Four Reasons to Own Dow Chemical

Step 1

Based on the last couple years, Dow Chemical's (DOW) Earnings Per Share easily cover its dividends. This isn’t your standard story where the operating earnings are falling below sustainability. This dividend has been stable. In fact, it brags in it’s increased or maintained dividends for 96 years. Note that Berkshire Hathaway (BRK.A) is on board this company in preferreds. Check the dividends against earnings below and the predictability of revenues and earnings over the past 10 years just below that.

Step 2

Buy it for cheap. See the chart below. If you buy now, you’re buying around the 52-week low. The PE ratio is 5.6, which implies negative earnings growth. Also, the price/book value is 0.73. This means that if it was liquidated, you’d expect to make money if their assets sell at book value. Also, the PEG ratio is less than 1.

Step 3

Why is it so cheap? Well, there’s a Rohm and Haas (ROH) acquisition that looks like it might be falling apart. My point, who cares? I’ll take the 10% and be happy. Odds are I’ll squeeze out 100% returns before I even catch a dividend because people will be fighting to take the dividend from me and I’ll gladly give it to them at $30. This is Game Theory at its best.

Step 4

If you don’t believe me, check out the company's last Q3 report and read the news.

Disclaimer: I own DOW. This isn’t the kind of company that I usually own, but I really couldn’t pass this one up. They’re paying me 10% to sit around and wait for a price appreciation that appears to be inevitable.

Comments

[sanjiv:]

i also have the same feeling as yours and honestly i believe that dow CEO shud throw ROH out of his office in order to put his own house orderly.

i have a price target of around $ 32 on the share.

sanjiv

Jan 05 08:48 AM

[SJD:]

Another solid and concise analysis. DOW will also benefit tremendously from lower commodity prices, particularly petroleum. Nice job Glen.

Jan 05 09:32 AM

[CHS:]

I am long DOW at an avg price of $26/sh, think it's a great company overall, good management, long standing, etc etc etc; I have a lot of hope for the future and am not planning to sell. BUT, I have to admit that after the K-DOW deal fell apart, I am not so warm and fuzzy as I was a few weeks ago. Considering that 3 of the 4 "reasons to buy" are backward-looking, I don't agree that this is a great article. I'd prefer to see more forward-looking analysis than "so what" if the ROH deal falls apart. There's a lot going on with this company right now, and the next 12 mos are going to have way more impact on the future stock price than the last 12.

Jan 05 10:03 AM

[epeon:]

I agree. I bought DOW last week when it dipped below $15. I plan to hold it till DOW crosses $20.

Jan 05 01:14 PM

[Mansij Hans...:]

The problem with this analysis is that it doesn't look at net cash flows.

If you look at net cash flow for the last 3 quarters, their total cash flow from operating activities minus the total expenditure from investing activities - the net cash flow - is less than their dividend liability.

In other words, the only way they have been able to pay their dividend for the last three quarters is because they have been borrowing money to do it.

So, perhaps they can keep borrowing until the economy turns around, but most of their businesses are in sectors which have no patent protection AND face increasing competition from China.

Furthermore, while Dow has payed its dividend for 96 years, most people don't realize it has borrowed money 3 of those years to pay for it. This is the fourth time they are doing it. Its another reason they are cutting employees - severance payments are one time charges which are generally excluded from EPS numbers, where as salaries directly influence the overall EPS number.

Dow has almost no growth buisnesses and no desire to drastically reduce its size. Unless cost of manufacturing in China goes up significantly and Dow immediately starts selling of its dead divisions, I view Dow with significant going problems and would chose a Certificate of Deposit over Dow stock.

Jan 05 02:39 PM

[Prudent Guy:]

With respect to your reason #3, I don't think you really understand what is going on here.

The pricing does, indeed, have to do with the pending ROH acquisition. But it's that low precisely because Dow has virtually no maneuvering room for altering or getting out of the ROH acquisition, which looks like an absolute disaster at this point.

If, somehow, they were to get out of it, then I would not be surprised to see a 10%-15% single day pop in Dow's share price. But that's pretty unlikely - for ex, there isn't a real "buyer's remorse" clause in this deal, just a 750m penalty Dow would pay ROH if the deal failed regulatory approval (very unlikely).

As it is, they are left with having to use a lot more of that bridge loan than anyone expected, and when they have to refinance such a large amount in fairly short order, the credit market future is murky.

I admit the dividend is tempting, but things are a lot darker for this company than I think you understand. Maybe they'll pull it off (perhaps they could renegotiate the Kuwait deal so they get SOMETHING out of that), but it's not a cut-and-dried BUYBUYBUY at this level - there is still significant uncertainty/risk.

Jan 05 04:27 PM

[mikemichaelson:]

This is a really bad article. There is no explanation of the competitive advantages DOW has on it's competitors, of the declining free cash flow to a level lower than the required future dividends, of important balance sheet metrices like current ratio or debt/equity ratios, and of the fact that no matter what the current book value is the current credit environment won't allow any company like this to sell off its assets at their current book value to justify what seems like a "cheap valuation" based on price to book value measures.

Jan 05 07:37 PM

[{5U}:]

I agree I am surprised this website is letting some kid with no real investing experience post actual articles


On Jan 05 07:37 PM mikemichaelson wrote:

> This is a really bad article. There is no explanation of the competitive
> advantages DOW has on it's competitors, of the declining free cash
> flow to a level lower than the required future dividends, of important
> balance sheet metrices like current ratio or debt/equity ratios,
> and of the fact that no matter what the current book value is the
> current credit environment won't allow any company like this to sell
> off its assets at their current book value to justify what seems
> like a "cheap valuation" based on price to book value measures.

Jan 05 09:10 PM

[Jamaican in...:]

You know while the company's leaders may become distracted from their core business preparing for the upcoming litigation, there is very little except for the politics that would make me hesitate to purchase DOW Chemical.
Lets start, it has a p/e ratio of 5.7 compare that to its competitors whose price compared to earnings is about 9. This means that it earns much much more than its competitors if the cost of aquisition is equaled.
Its business is manufacturing plastics, hydrocarbons for industry, epoxy resins, agricultural products and construction materials.
The world is in a recession, and the things the various economies will need to drag it out of the recession (food, industrial chemicals, building materials, plastics, fertilizers etc) are what DOW produces, and it derives greater revenue from the sale of these products than its competitors (see p/e ratio for DOW vs industry).
DOW is very well positioned to take advantage of its core business and expertise as the world economy comes out of the recession where basic comodity prices (raw materials DOW uses to manufacture its products) are at an all time low.
Up until now I have not owned any of it... but that may well change soon.

Jan 06 08:36 AM

[edwar77:]

There are so many things wrong with Jamaican in Africa's analysis I hardly know where to start. To begin with the P/E ratio is an indication of relative value of the stock price. It does not as you suggest tell you that DOW earns more than it's competitors but only that the market has put a low multiple on DOW's earnings. So it tells you nothing of the efficiencies of the operations.

I do agree with you that without the anchor of ROH DOW would otherwise be able to endure the recession and prepare to take advantage of the next up cycle. Alas ROH is real and in one way or another it will cost DOW dearly. That's what an incompetent cowboy CEO and weak BOD gets you these days in corporate America. Once I read the merger agreement carefully and researched the problems with the Kuwait fiasco I realized that the dividend would be soon toast. So I took my loss at $16.10 and ran "like a thief". The odds for a truly positive outcome for DOW in 2009 are very low in my humble estimation.

Jan 29 05:21 AM

[{5U}:]

Hey Glenn

How you doin on Dow???

Feb 03 04:59 PM

[suppose:]

Most of Dow's feedstock needs are hydrocarbons, which they purchase from hydrocarbon refiners.
Therefore they are subject to the vagaries of hydrocarbon prices, which have been on the increase for at least 3-4 years, and the fact that most foreign competitors have lower cost feedstocks available to them than does DOW.
Simply put on most products Dow's manufacturing costs are higher, making them non-competitive.
They are bleeding cash and this is why they acquired Rohm & Haas, which makes speciality products that are semi-proprietary and turn consistent profits.

Unfortunately they paid too much for R & H. Ultimately bits and pieces of Dow's business will be purchased for cents on the dollar and the unsaleable parts will be shut down and liquidated.

Apr 02 11:33 AM