What's Going to Power Dow in the Long Run
Neha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Dow Chemical’s (NYSE: DOW) second-quarter numbers aren’t anything to write home about—it missed Street estimates on both top and bottom lines. Economic headwinds are strong, demand is low. The ride this year is going to be bumpy, but that doesn’t mean the company will fail you in the long run.
Despite low input costs (energy and feedstock costs were $1 billion less than that incurred in the second quarter last year), Dow’s second-quarter net income slumped 34% from the year-ago quarter to $649 million as sales fell across divisions due to low demand. Dow operated its plants at just 78% capacity.
As at DuPont (NYSE: DD), Dow's electronics business continues to feel the heat of softness because of destocking by customers. Sales in its electronics and communications division slipped 4%. Volumes are improving sequentially, but at a slow pace. Dow’s coatings and infrastructure solutions business, as well its largest division, performance plastics, got hit largely because of weakness in Europe. Accounting for a third of its total sales, the region is the major headwind Dow faces right now. Worries have compelled it to shut down some plants, reduce workforce and restructure operations in Europe—factors that are likely to add to costs in the near future.
The only bright spot in the second quarter was, not surprisingly, Dow’s agricultural sciences division. Sales rose 12% backed by a strong planting season in the U.S. as well as robust global demand for seed and crop protection products. Agriculture proved to be the saving grace for DuPont as well as it contributes nearly a third to the company’s total sales.
Dow admits it will continue to feel the heat of economic slowdown in the near term. But that is not deterring the company from making investments that will help it grow bigger in the years to come, and which is riding my positive view on the stock.
Sales in Dow’s largest business, plastics, might have been down, but volumes are improving. The long-term outlook for the plastics business looks bright, particularly in the wake of rock-bottom natural gas prices, which is not only keeping costs in control but also triggering some big investments in the industry. In trend with most industry players, Dow is showing preference for gases over naphtha (used to run plants as well as make ethylene used in plastics), and is carving out investment plans accordingly.
Earlier in the year, after Royal Dutch Shell (NYSE: RDS-A) announced plans to build an ethylene cracker (which will also be the first such cracker to come up in the U.S. since 2000), Dow joined the league with plans to set up an ethylene plant in Texas. The project is on track to start operating in 2017. Other big plans include setting up new propylene facilities. Dow is opting for expert Honeywell International’s technology to convert shale gas to propane to propylene at one of its plants to be operational by 2015. These moves, together with restarting an existing cracker will increase Dow's ethylene production capacity in the U.S. by 20% in the next three years. Dow is currently the second-top ethylene producer in the world in terms of production capacity, ahead of both Exxon Mobil (NYSE: XOM) and Shell. Exxon Mobil too, in a bid to tap the opportunity, announced expansion plans for its refining and petrochemical facilities at Texas which include building an ethane cracker and adding polyethylene lines to its plastics complex.
Not to forget Dow’s joint development of the world's largest petrochemical facilities together with Saudi Arabia-based oil company Saudi Aramco.
Beyond the ordinary
Dow’s mind-blowing business diversity should help it balance risk and tide over challenges well. Beyond plastics, the company is Foolishly tapping into growing alternative-energy trends. The most interesting tie-in is the one with Ford (NYSE: F), under which the two will develop cheap carbon fiber composites that can be applied economically to Ford’s vehicles to make them lighter keeping President Obama’s ambitious fuel standards in mind. Dow’s relationship with the auto giant goes a step further with its plans to power Ford’s trucks with its lithium batteries—a business Dow is expanding.
In another agreement, Dow has agreed to buy millions of gallons of innovative algae-based fuel from Solazyme over the next few years for application in its electricals business. The chemical major is also aggressively promoting its revolutionary solar roofing shingles, launched last year in collaboration with leading homebuilder D.R. Horton.
As for its agri-business, Dow has a lot of products lined up. During the second quarter, it launched its corn-protection product POWERCORE to gain traction in the high-potential Latin American market.
To support its massive growth plans, Dow is working judiciously to lighten its debt burden. From 41.6% in the second quarter last year, the company has brought down its net-debt-to-capital ratio to 40.4% this time, remaining on track to meet its target of 40% by the end of 2012. My only concern is its dividend payout ratio of 68%, which I feel is a little too high for comfort given the debt on books. One can’t even rule out the possibility of the company cutting back the dividend, as it had done way back in 2009, in case the downturn hits the chemical market harder. Nevertheless, a handsome dividend yield of 4.4% is nothing to complain about.
The Wait Continues…
Dow’s a stalwart, but what’s keeping it in the news in recent months isn’t any of its wise moves or performance. It is something that has more to do with ethics and corporate social responsibility— areas no company can afford to ignore in the 21st century. The impossible-to-deny relationship between Dow Chemical and the Bhopal gas tragedy that shook the world nearly three decades back hit headlines when the company decided to be a sponsor in the 2012 Summer Olympics.
Dow has already faced the ire for shirking responsibility over the years in the form of worldwide protests, legal costs, and damage to reputation. The Olympic Games indeed seem to be the perfect platform for the company to assume responsibility, make reparations and salvage some of its reputation to emerge a true business leader.
The day Dow does it, as a person who values ethics above all-- I’ll raise my hands in salute to the company; and as an analyst-- I’ll be more confident about my bullish view on the company that otherwise is growing solidly and even pays out well to boot. Click here to add Dow Chemical to your stock watchlist to stay updated on all its news and analysis.
Neha Chamaria has no positions in the stocks mentioned above. The Motley Fool owns shares of Ford and ExxonMobil. Motley Fool newsletter services recommend Ford. 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.