.

The Trade:

For these reasons and more I want to be an owner of Dow and think that the current price around $30 a share is a fair price to pay for this exceptionally well run company.  However, I think I can do better than pay a fair price by writing an at-the-money put and pick up some additional income for my virtual portfolio , the “No Drip, No Mess” Portfolio.  For the portfolio I’ll be writing a December $30 put which should net me around $200 or a 6% yield on my capital.  If assigned it will give the portfolio a 3% allocation to Dow to start and if shares drop closer to $25 I’d look to buy enough shares to boost that allocation up to a 5% position.  Dow’s options pay fairly well and writing puts is a great way to begin a position in the company.  Not sure if options are right for you, click here to learn how to become an options whiz.

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