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Dow Chemical (NYSE:DOW) recently announced the plan of separating its chlorine business through a possible sale in the future. The chlorine business comes under the company's performance materials segment and contributes almost $5 billion in annual revenue; that is 8.8% of the company's total revenue in 2012. At the current market capitalization of Dow Chemical, the total worth of the chlorine business is around $4 billion.

Although the company's third quarter profit grew 17% year over year, its overall performance received a blow from declining sales reported by the performance materials segment. This resulted in a 36% decline in EBITDA of the performance materials segment, year over year. The company has been trying to counter the poor performance of some of its business segments. Dow is focusing on selling-off low margin businesses in a bid to improve its overall profitability. The company is already running an asset sale program under which it expects to generate around $3 billion-$4 billion through sale of non-core assets by the end of 2015. With the chlorine business up for sale, I expect the company to meet its asset sale target comfortably.

The company plans to use the asset sale proceeds in the near term to reduce its outstanding debt. Since the beginning of this year, the company has aggressively reduced debt by $2.4 billion, thus helping it reduce its interest expense by $120 million. Going forward, I expect the reduction in interest expense to generate better cash flows, thus resulting in improved financial flexibility.

Asset sale: Impact on efficiency

In the last four years, the company has divested non-core businesses that accounted for almost $10 billion in revenues.

Dow Chemical

2009

2010

2011

2012

Return on capital employed

1.1%

5.4%

7.2%

4.2%

From the above information, it can be easily interpreted that the company's ROCE in the last four years has not been impressive. I believe this is why the company has been focusing on reducing its exposure to lower margin businesses. As mentioned before, the performance materials segment saw a steep decline in EBITDA in the third quarter. Further, the segment's EBITDA margin was 9.5%, much lower than the company's overall EBITDA margin of 13.3%. I believe the sale of the chlorine business, a part of the performance materials segment, will help the company improve its overall profitability as well as efficiency. However, the time frame within which the sale is going to be completed and when the company would be able to derive its benefits remains highly uncertain.

On similar lines, Dow's competitor, E. I. du Pont de Nemours (NYSE:DD), or DuPont, announced the spin-off of its performance chemicals unit from its business. Its chemicals business, which posted 38% decline in operating profit in the third quarter year over year, was dragging DuPont's overall performance. The division's lower growth and volatile earnings were making it difficult for the company to enhance shareholder value, thus prompting the company to separate the division from its overall business.

Using the same metric, I have analyzed DuPont's efficiency by calculating its ROCE over the past four years.

DuPont

2009

2010

2011

2012

Return on capital employed

7.9%

12.4%

12.5%

8.5%

As compared to Dow, DuPont has been able to provide a better ROCE in the last four years. However, the company witnessed a decline in its ROCE partly due to the decline in its pre-tax operating income, or PTOI, reported by the performance chemicals segment. The segment's PTOI declined 17.5% in 2012 as compared to 2011. The performance chemical's spin-off is expected to be completed by mid-2015, and this will allow the company to streamline its focus on its agriculture and nutrition businesses.

Contrary to Dow Chemical and DuPont, BASF (OTCQX:BASFY) is following a completely different strategy. BASF is not taking the divestment route and is focusing on improving the performance of its lower margin businesses by employing cost cutting measures. The company's cost cutting program, known as STEP, is expected to increase earnings by $1.36 billion from fiscal 2016 onwards. With this program, the company plans to lower the fixed expenses of over 100 projects, thus increasing profit margins. The effectiveness of the cost-cutting program was reflected in the company's third quarter results, wherein its operating margin increased from 8% to 9.5% year over year. Further, in terms of generating return on capital employed, the company is well ahead of its peers.

BASF

2009

2010

2011

2012

Return on capital employed

6.7%

15.9%

14.9%

15.8%

Conclusion

Dow Chemical has been making strategic moves to counter the dull performance of its performance materials segment. Its plans to divest unrelated assets would certainly help it narrow its focus to more profitable segments. However, it is well behind its peers when compared on the basis of generating ROCE. Although I believe the company's plans of selling non-core assets would certainly improve its efficiency and profitability in the future, it is difficult to comment on when those asset sales would reflect better efficiency. Therefore, I recommend investors hold this stock.

Source: Dow: Time To Say Goodbye To Non-Performers