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Watch Out: There’s Huge Opportunity in Dow

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) last quarter was a disaster, it is down to cost cutting to save margins, its stock has shed 7% in the past three months, and the downdraft battle only seems to be worsening.

So will Dow buckle under the pressure? It’s prudent to delve deeper before jumping to conclusions. Let’s see how Dow fares.

Strengths

It’s huge: Dow is the world’s second-largest ethylene producer by capacity after Saudi Basic Industries, which means it is ahead of ExxonMobil, Royal Dutch Shell (NYSE: RDS-A), and Chevron. Wow!

It’s wide: Dow scores high for diversification. Broad business categories include performance materials (automotive and oil and gas), performance plastics (medical and packaging), agricultural sciences, advanced materials (electronics and coatings), and feedstock and energy.  Phew! Naturally, risk is beautifully diversified, which works wonders when one strong business makes up for a dull one. Case in point: in its last quarter, agricultural sales rose 8% while that in the other five divisions slumped.  

It’s wise: No product accounts for more than 5% of total sales, which means no dependency on a single product.

It’s creative: Innovation is in Dow’s blood. From revolutionary solar roofing shingles to advanced lithium-ion batteries to paint pigment alternatives, Dow is doing it all. It invested $1.65 billion in research and development last year, and even bagged a spot in Reuters’ first-ever list of Top 100 Global Innovators.

It’s growing: From 28% in 2008, Dow’s revenue from emerging economies stands at 31% currently.  Its immediate target is 35%. 197 sites in 36 countries catering to customers across 160 countries – that’s Dow for you. Increasing global presence topped with solid investments makes for the perfect recipe for growth.

It’s quick: Dow’s management isn’t slow in taking stock of situations. In the wake of global slowdown, Dow will go leaner by downing the shutters on 20 facilities and cutting 5% of total workforce. Expected savings are $2.5 billion over the next two years. DuPont (NYSE: DD) is on the line too, but not as aggressively – it will reduce its workforce by 2% to generate savings of $450 million next year.

It’s generous: Hold your breath: Dow has paid dividends every quarter for the past 100 years. Its dividend payout ratio has averaged around 50% since 2005, and it yields a solid 4.5% currently.

Weaknesses

It’s struggling: Dow’s operational metrics were great, till last year. Dow struggled throughout the year. Over the past twelve months, its revenue and earnings shed 5% and 24%, respectively. What concerns me is this: Europe accounts for more than a third of Dow’s sales. With crisis only worsening, tough luck is unlikely to leave Dow’s side soon.

It’s burdened: At total-debt-to-equity ratio of 103%, Dow is highly leveraged. While high debt isn’t unusual for a capital-intensive industry like chemicals, long periods of sluggish economy conditions might trigger a cut in dividends. Dow did that in 2009 -- investors should be aware. Cash flows of $1 billion aren’t quite enough for debt that runs up to $18 billion.

It’s risky: Dow’s reputation is disastrous when it comes to social responsibility. Its involvement (in a manner hard to question) in a horrendous tragedy that killed thousands in India in 1984 still haunts. Dow’s sponsorship at London 2012 Summer Olympics was met with outraged protests. The company has already borne huge legal costs over the years, and as long as the case remains pending, the red flag will fly.

Opportunities

It’s focused: Together with Saudi Aramco, Dow will set up the world’s largest petrochemical facility by 2016 that would generate $10 billion revenue annually. The key product will be polyurethanes, which has proved to be profitable even during downturns – when all other divisions reported a fall in sales, Huntsman’s (NYSE: HUN) polyurethanes business reported a 10% jump in revenue for the first nine months of the year. The project will pitch Dow closer to Huntsman, giving it a chance to improve its MDI (a major polyurethanes product) market share from 12%. Huntsman currently dominates with 18% share.

It’s gassed up: Low natural gas prices could be a game changer. As soon as Shell revealed plans to build in Pennsylvania what-would-be the first ethylene plant in the U.S. since 2001, Dow announced an ethylene cracker in Texas targeting completion by 2017, which coincides with Shell’s time frame. Ethylene is derived from ethane which in turn comes from natural gas deposits. In a recent presentation, LyondellBasell (NYSE: LYB), the eighth-largest ethylene producer, showed how cost of ethane has nearly halved from its year-ago level. Anticipating great potential, Lyondell is also investing $400 million to boost capacity. Dow’s moves should pump up its ethylene production capacity by 20% by 2017, taking its two largest businesses to new heights.

It’s innovating: Lithium batteries and carbon fibers to take the weight off vehicles, innovative algae-based fuel, sugarcane-based ethanol in Brazil, bioplastics – the list of alternative-energy trends Dow is tapping into is long. Agriculture by itself is a huge opportunity; else DuPont wouldn’t have taken pride in getting more than a third of its revenue from this sector today.

It’s smart: Dow claims that over 95% of smart devices manufactured worldwide use its materials. Need I say more?

In short, opportunities for Dow are more than you or I can imagine.

Threats

It’s melting: Slowdown in emerging economies hurts Dow. Agriculture is the only division where demand remains firm, but it isn’t much of Dow’s total sales. Improvement in these markets could be painfully slow, and a worsening Europe could prove a disaster.

It’s volatile: Prices of ethylene and propylene feedstock have swung wildly in the past few years, making it tough for Dow to improve margins, and they remain a threat big enough to keep the company on its toes.

It’s crowded: Diversification comes with its cons, one of which includes a longer list of rivals. Along with chemical companies, Dow has to tackle oil majors and agricultural players as well. And none of them are sitting on their hands while Dow swells. So Dow will have to remain proactive throughout to prevent others from beating it in its own race.

Foolish roundup

Dow might not seem like the best bet at present, given the economic headwinds and its high P/E of 22 times when DuPont and Huntsman are trading at 13 and 7 times earnings, respectively. Yet, Dow looks strong enough to handle macro challenges and turn out a winner in the long run. Keep a track of the stock as it marches towards growth by adding it to your stock watchlist. Click here to add it. 


Nehams 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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