Since Dow's (NYSE:DOW ) split from DowDuPont in 2018, the stock has risen slightly less than the S&P500. Dow faces temporary headwinds, such as price pressure on its polyethylene products. In addition to this price pressure, logistical issues on the US Gulf Coast prompted management to temporarily cut its polyethylene production rates by 15%. Keybanc recently lowered the expectations of major chemical companies. But this presents a good buying opportunity.
DOW Total Return Level data by YCharts
The headwinds are temporary, and the stock is too cheap to ignore. Management has initiated a $3 billion share repurchase program that will drive the stock price to a higher level.
Dow is a company that was spun off from DowDuPont in 2018. The company provides packaging solutions, infrastructure, mobility and consumer applications in the United States, Canada, Europe, the Middle East, Africa, India, Asia and Latin America.
The company operates through three business segments:
Net Trade Sales by Segment and Business
The first business segment supplies various ethylene, propylene and aromatic products. These are mainly used in packaging, mobility, etc. This business segment is a major contributor to their revenue. Main competitors in this business segment are Borealis, Chevron Phillips Chemical, Exxon Mobil (XOM), INEOS, Lanxess, LyondellBasell (LYB), Nova, SABIC, Shell (SHEL), and Sinopec.
Their second business segment provides polyurethane, polyvinyl chloride and other industrial solutions. These products are used in pharmaceutical industry, aircraft defrosting, concentrated solar heat transfer fluids, construction and so on. Competitors here are Arkema, Ashland, BASF, Covestro, Eastman, Hexion, Huntsman, INEOS, LyondellBasell, SABIC, Sasol, and Shell.
Their third business segment focuses on the production of acrylic binders for paints and coatings, adhesives, inks and paints, personal care and home care, which are used in a variety of industries. Competitors in this segment are Arkema, BASF, Celanese, Elkem, Evonik, LyondellBasell, Momentive, Shin-Etsu, and Wacker Chemie.
Dow supplies a wide range of chemical products for various industries. The company is well diversified, but there are many competitors in their business segments. Dow's polyurethane business is the world's largest producer of propylene oxide, propylene glycol and polyether polyols. This should give them a competitive advantage.
A recent article described that Dow has temporarily reduced polyethylene operating rates by 15% of global nameplate capacity. Global logistic constrains, port and rail congestion in the U.S. Gulf Coasts and "dynamic conditions" in Europe are the reasons for the reduction. Dow describes that the duration of these measures depends on the duration until the market and logistical conditions have normalized.
We also expect these actions to help balance elevated inventories in warehouses and at key ports around the world and its logistics resiliency, particularly in the USGC ahead of the most active part of the annual hurricane season in the U.S.
Shipping from Houston has improved slightly, but they can still only ship half of what they need to ship. Container volumes via Houston (the Gulf Coast's main container port) increased by 22% in the first half of 2022 compared to the same period in 2021.
The reason for the congestion is that the East and Gulf Coasts are gaining more market share than the West Coast, especially after the massive congestion at Los Angeles and Long Beach in 2021. Also, shortages of rail capacity and warehouse space mean that cargo stayed in ports too long.
East Coast Gains Market Share (Dow Investor Relations)
East Coast Gains Market Share (Dow Investor Relations)
These problems occur not only in the US, but also in Europe and the rest of the world. In Europe, dock workers are on strike or on vacation and there is an acute shortage of truck drivers.
For Dow, the logistical problems could lead to an increase in supply. It therefore makes sense to cut operating rates by 15% to maintain the prices of their products. The lower production volume should bring polyethylene prices back to normal levels.
Keybanc recently downgraded Dow and other chemical companies due to pressure on polyethylene, polyvinyl chloride and other product prices. Polyethylene products remain Dow's largest source of income, as Packaging & Specialty Plastics accounts for more than half of Dow's revenues.
Polyethylene prices have fallen somewhat over the years, but as you can see in the chart below, prices fell drastically during economic recessions. Polyethylene prices are approaching historic lows and as Dow and other manufacturers cut operating rates, prices will bounce back.
The global polyethylene market is expected to grow at a CAGR of 3.4% until 2027. One of the key drivers of growth is the production of electronic vehicles. This is reflected in the presentation of Dow's quarterly results: car production in China increased by 30% MoM, with record sales of electric vehicles. Electric vehicles contain 3-4 times more silicone than traditional combustion vehicles. Polyethylene is preferred because it is lightweight, easy to process and has favorable material properties. The use of polyethylene in EVs is an advantage as the EVs become more fuel efficient. Fuel efficiency is more important because car batteries make EVs much heavier than traditional combustion engines.
Polyethylene is also used in packaging and has the advantage of having the property of forming a moisture barrier. This prevents food contamination and loss of quality. Dow is well positioned to grow in these secular trends.
In 2021, Dow generated $5.6 billion in free cash flows, of which $3.1 billion is returned to shareholders through dividends ($2.1 billion) and share repurchases ($1 billion). The repurchase yield was about 3% last year.
Management is shareholder friendly and recently introduced a new $3 billion share repurchase program, which complements the current remaining program (then $775 million). In the second quarter, $800 million worth of stock will be repurchased, so there's about $3 billion left to repurchase. This translates into a nice buyback yield of over 8%, which should boost the share price.
The forward dividend yield is 5.5%, which is the 443rd consecutive dividend payment by the company or its subsidiaries since 1912. The dividend plus the large share repurchase program is well covered by their free cash flows. There is no long-term debt maturity until 2027, so the company should be doing well.
What about its valuation? For an industrial company, I prefer to use EV/free cash flow because it includes the market value plus debt minus cash compared to the free cash flow generated by the company.
DOW EV to Free Cash Flow data by YCharts
Dow is trading at a historically low valuation. Compared to LyondellBasell, Dow is valued more expensively. However, this difference is small. Both companies are valued very cheaply with an EV/FCF of 6 to 7.6. It is also interesting to explore LyondellBasell in more detail. The low valuation, secular growth in polyethylene for EVs and packaging, and the shareholder-friendly management make Dow worth buying.
Dow recently spun off from DowDuPont in 2018. The company provides various chemical products divided into three business segments: 1. Packaging & Specialty Plastics (51% of sales in 2021), 2. Industrial Intermediates & Infrastructure (31% of sales in 2021) and 3. Performance Materials & Coatings (18% of 2021 turnover). Recently, Dow has faced headwinds from price pressure in its polyethylene business. In addition, the congestion of ports and railroads on the US Gulf Coast has prompted Dow to cut its polyethylene production by 15%. These temporary headwinds provide opportunities to buy the stock. Because the production of polyethylene has fallen, prices will rise. The secular trend remains intact, EVs come with 3-4x as many plastics as traditional cars, increasing demand. The stock is favorably valued and management has announced a $3 billion share repurchase program. The stock is worth buying.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in DOW over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.