DOW INC DOW
July 15, 2019 - 11:43pm EST by
JohnKimble
2019 2020
Price: 50.93 EPS 4.27 5.45
Shares Out. (in M): 750 P/E 11.9 9.4
Market Cap (in $M): 38,100 P/FCF 0 0
Net Debt (in $M): 14,776 EBIT 0 0
TEV ($): 52,974 TEV/EBIT 0 0

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Description

 

Overview

New Dow was spun out of DowDuPont on 4/1/19, opening the following day at ~$55/share, after a multi-year process of smashing Dow and DuPont together and creating three rejiggered companies from two. With the spins complete, I believe Dow to be the cheapest of the pieces.

Thesis

Materials generally and Basic/Commodity Chemicals specifically have been a terrible place to be for quite a while. Dow is a mispriced security in a bombed out sector. I believe most of the mispricing beyond the sector to be caused by pessimism around the ethylene/polyethylene (“E/PE”) business, which has pricing tied to oil and which has seen capacity expansion in the past few years. Also potentially contributing to the mispricing is the fact that Dow is a newly spun out security that is different enough from old Dow but perhaps still carries that taint (poor management and high on the cost curve - both no longer the case).

At today’s price you’re paying 6.7x/5.8x  2019/2020 consensus EBITDA and 11.9x/9.4x ‘19/’20 consensus EPS and getting a 5.5% dividend yield. I believe mid-cycle earnings power to be materially higher than 2020 consensus.
We’re at the tail end of global E/PE capacity additions, and once the market sees capacity utilization & margins move higher I believe the stock will re-rate.

Financial Overview

Dow and DowDuPont have recast their segments more than ten times, so you should note that the most recent segment statements provided in an 8-k on 6/3/19 will diverge from my historical statements by trivial amounts.
I’m providing my best crack at 10 years of financials for each segment because I think viewing commodity businesses through a cycle is important, and for the sake of continuity I haven’t followed the latest recast. In the Consolidated Results below you can compare my estimates to that 8-k for reference.

Also note that in my 2019E numbers I’m following the latest segment reporting. 

Finally, keep in mind that the Rohm & Haas deal in ‘09 distorts the ‘08 to ‘09 comparison, but the comparison of the business in ‘09 vs. ‘10 and ‘11 is valid and instructive. 

Performance Materials & Coatings

Financials:

Description:
Consumer solutions: polymers, emollients, chelants, dispersants to HPP companies. Goes into skincare products, soaps, sunscreen. A higher end business. 
Coatings & performance monomers: acrylics that go into paint & coatings, propylene based inputs & plenty of competition

Industrial Intermediates & Infrastructure

Financials:

 

Description:

Industrial Solutions: contains Amines, ethylene oxide / ethylene glycol (EO/EG), oxygenated solvents (divested), and polyglycols, surfectants & fluids. Also has smaller solar and oil & gas businesses.
Polyurethanes & CAV:

Construction chems including sealants and construction adhesives.

Polyurethanes includes 4 parts - Isocyanates, Propylene Oxide/ Propylene Glycol (PO/PG), Polyols, and Polyurethane Systems

CAV - only the European Chlor-alkali business as the North American business was sold to Olin in '15. 

 

Packaging & Specialty Plastics

Financials:

Description:
This is a straightforward segment containing ethylene crackers and related co-products. Economics are largely determined by the natural gas / oil spread (or more accurately the naphtha / NGL spread). 

Consolidated Results

Here is the 8-k on 6/3/19 showing the newest segment breakdown. You can compare ‘17 and ‘18 to my numbers, with the big adjustment being changes in transfer pricing of intermediate chems between the segments.


 

2019E and “Mid-cycle”

Two key considerations for me are the mid-cycle earnings power of the business and a reasonable downside scenario.


Management has set their dividend and buyback targets based on being able to keep the dividend and the investment grade rating in recession scenarios. They’ve also targeted total shareholder returns based on returning 65% of mid-cycle earnings, where approximately 45% should be the dividend and the remainder should be buybacks. With a 70c/q dividend, management implies mid-cycle EPS of $6.22 (2020 consensus is $5.45).

 

I’ve arrived at similar mid-cycle and downside scenarios:

For a downside scenario, check out 2009 EBITDA for the segments above vs. 2010 (better to look this way vs. ‘09 vs. ‘08 given the Rohm & Haas acquisition in early ‘09). EBITDA in ‘09 vs. ‘10 was almost 40% lower. Note that ‘09 doesn’t include a full year of Rohm & Haas and that it was probably more severe than a typical future recession might be. So Dow management’s estimates of a 30-35% compression in EBITDA seem reasonable to me. 

 

For mid-cycle, the key assumptions I’m making are around remaining synergies and stranded cost removal, a modest rebound in E/PE margins, and breakeven results at Sadara (vs. losses currently). 

Most synergies and stranded costs will be realized this year (see the 3/18 presentation) so I’m taking these values at face. 

E/PE margins are a bit trickier, but I’m essentially having them regain about $560mm in 2020 after declining $750mm in ‘18 (see Dow bridge below) and another estimated $750mm in 2019. 

I’m assuming that global operating rates in 2020 will at least match those in 2018 and most likely exceed those of 2018 and 2017. Despite that, I only have Dow recovering $559mm of E/PE margin in 2020 after $1.5b of E/PE margin compression from ‘17 to ‘19. 

Dow’s view (see below), and LYB’s view for that matter are that operating rates will actually improve.