Dow Chemical´s Promising Future

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Sep 06, 2014

In this article, let's take a look at The Dow Chemical Company (DOW, Financial), a $65.41 billion market cap company, which is the largest U.S. chemical company and provides chemical, plastic andagricultural products as well as services.

Portfolio Mix

The company´s has about 40% of annual sales from the cyclical commodity businesses, and the other 60% from the less cyclical specialty products. The firm focuses on moving its portfolio mix more toward its specialty chemicals, which we think it is in the right direction.

A Leader Position

The firm has a leading position in many products. We can enumerate some of them: chlorine, coatings materials, ethyleneoxide, olefins and polyethylene plastics.

Pricing Power

The chemical industry needs constantly advances, because chemicals are characterized by innovation. Many times, the customers itself propose the initiatives. This make that barriers to entry are higher and the firm can maintain a great pricing power.

Basic Chemicals and Plastics

In these two, we have to mention that barriers to entry are low, which means that profitability is determined principally by scale, technology as well as energy and feedstock costs. Very few rivals can compete with these advantages that Dow Chemical shows.

We think that investments in feedstocks at the U.S. Gulf Coast and in the Middle East should help the company to boost profitability.

Strong Cash

Dow Chemical has strong cash flows that allow the company to announce a 28% hike in its dividend payout of $0.37 per share. Its current dividend yield is at 2.5%, which is higher than the industry average. Moreover, last year it has authorized a program in which it can buy back shares worth $1.5 billion, which is usually seen as a good sign by Wall Street and market investors.

Revenues, Margins and Profitability

Looking at profitability, revenue growth by 2.33% but earnings per share decreased in the most recent quarter compared to the same quarter a year ago ($1.87 vs $0.82).

Ratios such as debt-to-equity ratio and quick ratio show good levels which let me think that management is making effort in this matter.

Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.

Ticker Company ROE (%)
DOW Dow Chemical 17.8
LXU LSB Industries Inc 13.35
FMC FMC CorporationR 19.34
ARG AIRGAS INC 19.06
AGU Agrium Inc 15.63
Industry Median 6.72

The company has a current ROE of 17.8% which is higher than the one exhibit by LSB Industries (LXU, Financial) and Agrium (AGU, Financial).In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking those levels or more, FMC Corporation (FMC, Financial) and Airgas (ARG, Financial) could be better options. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.

03May20171401231493838083.png

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 19.9x, trading at a discount compared to an average of 24.1x for the industry. To use another metric, its price-to-book ratio of 2.8x indicates a premium versus the industry average of 1.86x while the price-to-sales ratio of 1.2x is above the industry average of 1.02x.

As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $27.267, which represents a22.2% compound annual growth rate (CAGR).

03May20171401231493838083.png

As we can see, the share price has jumped by 43.23% when compared to the one year ago level. We think that it should continue to move higher despite this gain.

Final Comment

For everything seen in the article, we think this chemical goes in the right direction. Further, the PE relative valuation and the return on equity that significantly exceeds the industry average and make me feel bullish on this stock.

Hedge fund gurus like George Soros (Trades, Portfolio), Jim Simons (Trades, Portfolio), David Dreman (Trades, Portfolio), Ray Dalio (Trades, Portfolio), Daniel Loeb (Trades, Portfolio) and Paul Tudor Jones (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014.

Disclosure: Omar Venerio holds no position in any stocks mentioned