The Dow Chemical Company (NYSE:DOW)
Citi Basic Materials Conference Call
December 3, 2013 09:30 ET
Jim Fitterling - Executive Vice President, Feedstocks, Performance Plastics, Asia and Latin America
Jim Fitterling - Executive Vice President, Feedstocks, Performance Plastics, Asia and Latin America
Thanks very much and appreciate the attendance today. Before I start I just want to make the prerequisite comments about all the sales comparisons and divestitures, exclude divestitures and EBITDA comparisons that I’m going to give you today exclude certain items and also please note that any of our disclosures on forward-looking statements and non-GAAP financial measures both of these can be found on our website. Today I’d like to cover really four high level items with you.
First is Dow’s continued drive to focus on markets and how that’s driving our earnings growth and how we are allocating our resources to attractive markets that are growing so we can capture the value for innovation. And then I’ll switch a little bit into our steady and intense focus on return on capital and shareholder return which is driving both improvement actions and also some of the strategic portfolio decisions like the one we announced yesterday. And then I’ll touch on some of the specific near term catalysts that have us on our earnings growth trajectory to 10 plus billion dollars and finally I’ll close with a look at financial achievements and what the priorities of the executive committee are as we go forward.
So first we’ve been on a journey for the last several years in transforming the portfolio and most recently a lot of our activities are centered around looking at the market alignment and the market focus of our portfolio. And we are trying to take coordinated actions to increase our exposure to attractive end-markets while maintaining a strategic focus on maximizing return to our capital on our shareholders and part of that is a portfolio change and part of that call sort of change as well.
Let me just give you a quick overview of how we look at the market selection and how that’s driving our investment for higher earnings. And we start with attracting selective end-markets and understanding the value chain and how we can support our resources to create and defend some sustainable advantages. I want to give you a couple of examples upcoming on our plastics and our Ag businesses which are some of our key drivers.
And then we’re looking at markets that are large and growing where we have a – that have long term drivers in place and unmet needs in place that we can take our science and technology solutions too, and the willingness to pay for technology driven answers to those problems that directly and efficiently meet the needs of the marketplace and we’ve talked about some of these in some of the various conferences.
I think you heard us talk about plastics and what we are doing in our Electronics business, what we are doing in Ag Sciences, our Water business would be examples of that. Our decision on the stronger participation around the key markets, Electronics or Coatings or Packaging, Ag, Consumables, Infrastructure and Transportation really get back to the value-added part from innovation and in the last five years we’ve invested nearly $8 billion in research and development and we have a very rich pipeline of innovation and prioritize opportunities to deliver real near term MTB.
When it creates advantage we leverage that globally and leverage that integration throughout our value chain and that maximizes the amount of value that we can capture in the business and enables a low cost position for us to compete globally. And the low cost position is still an important part of Dow going forward although we are shifting from strictly products offered to more of a market driven focus here. And in line with the stated objective where we select and attractive markets for our investments we are also deselecting some markets that we don’t see as a strategic fit longer term. So in line with that we’ve recently announced that we’ve increased our divestiture target to $3 billion to $4 billion worth of businesses by year end 2015 and I’ll talk more about that shortly and recap some of yesterday’s announcement.
So at a high level we are going deeper and narrower into markets where we have established position of strength and where we can generate superior margins by leveraging science and technology and highly competitive cost position moving from what we would call a classic products offer strategy to more of a market driven model without losing the strength that we’ve gained over 115 years. So let’s take a closer look at how are aligned to some attractive long term growth markets.
First I’ll touch on our Ag Sciences segment which is a very research base and technology focus business with a very strong fundamental demand driver and the basis of the key growth here is that there is a growing global resistance test with these – to the existing technology that farmers rely up on to drive the Ag industry and its presenting challenges for food production and its driving new demand for new and differentiated solutions to improve yield and reduce the cost of crop production and that demand continues to grow as the population continues to grow and Dow has leverage disposition as an integrated science company to meet the evolving needs of farmers.
On this slide you will see a few examples of leading innovative solutions, each of these addresses a promising market opportunity with a significant MTB potential that can be achieved in the medium term. And in our Crop Protection platform I want to highlight sulfoxaflor insecticide which is a product that received EPA registration in May of this year and targets about a $2 billion market opportunity where we had previously not participated. Also in our seeds, traits and oils business which we’ve been investing in for years we continue to post strong growth with sales up year-to-date over 18% and continued gains for corn hybrids which are featuring our SmartStax technology.
And looking forward this is where we’ll implement and launch our Enlist Weed Control System which is the next generation solution of that technology to combined both innovated traits and seeds and novel herbicides in corn, cotton and soybeans to deliver high performing solutions needed by farmers to address the increasing challenge of weed resistance. We believe Enlist is the right answer at the right time for farmers. Our solutions are helping farmers increase yields and productivity and for the whole segment it’s evident this year in our 11% sales growth year-to-date and we remain enthusiastic about our growth prospects in the Ag Sciences.
Next Performance Plastics which is near and dear to my heart is a segment that focuses on serving dynamic end used market with differentiated products. We have a very strong value chain engagement in this segment so it’s more than just making plastics and selling plastics we are working all the way through R&D and production all the way to the brand owners trying to combine the low cost feedstock position that we have and that advantage which is enabled by our operational excellence with also an advantage business model which generates premium margins for us. We have a technology portfolio and some industry leading brands to grow and drive in these markets and as a result we become the partner of choice to deliver solutions such as food safety and quality to brand owners.
So in a very simple way Dow’s industry leading packaging franchises aligned with the customers and the markets that have some very high term, long term growth potential. And one of the reasons we’re excited about the packaging industry is this is a $690 billion industry today when you include all of the packaging materials that are used today. The plastic portion of that is $240 billion and within that the flexible packaging part of that market is about $90 billion and that is one of the fastest growing part of the entire packaging segment. A lot of sustainability drivers driving that demand but also a lot of quality and food safety drivers driving that and a lot of marketing drivers for the brand owners as well.
The market trends continue to demand more from the industry so as we continue to urbanize as you continue to see population growth and rising incomes in emerging markets, food waste reduction activities all through the food chain. This all drives the need for increased sustainability, some better high performance packaging solutions and in places that we can deliver increased shelf life for brand owners’ products and as we add the marketing capabilities to them. Per capita consumption of our Performance Plastics products continues to rise because packaging contributes such a important way to a sustainable modern lifestyle. And so as you look at the emerging geographies you see some very high upside to the market growth.
See on packaging we are well positioned to capture additional growth in markets such as our Hygiene & Medical business, Infrastructure, Consumer Durables, and Transportation and in fact all of our investments in Sadara and Gulf Stream, our Texas projects and Louisiana projects are directly targeted at these high value margins. So those are couple of examples in our two largest segments of the company and there are many more likely across the company.
Over the – if we shift now the return on capital over the previous 12 months we’ve maintained a steady focus on driving a return on capital improvement and an increase in shareholder value. And in our last Investor Forum we shared some business-specific ROC drivers, first we said we would grow the businesses with attractive return and attractive end-market alignment, second we laid out some improvement plan to improve those businesses and run those businesses located in markets where we expect demand to regain its footing so more in the middle of the slide. And these businesses have some strong underlying competitive advantages for Dow and we’ve taken and are taking steps to enhance their position through a combination of cost reduction initiatives and strategic growth investments and these efforts are gaining traction.
We’ve seen some improvement recently in our Coatings & Infrastructure segment driven largely by the business-specific plans that they have and that we put in place for 2013. And finally we shared our plans to improve and transact those businesses which are in the bottom left hand corner of this slide that do not meet our strategic or financial criteria. So you can see we’ve been a steady course and will continue to provide you with progress, updates on our progress including yesterday’s announcement of dividends that will separate a large portion of our core exchange.
Yesterday we announced that we would carve out our global Epoxy business, our global Chlorinated Organics business and our Chlor-Alkali and Chlor-Vinyl assets in the United States Gulf Coast region, the Chlor-Alkali and Chlor-Vinyl assets in some of the oldest businesses in the company. The strategic separation of these businesses represents revenue of up to $5 billion and we mentioned yesterday about $4 billion of that as the merchant sales and about $1 of that could be sales back to Dow including 11 manufacturing sites with approximately 2000 employees. The separation creates value for both entities first to allow Dow to increase its focus on delivering science-driven solution to market with attractive long term growth and for the new units the separation allows the new management team which we announced yesterday to enhance their focus on operational excellence and low cost structure. You’re going to expect execution of one or more of these transactions related to these businesses to occur in the next 12 to 24 months.
Now I think it’s important for us to quickly review some of the specifics of yesterday’s announcement. These businesses are aligned to markets which Dow chosen to exit over time in fact in Chlor-Alkali and Chlor-Vinyl you can say that over the last seven years we’ve been making some announcements along that way to exit parts of that business. So we are right-sizing our upstream needs for chlorine where we can focus is to match our downstream focus. And most of that large chlorine footprint is in the U.S. Gulf Coast. These businesses are valuable, they are competitive within their industry today and we believe they are going to be attractive for the right owners. However as we continue to prioritize resource allocation towards higher return to market to lower volatility these are some of the most cyclical commodity businesses that we have and really are not aligned with our narrowing market focus, a good example I mention would be PVC which we don’t view as an area where we can particularly bring a lot of science and technology and extract a lot of value for the market to those investments.
So the assets that we’ve included in the carve out include our U.S. Gulf Coast Chlor-Alkali and Chlor-Vinyl facilities which are located in Freeport, Texas and Plaquemine, Louisiana and that will be inclusive out of our interest in our Dow-Mitsui Chlor-Alkali joint venture which is in the start-up phase right now in Freeport, Texas and our selected Brine and Energy assets in the U.S. Gulf Coast that somebody will need that investment in those assets to operate a very strong and competitive business.
I’ve got executive oversight for the separation and transaction to activity as well as my other business activities. And in addition to finding the best ownership structures and tax effective deal structures and also focused on ensuring that Dow retains the chlorine integration which benefits our growing polyurethane business as well as those that support our key markets especially in products which are marketed by Dow Ag Sciences business.
On Slide 9 and this slide I think appeared earlier this year in one of Andrew’s earnings call. You can see separating these businesses that I just described are some of the lower returning businesses in the portfolio today and it allows us to take another significant step forward in a very disciplined process to portfolio refreshment and increasing our orientation towards market-driven solutions with attractive long term growth prospects. Now we’ve got about 75% of our portfolio residing in high margin high growth segments and will further capitalize on our attractive industry and leading positions and targeted value chain. We are focusing our attention, our resources in our investment decisions on two plus cyclical businesses that have higher returns on capital so that we can accelerate growth.
And we are moving more towards running a more customer intimate market driven model in these businesses taking an outside end look at the market and customer needs and aligning our unique science and technology leadership capabilities to affect value out of these large markets and focusing on delivering solutions. So packaging is a great example of that where historically we would have talked about the Dow Polyethylene business and our focus really here is how to develop the best Packaging business, the best Hygiene & Medical business that we can in the Performance Plastics franchise.
That strategic focus would drive higher earnings growth and better total shareholder return to our shareholders long term. As I mentioned before I give you some granularity on the past to greater than $10 billion of EBITDA earnings near term. So we made a lot of specific choices that have positioned the company very well with a number of growth catalysts in the near term. And these we believe will happen somewhat independent of a change in the market dynamics.
So first we start on the left our restructuring activity has taken hold already and will continue to gain further traction in 2014. Year-to-date this year we’ve achieved $320 million of our targeted $500 million in cost reduction, those were from a couple of previously announced restructuring programs and we will hit this target which is going directly into EBITDA.
And additionally we’ve generated about $500 million in additional actions to drive higher cash flow in 2013 alone and those are showing up in our earnings now. The continued implementation of the restructuring and cost reduction activity will continue to provide earnings sale in 2014 and 2015 of more than $350 million. Secondly on top of that these actions are complemented by a tremendous new specific earnings growth streams such as our investments in the U.S. Gulf Coast taken advantage of the shale gas phenomenon here. The start-up of our Sadara joint venture plus our new EBITDA from innovation and these very controllable Dow’s specific catalyst will drive Dow’s EBITDA north of $10 billion.
And we’re very fully focused on executing these growth projects. And then third at the middle there I mentioned of our $3 billion to $4 billion in transactions will generate proceeds and enable us to continue to improve our resource allocation by separating non-strategic assets like those I just mentioned and those that require a different operating model. And then finally at the bottom just some notable sources of potential upsides which are not baked into our next year’s plan but are things that we believe could happen that could have some upside for us, some leverage from lower pension expense and raising interest rate.
So just to give you some sensitivity there 100 basis point increase in the discount rate has the impact of about $250 million of lower pension expense for us. Some operating leverage, an 100 basis point increase in operating rate for us translates about $200 million in EBITDA. And then finally global ethylene as we continue to move towards what we believe is going to be a 2015, 2016 peak in the global ethylene cycle, £20 billion of global capacity, an incremental $0.01 a pound margin on that is another $200 million of upside potential.
So when you look at all the add-up of those you can see that we’ve got actions in place and we’re driving some very specific Dow catalyst to get ourselves to above the $10 billion of investments and continuing to drive strategic portfolio decisions to make the whole portfolio of Dow more valuable. On our financial achievement as we move into the close here, we’ve had very strong cash flow (Technical Difficulty). And on this front we’ve made some substantial progress including our fourth quarter debt retirements of $700 million. So we’ve reduced our gross debt by $3.1 billion in 2013, our interest expense is down $120 million year-to-date and more than $300 million annually since 2010.
Going forward the cash generation from the activities that I described earlier and the (caustic) from our accelerated divestiture target positions us very well to execute against our stated cash priorities with a balanced approach of funding our growth and high return on capital organic growth projects like Sadara and the Gulf Coast project while maintaining a focus on increasing levels of shareholder remuneration. And in addition we will continue to look for attractive opportunities to retire debt and other high cost balance sheet instruments to increase earnings per share.
So in closing up let me just talk about the priorities of the executive committee which is very highly aligned to the strategy, the announcements that we made yesterday and all the growth activities going forward. We’re closely managing each of these projects to ensure some timely and successful execution I think that’s evidenced by the success we’ve had on our previous divestiture program. These projects will accelerate our narrower and our deeper market focus. We’ll continue to generate strong cash flows through an intense focus on operational discipline and business-specific value drivers we’ve announced previously we have programs in place for several of our business to make specific improvements.
We maintain a very targeted focus on managing the portfolio for margin expansion and earnings growth and as we discussed we are very intensely focused on the divestitures of non-strategic businesses which will allow us to generate higher returns to increase resource allocation on these businesses with high attractive long term growth prospects and that’s how we maximize value for our shareholders.
So with that I’d like to thank you for your attention today and I’d be happy to take any questions that you have.
Yeah the timing I think is driven by a couple of things so we’ve had a lot of questions about the market opportunity in terms of the cycle and I think that’s your question. Well we also have an opportunity in terms of the shale gas dynamics that’s happened into the Gulf Coast right now. And we think that it’s an attractive time there it’s a lot of investments coming into the Gulf Coast, there are lot of interested parties who would like to back integrate into those kinds of technologies. So we have to balance between those two and looking at where we can be by the time of transactions done. As we sit on there the complicated carve out is going to take 12 to 24 months to get them concluded.
It may not be just one large deal, it could be three deals. We carved it up separately like that because we believe there are probably different interested parties in different parts of that business. The way we built it up over 115 years is may not be the way somebody is interested to take it up our hand so we have to what the market kind of drive what value we can get. So I think by the time that we get this done I think we’re going to – it’s going to be a value creating very positive decision for us moving forward. We’re going to do our best to get the very best shareholder value we can out of the deal.
(Question Inaudible) and because it probably couldn’t be depreciated right now?
Yeah the Freeport you are referring to the Freeport assets that we announced were shutting down.
So I think yesterday’s announcement about the closure of 800,000 tons of capacity please vote – Andrew mentioned this on the webcast and I think there is a couple of things that you have bear in mind. Internally it’s always our intent to close that asset when we started at Dow-Mitsui Chlor-Alkali. And in fact Dow-Mitsui Chlor-Alkali investment was made precisely because we were looking at a cash effective way to make an investment in replacing that chlorine capacity. That’s over capacity; Andrew mentioned 70 years some of those assets were actually 73 years old. So in our view they are going to require some capital to maintain, we don’t use it, that’s a good return on capital for investors and make more sense to us to close that and as Dow-Mitsui Chlor-Alkali comes up. So we’ll face that in as the new plan starts up.
Okay. And then on your new PDH unit, let me give us your thoughts on propane export capacity, where do you see propane prices going and what kind of returns do you expect on that asset?
Yeah I think because we are into winter time and we are into a little bit to the market anomaly now where propane has been exported in advance and a lot of fractionation capacity which is coming on in the first half of next year. So you have a little bit of a dynamic right now where propane prices are moving up. We’ve taken a long term view on this, long term with everything that’s happening with natural gas here and the development that propane is going to continue to be long and advantage to the United States.
So we are still strongly committed to the PDH Investments. When we look at the ratios and the value that were used in our long term plan propane is not out of line to anything that we looked at long term and I think we’ll continue to monitor that but that project is going extremely well and it’s going to startup at 2015 I think it’s going to be highly accretive to Dow. It will have about a 300 basis point improvement in margin on the polyurethane franchise about 150 basis point improvement on the Acrylics segment which is the Coatings & Infrastructure segment.
And just lastly can you talk about the report that I heard by Buffett and what do you think that it could be in a position to buy those maths?
Yeah obviously we as was mentioned yesterday I think there is good upside potential for Dow here and those investments are looked at by Buffett and KIA as attractive investment. And of course the way they are structured means that we would have to have both parties sit down to be able to negotiate a way out of those. I think as the company’s performance continues to improve as we drive to 10 plus billions of EBITDA earnings. At some point here we will see a window where it makes sense to do something with those. At this point I don’t think we’ve had the agreement on that. So we’re just continuing to look for that opportunity as we improve the business.
Yeah I think a spin-off is always something that could be considered. What I mentioned before we carved it out in Chlor-Alkali for Viny Epoxy and in Chlorinated Organics, mainly because our view is that you have different interested parties in different parts of those businesses, Chlor-Alkali, Chlor-Vinyl companies are interested in the PVC market. And that integration they are interested in the PVC market in that integration, they are interested in the caustic market, the Epoxy business that the unique set of competitors out there. So we need some integration but they are primarily interested in end used applications for the Epoxy.
And Chlorinated Organics which started out in the early days as metal cleaning and dry cleaning is migrated more towards refrigerant types of businesses, the intermediate used to make (indiscernible) refrigerant to next generation refrigerant. And I think what you find is that you have different interested parties in each one. We could spend it out and it’s on it could be viable but I think our belief is probably get better value for our shareholders by breaking it up in the part. And the complication is really one of just buildings 70 years worth of integration with Gulf Coast and then having them separated. So some of that will be physical and some of that will be contractual separates the way that setup.
Plaquemine assets yes, the Chlor-Alkali, the Chlor-Vinyl and the power asset in Plaquemine the whole night, not all of Plaquemine because Plaquemine has a lot of assets therefore other downstream businesses, so plastic has a very big footprint and cycling yeah but not Plaquemine has a whole – just those businesses.
Jim, one quick last question, when you look at your POP, how did you decide to heat them what are today into the current?
Looking at markets polyurethane’s markets and where we growing with our investments in polyurethane over time. The POPG assets are integral to polyurethane. It would be like at this stage in our life cycle being in the packaging business without being an ethylene producer, it doesn’t make much less sense to us. I don’t think that if we try to spin that out that somebody would be interested and given me the cost advantage that I need for the polyurethanes business. So our decision was to keep its highly integrated and the PO business is one of the most fundamental building block for that whole chain as well as the coin that goes into (indiscernible). So you want to keep that franchise a lot because it serves a lot of high valley, high growth industries, it serves a lot of industries so we think we can create more value from science and technology solutions as we continue to shift our business in polyurethane up from a more commodity base or more specialized phase of applications.
Jim Fitterling - Executive Vice President, Feedstocks, Performance Plastics, Asia and Latin America
Thank you very much. Thanks, (Steve Jay) for the invite.
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