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Dow Chemical: If The World Economy Recovers, This Company Will Take Off

December 23, 2011 | About:
Chemistry is a key to life as we know it. And through the growth of industrial America, Dow Chemical Company (DOW) has been supporting America, and more recently, the world through better chemistry. DOW was a leading military supplier of chemicals during all wars from WW I through Vietnam. Part of that heritage is it was a leading maker of Agent Orange and Napalm. I have a soft spot for DOW, as its headquarters is in my home state. I am going to take a close look at DOW and compare it with some of its peers to see how it measures up from an investor's point of view.

Herbert H. Dow sought to sell household bleach in 1897, and that was the start of what became Dow Chemical Company. Its business was substantially enhanced by two large acquisitions; Union Carbide in 2001, and Rohm & Haas in 2009. These purchases, along with smaller purchases, were part of Dow's strategy to trend away from commodity chemicals, and toward proprietary and consumer products with higher profit margins. It seems to be working, but not without hiccups.

In the third quarter of 2011, DOW reported revenues up 17% year over year, with increases across all geographic and product categories. Profits were also up 17%, to $729 million, or $0.62 per share. DOW was trading recently at about $28 per share. Its 52 week range is from $42.23 to $20.61. It has a market capitalization of a little over $33 billion, and a P/E of 11.5. It recently raised its dividend by 67%, to $0.25 per quarter, for an annual yield of 3.9%. I view it highly likely that dividend amount will continue to increase. DOW cut its quarterly dividend from $0.42 to $0.15 per share in 2009. It was the first time in the company’s history that it had ever cut the dividend, and I believe DOW wants to make up for that cut as soon as possible.

Looking at secondary numbers is somewhat less impressive. DOW has been on a roll since bottoming out in recessionary 2009. In the year to date ending September 30, 2011, DOW reduced its debt by $4.2 billion, bringing its debt/capital ratio to just over 40%. Much of DOW's recent success has been predicated upon its ability to raise its prices, and focus on developing markets. DOW by its nature is fully exposed to macroeconomic conditions worldwide. Actual sales volumes in North America and Europe actually declined in the third quarter on a year over year basis. But volume increases in places like China and Brazil allowed overall product volumes to be even on a year over year basis. All of the increased revenue in the third quarter, therefore, was due to price increases.

DOW has made much of its environmental stewardship, and its list of awards and achievements is long. It has been part of the Dow Jones Sustainability Index eleven times. Yet it is still at its core a chemical company, and its work has led to dioxin contamination over a fifty mile swath of rivers and floodplains downstream from its Midland, MI headquarters, and years of remediation have failed to rid the area of dioxin contamination...

Two of DOW's leading competitors are probably German based BASF SE (BASFY) and 3M Company (MMM). This table highlights some key statistics.

Ticker P/E Market Capitalization ($ billions) 12 month trailing return on equity % 12 month trailing return on assets % Dividend yield %
DOW 11.5 33.2 13.5 4.2 3.9
BASF 7.9 63.3 30.2 10.1 nil
MMM 13.8 56.8 26.1 12.3 2.7


All of these companies are similarly affected by economic conditions. And BASF in particular is exposed to the uncertainty of the European market. But what is clear is that compared with these peers, DOW is not very profitable.

While the bulk of DOW's sales are in plastic and chemicals, I believe much of the future of DOW is in its water purification and agricultural divisions. DOW's water purification system using Filmtec reverse osmosis membranes are used throughout Asia, Africa, and the Middle East to purify water for human consumption. The agricultural division makes herbicides, fungicides, and genetically modified seeds. More than any other part of DOW, the agricultural and water divisions are relatively immune from cyclical forces, and growth is nearly guaranteed due to climate changes and a burgeoning world population.

One other bit of good news about DOW is as of year end 2010, its pension fund held assets of $21.2 billion, over $5 billion more than actuarial estimates of DOW's pension obligation of $15.9 billion. That sort of imbalance is certainly not a bad problem to have.

DOW carries a mean analyst rating of a fairly neutral 2.5. Charles Brandes owns just over 200 thousand shares, the investment firm Dodge and Cox owns over 33 million shares, and Capital World Investors owns nearly 90 million shares. DOW's stock has a beta of 3.0, indicating the stock price is volatile. But if the world economy continues to recover, few companies are better positioned to bounce than DOW. Personally, I am not willing to make that bet. But I would not think you were wrong if you did.

About the author:

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Rating: 3.5/5 (13 votes)

Comments

DocMoney
DocMoney - 2 years ago
Well, I own BASFY. Dividend yield is not nil; it is about 4.5% now. Also, BASFY has a thriving US division, as well as multiple emerging and developed market divisions, so it is not confined to the Eurozone.

When you do EV/Owner earnings, you get about 9 for BASFY and more than 20 for DOW. The valuation gap is pretty significant.

What I like about chemical companies now is that their margins are set to be fat due to low natural gas prices, from which many chemicals are made. By the way... Did you know BASFY has its own... natural gas and crude oil exploration, production and trading company? It's called Wintershall.

By the way, Wintershall has operations in Libya and BASFY stock was punished when the Gaddafi thing went down - but now they are restarting production...

BASFY has the scale to compete with just about anyone, it is cheap by the numbers and appears well-managed. Someone please write it up for the value contest and send me half the winnings:)

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