An Easy Way to Get Cash-Rich This Year
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When the going gets tough, the tough get going. It couldn't get more apt for Dow Chemical (NYSE: DOW). With core markets witnessing a lull, the chemical baron is working harder to push up margins. Or let me interpret it this way. When things are not moving, Dow wants to let go of stuff that is getting hard to handle.
After deciding to do away with 5% of its workforce and pull the shutters down on several plants, Dow now plans to shelve some assets that do not seem to fit its bill anymore. Is this divestment worth attention? If yes, what’s in it for you?
Not the first
2012 was a dull patch for the diversified chemicals industry. With growth hard to come by, most players are taking time out to restructure and align operations to taper costs and perk up margins. Several similar announcements already poured in from DuPont (NYSE: DD) and Huntsman (NYSE: HUN) in recent months.
DuPont is doing away with 1,500 employees over the next year and recently sold off its performance coatings (auto paints) business in a $4.9 billion deal. Huntsman spent a major part of 2012 hauling up its two loss-making businesses – advanced materials and textile effects. While this restructuring is in progress, Huntsman is already drawing up plans to scale down its pigments business in the years to come. Clearly, cost cutting has caught everyone’s fancy.
It was coming
Two of Dow’s businesses, which are parts of its two largest divisions -- performance materials and performance plastics – will be put up on sale. The two divisions accounted for 50% of Dow’s total sales last year. Polypropylene (a plastic polymer) and plastic additives (used in automotive, construction, consumer goods, and other industries) units should be out of Dow’s home over the next year and a half.
Dow was increasingly getting fidgety about its plastics portfolio for a couple of years, and had already sold off a major portion of its polypropylene business to Brazil-based petrochemical major, Braskem SA in 2011. Dow’s performance plastics segment, of which polypropylene is a part, was among the worst performers last year with an 11% dip in revenue.
Likewise, sales at Dow’s plastic-additives inclusive performance materials division slipped over 5% in the fourth quarter with full-year revenue down about 7%. Chemtura, the world’s leading additives maker, witnessed softer global demand in its last quarter as well. Sales in its additives business slipped 5% last year on lower volumes. So this business is on soft grounds, and Dow might be doing just right hiving it off.
A workable idea
The idea behind the moves is to focus on better profit businesses. Interestingly, the two largest divisions are also among the best margin generators. Even with a low key business like polypropylene, performance plastics tops when it comes to margin generation -- It alone accounted for 54% of Dow’s total EBITDA last year. More than 40 new products were launched and sales for elastomers (rubber) hit a record high in 2012. A new facility is already on its way in the U.S.
The story is similar with Dow’s performance materials business, which is second largest after plastics. It generated around 12% EBITDA margin over the past four quarters, but Dow has a target of up to 18% in the near future. As low-profit units are chucked out, target margins should be easily attainable.
It’s not surprising then that as the largest divisions, these two are drawing plenty of attention from Dow. In fact, the biggest chunk of funds is going into them. So alongside divesting, investing is also full on for these divisions. Among the biggest projects are ethylene and polyurethanes capacities ramp up.
Following the footsteps of Royal Dutch Shell and Lyondell Basel (NYSE: LYB), Dow is aggressively expanding into ethylene. It has restarted a cracker in Louisiana and is setting up a new one in Texas. Dow clearly doesn't want to miss the opportunity low ethane (a natural-gas component that produces ethylene) prices have thrown up.
Lyondell, which has lined up several projects, views it as a "seize the moment" time. It is about to kick off one of the first projects in the U.S. that will up its U.S. ethylene capacity by nearly 20%. Three of its capacity-expansion projects revolve around Texas, and most should be over by 2015. In fact, as the world’s largest polypropylene maker, many are expecting Lyondell to be a front runner for Dow’s unit.
Dow’s other goal is to take its polyurethanes business to an altogether new level. It has proved to be the most profitable business for Huntsman in recent times. Huntsman currently dominates the market with 18% share. While Dow is at 12% clip currently, it could well overtake Huntsman once its would-be world’s largest petrochemical facility that is currently underway in Saudi Arabia starts operating by 2016. With the Asia-Pacific region as the main target, this project will be Dow’s window to emerge as a global leader.
What you can expect
Dow expects to raise $1.5 billion from the sale of the two units. Its war chest just got heavier with a $2.5 billion award for damages in an arbitration case with a Kuwait- based company. These, together with planned reduced capital expenditure of about $2 billion this year, should push up Dow’s free cash flow (currently at $1.5 billion) significantly.
Like DuPont, Dow wants to use the extra cash to pare down debt while rewarding shareholders. Any improvement in Dow’s current total debt-to-equity ratio of 124% will be welcomed by investors. In 2012, Dow increased dividend by 34%, and in February it announced a $1.5 billion buyback program.
One can expect a lot more bounties as Dow gets leaner and better. More important, the two businesses I detailed here aren't the only ones Dow is spreading its wings over. A lot is brewing in other areas as well. I’ll tell you more in an upcoming post together with what you should do with Dow’s stock now. Stay tuned.
Neha Chamaria has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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!