Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

The Dow Chemical Company (NYSE:DOW)

Q1 2010 Earnings Call Transcript

April 28, 2010 10:00 am ET

Executives

Howard Ungerleider – VP, IR

Andrew Liveris – Chairman and CEO

Bill Weideman – EVP and CFO

Jerome Peribere – President & CEO, Dow Advanced Materials

Analysts

P. J. Juvekar – Citigroup

Don Carson – UBS

Sergey Vasnetsov – Barclays Capital

Robert Koort – Goldman Sachs

John McNulty – Credit Suisse

Paul Mann – Morgan Stanley

David Begleiter – Deutsche Bank

Frank Mitsch – BB&T Capital Markets

Kevin McCarthy – Banc of America/Merrill Lynch

John Roberts – Buckingham Research

Jeff Zekauskas – JP Morgan

Bill Young – ChemSpeak Advisors

Operator

Good day and welcome to The Dow Chemical Company’s first quarter 2010 earnings results conference call. Today's call is being recorded. At this time, I would like to turn the call over to Howard Ungerleider, Vice President of Investor Relations. Please go ahead, sir.

Howard Ungerleider

Thanks Karen. Good morning everyone and welcome. As usual, we're making this call available to investors and the media via webcast. This call is the property of The Dow Chemical Company. Any redistribution, retransmission or rebroadcast of this call in any form without Dow's expressed written consent is strictly prohibited.

On the call with me today are Andrew Liveris, Dow's Chairman and Chief Executive Officer; Bill Weideman, Vice President and Chief Financial Officer; Jerome Peribere, President and Chief Executive Officer of Dow Advanced Materials; and David Johnson, Director of Investor Relations.

Around 6.30 this morning, April 28th, our earnings release went out on Business Wire and was posted on the Internet at Dow's Website, dow.com. We have prepared some slides to supplement our comments in this conference call. The slides are posted on our Website on the presentation’s page of the Investor Relations section or through the link to our webcast.

As you know, some of our comments today may include statements about our expectations for the future. Those expectations involve risks and uncertainties. We cannot guarantee the accuracy of any forecasts or estimates and we don't plan to update any forward-looking statements during the quarter. If you would like more information on the risks involved in forward-looking statements, please see our SEC filings. In addition, some of our comments may reference non-GAAP financial measures. A reconciliation of the most directly comparable GAAP financial measure and other associated disclosures are contained in our earnings release or on our Website. Our earnings release as well as our recent SEC filings are available on the Internet at dow.com.

The agenda for today's call is on slide three. Now, I would like to hand the call over to Andrew.

Andrew Liveris

Thank you Howard. Good morning everyone and thank you for joining us to discuss our first quarter results. To get you to turn to slide four, if I could sum up the quarter in just a few words, it would be this. We are a company that continues to deliver on its commitments and we believe the outperformance in the first quarter represents a pivotal point in demonstrating the earnings power of the new Dow.

The benefits of staying true to our strategic agenda are clear and we are proving it quarter after quarter. Our results once again showed the merits of our strategy in several key ways, starting with our broad-based topline growth and significant EBITDA margin expansion. Let me summarize a few high-level takeaways from the quarter. Operating earnings were $0.43 per share, up significantly from $0.11 per share in the first quarter of last year.

Sales were up a robust 33% year-over-year on a pro forma basis, and excluding divestitures driven by significant improvements in both price and volume. And on a sequential basis, our growth continued as well, with sales up 8% over the fourth quarter, pointing to a strengthening global recovery. Another very encouraging sign was our volume growth in both North America and Europe, each up an impressive 11% compared with last year.

Emerging geographies grew as well, with volume up 27% on a year-over-year basis. In fact, volume in China was up an impressive 46%. All of this pushed our global operating rate to levels not seen since the second quarter of 2008, and our manufacturing momentum improved as the quarter progressed, despite several unplanned outages. EBITDA increased $877 million versus the same quarter last year and was up more than 60% in the combined performance segments.

EBITDA margin expanded both year-over-year and sequentially at the enterprise level. And finally, our joint ventures continued to outperform with equity earnings up more than $200 million year-over-year, reaching a record $304 million driven by performance at Dow Corning, EQUATE, and MEGlobal.

Let me turn to slide 5. We stayed true to our strategic path and in fact made great progress on our key milestones. Financially, we are delivering on the earnings power of the new portfolio, especially in our performance businesses and in emerging geographies. Operationally, we delivered cost reductions of $275 million in the first quarter. We remained well ahead of plan and are currently on an annual run rate of $1.8 billion, which is ahead of our commitments. Strategically, we exceeded our growth synergy targets by delivering $530 million in revenue on a run rate basis, while at the same time, we maintained our commitment to growth, increasing our investment in research and development by 10%.

We also made substantial progress in achieving our goal to divest $2 billion of non-strategic assets in 2010 and remain on track to deliver $5.5 billion in divestments in just 12 months, more than our commitment of $5 billion and in half the time. On slide 6, as most of you know, we signed a definitive agreement to sell the Styron division for just over $1.6 billion. Additionally, this deal includes supply and service contracts that would generate substantial value for Dow in the neighborhood of $400 million. This brings the total value of the deal to more than $2 billion, the high end of our stated target for 2010.

The value reflects what we consider an excellent multiples of over eight times EBITDA. The sale of Styron will be our fifth non-core divestments since April of 2009 all at favorable multiples. On slide 7, another feature of our earnings call has been to exhibit the tracking tool that provides a look into industry and market demand trends across our geographic footprint. This look underscores the unique view we have into the emerging global economic recovery based on our participation and the value chain of a vast array of industries and end markets. And the picture is bright.

On slide 8, starting with an operating segment view, volume was up across virtually all of our businesses. And we are seeing increased demand in a wide variety of end markets, most of which are tied to consumer spending, electronics, appliances and other durable goods and furniture, as long as consumer staples, all showed strong growth. In addition, the automotive sector in North America is improving and in Asia, it’s accelerating.

And finally, there is increased demand in our water business, which drove improved results in specialty materials. These trends are particularly relevant, given their alignment with a global mega trends that will drive our long-term performance and demonstrate that our new portfolio is very well positioned. As you can see on the right of the slide, infrastructure stimulus spending still hasn’t found its way through many value chains and commercial construction and developed regions continues to lag. But some good news is that the housing segment seems to have finally come off with historic lows.

On slide 9, turning now to a geographic look, we see a similar story with a few lingering challenges. We have our eye on high unemployment in developed regions, but we have seen positive signs that job markets have stabilized. The potential for access in credit bubbles in emerging geographies and lingering concerns surrounding sovereign debt in southern Europe could both be potential drags on global growth. However, these factors are clearly outweighed by the strengths that we are seeing.

The overall global economic environment is on a stronger footing, with a highlight being significant demand growth in Europe and North America. In addition, the step change in the relevant cost position of US Gulf Coast natural gas provides even further strength for Dow. Finally, continuing rapid growth in emerging geographies led by China where demand as I said was up an impressive 46% was driven primarily by growing domestic consumption.

In summary, Dow’s vast portfolio and broad geographic reach provide us with a unique perspective on the trends that are shaping the global economic recovery.

I would now like to turn the call over to Bill who will give you some more details on how these trends drove our results in the quarter.

Bill Weideman

Thank you Andrew. Let’s begin with a detailed review of our first quarter results on slide 10. Reported sales were $13.4 billion, an increase of 49% over the same period last year and 8% higher than the fourth quarter of 2009. On a pro forma basis and excluding divestitures, year-over-year sales were up 33%, driven by volume growth of 16% and increase of price of 17%.

EBITDA excluding certain items was up on a year-over-year basis by $877 million to $1.8 billion. On a sequential basis, EBITDA was up $356 million, an impressive increase considering that we had some margin compression in our performance businesses due to the rapid run-up in propylene costs. Earnings excluding certain items were $0.43 per share. The current quarter included $0.02 per share unfavorable impact for certain items. Details for these items are included in the appendix.

Our effective tax rate was 15.7%, in line with the 15% to 20% range we committed previously. The year-over-year increase in corporate was due in part to the inclusion of Morton Salt’s results in the first quarter of last year. Our current quarter results also included higher performance share compensation and increased participation in our employee stock purchase program. We view this as a positive as it aligns the interest of our employees with those of our shareholders. For modeling purposes, you should expect corporate to run in the range of $150 million to $250 million per quarter.

Moving to slide 11, overall volume growth versus the same quarter last year was 16% on a pro forma basis, excluding divestitures, with our Combined Performance segments delivering an impressive 19% increase. We also achieved price gains in nearly all segments and double digit increases across all geographies. Price was up an impressive 16% in North America and 24% in Europe.

On a sequential basis, price was up in all geographic regions with the exception of Europe. Again, North America showed strength with gains of 8%. Volume was up 4% versus the fourth quarter of last year, with particular strength in both North America and Europe.

Now, let’s take a look at how the company performed on a segment level starting on slide 14. In Electronic and Specialty Materials, volume was up 31% compared to the first quarter of 2009. In fact, volume in our electronic materials business was up 55% year-over-year. This reflects increased demand in memory, logic and display technologies.

Our semiconductor technologies are capturing share as this sector continues to recover. We also are seeing substantial growth in the demand for water applications as these fundamental markets recovery, contributing to substantial improvement in EBITDA margins across specialty materials. In Coatings and Infrastructure, volume increased 16% excluding divestitures, while price was up 5%. Emerging regions were driving increased demand while commercial construction continued to represent a challenge in North America and Europe. We are however seeing global improvements in residential construction end markets.

I think it’s important to highlight that excluding divestitures, EBITDA in this segment actually improved year-over-year. We also increased R&D spending as we moved the investment in our POWERHOUSE Solar Shingle program into the business this quarter, as we are getting closer to commercialization.

Taking both of these points into consideration, EBITDA actually improved 8%. In acrylic-based Architectural Coatings business generated a solid EBIT-to-margin of around 15%. Coatings in infrastructure should see further margin improvement as the businesses continue to work aggressively to recapture price related to more than 25% sequential increase in propylene combined with seasonal volume increases.

Moving to Health and Ag Sciences, both price and volume were down slightly on a year-over-year basis, due to continued oversupply of glyphosate. This segment still holds significant growth potential looking forward. Our new Ag Chem molecules continue to gain traction, our seeds, traits and oil flag points continue to grow and the introduction of SmartStax corn hybrids is continuing to meet our expectations.

In Performance Systems, volumes increased 27%, with increases in all geographies and business units primarily driven by Dow Automotive, which benefited from increases in automotive demand in North America and Asia and robust elastomer demand in all geographies through the continued strength in food packaging, a sector that has been extremely resilient during the recent economic downturn.

Finally, on this slide, you can see the primary driver, Performance Products, which posted volume gains of 27% excluding divestitures and price gains of 14%. Volume was up in all geographies in business units driven by consumer-led demand growth in polyurethanes, and growth in appliance end markets driven by government incentives and energy-efficient standards.

Slide 16 details the performance of our Basic Plastics segment. Sales increased 49% year-over-year and EBITDA was $718 million for the quarter. Volume and price increases in polyethylene were the largest contributors. Here, operating rates were high in the quarter, enabling the business to focus on price.

And finally, in Basic Chemicals, volume increased 16% and price increased 6%. The major drivers in performance in this segment were an increase in demand for caustic soda in North America due to the strength in the aluminum industry and the fourth consecutive quarter of price increases in vinyl chloride monomer which more than offset volume declines.

Now, turning to slide 17, another high point in the quarter was equity earnings. We have rebounded strongly over the past five quarters, and now exceed pre-recession levels. In the first quarter, we delivered a record $304 million in equity earnings, more than $200 million year-over-year. Turning to slide 18, our focus on financial discipline continued in the quarter, with tight control on working capital. Our CapEx spending was under $300 million in the quarter. However I would like to point that the first quarter is typically a low quarter for us in terms of capital spending, and we do anticipate an increase next quarter due to scheduled turnarounds.

It is important to know that due to the adoption of a new accounting standard in the first quarter, (ASU) 2009-17, previously referred to as FAS 167. Our investment in our Thailand joint venture will be recognized as CapEx going forward, springing our total spending closer to $2 billion for the year. However, I would also like to point that, this change will not increase our actual cash outflows. Cash flow from operations was slightly higher in the quarter versus a year ago, and remember, our receivables are higher as a result of our higher sales and we experienced a normal inventory build in our seasonal businesses. We remain on track to generate $1.5 billion in free cash flow in 2010.

Our net debt-to-capital rose slightly in the quarter, due to the adoption of a new accounting standards I just previously mentioned, changing the accounting treatment for some of our liabilities. Despite this change, we remained committed to achieving our 2010 goal of 45% net debt-to-total cap by yearend. With the increase of our profitability this quarter, our net debt-to-EBITDA multiple improved by half a point to 3.2 and we are on a run rate of 2.8 exiting the quarter.

I would also like to highlight, we continue to make meaningful progress on our cost synergy and restructuring goals, achieving $275 million in total cost reduction for the quarter and achieving an annualized run rate of $1.8 billion. That wraps up my review of the details for the quarter, and I will pass it back to Andrew.

Andrew Liveris

Thank you Bill. I would now like to spend a few minutes discussing the growth potential of the new Dow. This is clearly the central element of our strategy and our story. We have the right portfolio, the right geographic footprint and the right innovation pipeline and I want to emphasize, we have all of this today.

So, I would like to share with you a new and actually more granular look at our innovation pipeline and update you on the growth synergies we are realizing in our portfolio. So, please turn to slide 19 where you will see we currently have more than 500 projects in our innovation playbook, and these are strategically aligned with our four mega trends. This impressive playbook is supported by our significant investment in research and development which should yield another $1.6 billion. This investment is aimed squarely at the intersection of society’s greatest needs and business opportunities.

Our innovation pipeline represents $30 billion on a non-risk adjusted NPV basis. Consistent with our strategy and as you would expect, you see the pipeline is most robust in our performance segments. On slide 20, when you look at it from a stage day perspective, you can see that we have no shortage of new projects at the early stage of our pipeline, but equally exciting is how many are at advanced stage and near commercialization. We have a very rigorous process to ensure our programs deliver commercial success. On a risk-adjusted basis, these programs represent $12.5 billion of net present value and as you can see, the value is clearly tilted to implementation.

On slide 21, I will give you a few examples of some of the innovation projects that are yielding results today. Firstly, we have successfully commercialized next-generation STYROFOAM Brand Insulation in North America, which provides customers the same great performance with a much improved and better than alternative products environmental profile. Our proprietary technology was the result of a multi-year effort led by one of our researchers who by the way was recognized as a co-recipient for his contributions with a 2007 Nobel Prize. The technology gives us a significant competitive advantage in the marketplace, which is reflected in our first quarter results.

In our electronics business, we opened up a new display materials manufacturing facility late last year in Korea. This plant was fully operational in the first quarter, which was critical to meet increasing demand for display chemicals and OLED materials to very fast-growing areas of the industry. This new capacity came on at a good time, as Asian panel manufacturers are now running at full capacity.

And in our polyurethanes business, we launched a new technology that delivers productivity gains for our key appliance customers, including energy savings and productivity efficiency while lowering their raw material consumption. We are gaining market share as a result, in fact Haier, one of the world’s largest appliance manufacturers recently recognized Dow with a Best Strategic Supplier Award, thanks in part to this technology.

When you turn to slide 22 and look at acquisition-related growth synergies, we are capturing tangible value from a range of new market opportunities. Let me just give you a few examples. We have landed a new long-term multi-year agreement with a strategic customer, we gained new sales for acrylic monomers with an industry-leading adhesives producer. We developed new solutions in Latin America that enhanced oil and gas production. We generated new biocide cells for water treatment applications. We secured higher margin higher value PO derivatives businesses in the food sector through focused marketing. We invented new novel polyolefin disbursement base technology that has been adopted by leading global consumer products company.

There are many more examples and most of these have enabled us to achieve the $530 million in revenue already on a run rate basis, which already surpasses our full year 2010 goal. These growth projects clearly illustrate how the acquisition of Rohm and Haas provided the perfect opportunity to renew our existing customer relationships, jumpstart innovation and build stronger partnerships. Our commercial activities have been re-energized not just in advanced materials, but across the entire enterprise. And this mindset is proliferating through every part of our company, enabling us to grow faster and more profitably. No way is this more evident than in Dow Advanced Materials division where an entrepreneurial spirit is striving.

That’s one of the primary reasons we chose Jerome Peribere to run this division. As the former head of Dow AgroSciences, he led an organization that today is one of Dow’s most profitable growth-oriented businesses. This is a perfect time to ask him to talk about some of the key drivers of growth in his portfolio.

Jerome Peribere

Thank you Andrew. In Dow Advanced Materials, we drive an empowered culture where every employee has an own mindset and is accountable for delivering results while building a new and valuable technology pipeline and channel to market that sustain our future growth.

My comments today will only scratch the surface of our progress, but we are hosting an investor event next month where we will have an even richer discussion of Dow Advanced Materials and our winning formula for growth, and I would invite you to turn on to slide 23, where you will see that our businesses served a broad and diverse range of high growth end markets, their recognized leaders in their respective industries.

These businesses employ a model that focuses on technology-intensive innovations and high-touch customer service. I am proud to say that we have made tremendous progress in creating a formidable portfolio of high growth and high margin businesses. As you know, we gained from Rohm and Haas, in impressive electronics business, an industry-leading acrylics platform for strong customer intimacy model and a large and growing presence in Asia. To this, we are Dow strong industrial coatings position and we blended our industry-leading water businesses, our building and construction franchises and our vast geographic reach and hitting power.

Last year, our division had sales in excess of $9 billion, representing about 20% of Dow’s total sales, and contributing almost a third of total Dow’s EBITDA. I would like to touch upon some of the key business drivers for growth and profitability and invite you to turn to slide 24.

Dow Electronic Materials is a leading producer of technologies that enable the production of memory chips, displays, and other critical components that power today’s electronic devices. The business is strongly tied to demand for consumer electronics devices, which has rebounded significantly this year. In fact, this business is already operating at peak profitability despite volumes that are 20% below normalized levels. Our technology position and speed to market led to several significant wins in the quarter, with leading global memory and logic manufacturers as well as display producers.

Turning now on to our Building and Construction business, which like the broader Dow have substantially reduced its cost base, while continuing to invest in innovation. Since 2006, this business has increased average revenue per single family housing starts in the US by some 80%, benefiting from increasing regulations and product innovation. And in the high growth regions like China, we recently launched our external insulation finishing system, which enhances energy performance and lowers overall installation costs. Dow Coating Materials is the world’s largest supplier of coating raw materials to the global paint and coating industry. This business holds the broadest range of coating chemistries in the world, and the largest ever commitment in the industry.

You can see this already in our ultra low-VOC formulations. Today’s technologies cannot offer ultra low-VOC and deliver the performance properties that customers expect. Our tremendous expertise in emulsion polymers and high support R&D capabilities has led to rapid ultra low-VOC innovations that meet demanding performance requirements and are now in the hands of many customers. We expect to revolutionize the coating industry in the next five years, thanks to major additions to our technology toolkits.

On slide 25, our coating business isn’t the only area where we see the benefits of addressing environmental trends. Dow Adhesives and Functional Polymers is meeting demand for more lightweight and biodegradable packaging materials. This business increased penetration of water-based lamination adhesives and is very well positioned to meet the industry’s demand to move from solvent-based materials. And we are further strengthening our portfolio in the global packaging arena by leveraging expertise from other areas in Dow that also touched this very large and growing sector. Expect to hear more about this as the year progresses.

And finally, our large Specialty Materials portfolio serves markets ranging from food and nutrition to household care moving to biocides. You may know that this business is best for the industry-leading water portfolio. This is an area where we have created the world’s largest reverse osmosis membrane and ion exchange business. The benefits of our technology have already been rewarded in the marketplace, and considerably about half of the world’s largest membrane desalination plant that have started up in the last two years are using Dow technology.

On slide 26, we have a broad portfolio of innovations valued at more than $7 billion NPV. We will provide a very detailed review of our Advance Materials portfolio at our sector day on May 18th in Philadelphia. And I hope that you will be able to join us and take advantage of this opportunity to see examples of our growth projects and hear directly from our business and technology leaders.

Dow Advanced Materials is an incredibly exciting place to be right now, and I hope you will watch us closely in the months and quarters to come.

Andrew Liveris

Thanks very much, Jerome. I would like you to turn to slide 27, because I really would love to mention Dow Corning, which is another key growth driver for our electronics and specialty materials operating segment. Dow Corning has been growing its topline in a robust pace, 10% per year for the last 10 years. Now, you can understand why we are excited about the future of this joint venture, when you consider Dow Corning’s leading global silicone’s position and the tremendous growth of its polysilicone joint venture, Hemlock Semiconductor. Due in large part to strong fundamentals in the solar industry, Hemlock’s capacity will have expanded by more than 10 times by 2015.

Dow Corning will also be a part of the Advanced Materials sector day in Philadelphia. So, that’s one more reason for you to attend. Please turn to slide 28 where I am going to now turn to our outlook. The global economy is showing signs of a meaningful recovery, including the most significant piece of new information is the robust improvement we have seen in North America and Europe. Two geographic areas that until now have lagged the recovery of the world economy. Our 27% sales growth in North America and 35% growth in Europe are compelling proof points that economic recovery is now underway in these areas.

These numbers are even more impressive when you consider that volume gains comprised of full 11% of the growth in each region showing that demand is indeed returning. Broad-based strength in many sectors of North America such as electronics to automotive to furniture shows a sustainable upturn is emerging. Even housing starts have shown more positive signs in recent weeks, as new home sales surged to 27% in March, the highest gains in more than 40 years. Also new orders for durable US manufactured goods excluding transportation posted the largest gains in more than two years last month. Strength in all of these sectors illustrates that the consumer is finally returning. The story for emerging geographies is strong growth continuing at a robust pace.

Volume growth of 27% versus one year ago, with China, Brazil, Eastern Europe and South East Asia and India leading the way. In fact, volume growth as we have already said in Greater China was an impressive 46%. This strong performance coupled with a recovering demand in North America and Europe is driving notable manufacturing momentum and bode particularly well for Dow. We recognized there are some continuing challenges, especially in the construction industry and unemployment and tight credit conditions continue to weigh on consumer sentiment. However, to date, these have been balanced by improving consumer and business spending.

So, our outlook is one of the strengthening global economic environment with increasing signs of sustained growth. We saw the results of this growth in the first quarter through both volume growth and margin expansion, driven by our new portfolio and the benefits of our significant cost reduction efforts. And as we turn to our priorities in the coming quarter, we will continue to remain focused on delivering our commitments. This means maintaining operational and financial discipline, further strengthening our balance sheet, and investing for growth. Our actions to deliver our new portfolio with a lean cost structure and reinvigorated innovation engine coupled with our strong presence in emerging geographies lead are poised to deliver continued earnings momentum.

This quarter was indeed a pivotal point and given the world of glimpse of our earnings power, and of the constant and consistent progress we are making in driving our strategic agenda forward. Quarter-after-quarter, we are displaying the new Dow, a Dow that delivers earnings growth for its shareholders. Stay tuned as we continue to demonstrate the power of this new company.

I will now turn the call back to Howard.

Howard Ungerleider

Thanks Andrew. That wraps up our prepared remarks. For your reference, a copy of these comments will be posted on Dow’s Website later today. Now, we will move to your questions. Before we do though, I would like to remind you that my comments on forward-looking statements and non-GAAP financial measures apply to both our prepared remarks and anything that may come up during the Q&A. Karen, would you please explain the Q&A procedure.

Question-and-Answer Session

Operator

(Operator instructions) We will take our first question from P. J. Juvekar with Citi.

P. J. Juvekar – Citigroup

Good morning.

Andrew Liveris

Good morning PJ.

P. J. Juvekar – Citigroup

You know, Andrew, with shale gas keeping natural gas prices low in the US, wouldn’t K-Dow be more valuable now due to this advantage and how are you communicating this advantage to the potential buyers?

Andrew Liveris

Clearly, as we referenced in the call, PJ, the performance of our polyethylene business is indeed impressive and there is a couple of reasons for that, not the least the one you raised, which is US natural gas and of course ethane has decoupled from naphthalene and oil and that arbitrage is now been open for a while and if you go into the next several years and you take the shale gas production that will come online in this country, then that in our view is a sustainable advantage for some years. The consequence of that is that US natural gas will start to stabilize, be less volatile as will indeed natural gas liquids. This will still not be competitive versus the Middle East. The Middle East has the lowest cost of natural gas in ethane, but when you throw on top of that, the notion that the Middle East is running out of natural gas liquid production and ethane in particular, it is mostly dry gas with the exception of Iran, then the US production base and the US asset base that is in market and it has flexibility of cracker feed stocks which ours does. Ours is the most flexible in the industry, then it has an advantage getting market and therefore has made the business and the assets more valuable for the foreseeable future.

That value is being demonstrated in the results. Even though these are trough like conditions, the business is earning four to five times what is earned in the ’01 and ’02 trough, which is a spectacular statement, not the least of the reason being that we are relying less and less in exports, although of course export windows open and close based on this newfound arbitrage could be more sustainable. How are we communicating it? Well, we are pacing ourselves, because we have earned the right to do the right transaction at the right time, even though the strategy is exactly the way we wanted to be, to be a more predictable earnings growth company, the up and down of the cyclicality of that business is something that hurts that. The fact that this business is earning this much money has made the business more valuable and we are definitely taking our time in structuring the right deal. We have got that right. How this unfolds over the next many quarters, will be really driven by maximizing the value that you alluded to in your question. And ultimately the answer to your question is a resounding yes, that has been proved and increase the value of our franchise.

P. J. Juvekar – Citigroup

And just a follow-up on that, as we are telling benefits by the same token, propylene is getting hurt, and you buy a lot of propylene over Rohm and Haas business, so can you size for us the ethylene advantage versus propylene disadvantage?

Andrew Liveris

Well, propylene as you well know, there are several ways to get there, refinery-based propylene clearly being one of the key ones in the United States, which usually makes the US propylene along. What of course is happened over these many years is that you go to a light of feedstock that propylene coming out of crackers reduces, and therefore potentially especially with declining refinery margins, propylene would go short, which it in fact has started to do. Now, as we look at the outlook for propylene, we see actually these supply demand balances improving, particularly in the third quarter, and one of the biggest reasons for that is the world’s largest propane dehydro unit in Texas will come online and produce on-purpose propylene. Propylene dehydro is prevalent is elsewhere around the world, notably in the Middle East, but for it to be prevalent here in the US decouples propylene and remember, we actually consume, we consume a lot of propylene, but we produce half of it.

So, we produce half of the propylene we have consumed. We do believe that propylene will see some near term price drops. As a consequence of that, the propylene arbitrage to ethylene will be less. Clearly also on the back end of this year, there could be a drop in ethylene because of excess supply coming on in the Middle East. So, we do believe this first half in ethylene, polyethylene is strong that natural gas arbitrage would be good, but having said that, its sustainability with excess supply coming on the back half will see that start to drop, but we believe we will benefit on the propylene side of that.

Bill Weideman

Thanks PJ. Karen, next question?

Operator

Our next question comes from Don Carson with UBS.

Don Carson – UBS

Yes, thank you. Wanted to shift over to the Ag side, couple of questions there. You mentioned that, that SmartStax is meeting all its milestones, yet your partner seems to have missed some of their volume milestones. So, two questions, one, what impact did that have on your earnings? Two, given (inaudible) price more aggressively on so-called price for penetration strategy, does that have any impact on Dow AgroSciences’ income going forward?

Andrew Liveris

Thank you Don. On Ag, I think the key message here is independent of what our partner has said, you have got to know and remember that we price SmartStax independent of them and we have two key objectives in our strategy that may be different to the original strategy. Firstly, a rapid transition of our portfolio to SmartStax is very key to Dow. And two, to grow our market share. So, we have always priced SmartStax over triple stacks [ph] to reflect the incremental value that the technology brings, but at the same time, penetration pricing has been our mantra. So, we are doing everything, we are meeting our goals where everything we said we do, we have done. There is no question that even with a revised numbers from our partner, (inaudible) is still one of the largest biotech launches in history. We are selling everything we have available to sell. There are no surprises in our field trials, and we are achieving the results that we said we would achieve.

In fact, we are very confident, we actually are launching SmartStax to nearly 40 hybrids this season and expect to have SmartStax in more than 70% of our corn portfolio in the next two to three years. So, we are on target, no effect from the partners’ announcements to us, we are on strategy and we see absolutely no negative effect to our forecast.

Don Carson – UBS

So, Andrew, just to clarify then, your royalty fee from Monsanto doesn’t go down even if they are priced to the grower is going down?

Andrew Liveris

We have stayed away, I think you know, Don, from answering that specific question. I know people want to know that, but we stay true to our organic growth strategy, which is actually a lot of way we are deriving our NPV value.

Don Carson – UBS

Thank you.

Operator

The next question will go to Sergey Vasnetsov with Barclays Capital.

Sergey Vasnetsov – Barclays Capital

Good morning.

Andrew Liveris

Good morning.

Sergey Vasnetsov – Barclays Capital

All segments have shown a significant improvement, Andrew, but Basic Plastics segment shined with 20.5% EBITDA margin at the time of support trough, and I am mindful that, volatile business coming up and down, but more broadly across other commodity chemical companies and products and regions, it seems to me that the profitability is achieved for the high level – high profit to the low operating rate compared (inaudible). So, have we seen the same and does it suggests that there may be the overall market discipline is better in this trough compared to what you have seen three years back?

Andrew Liveris

You know, Sergey, it could be market discipline. I probably would give you that, but I really do think the bigger reason is actions we and others have taken in Europe and US to rightsize the footprint, especially here in the US and Canada to not really have the export capacity in downstream businesses. Remember, we shuttered EDC, EB/Styrene, EO/EG and really reconfigured the footprint for our Basic Plastics PE in particular here to US demand. And we are definitely the most competitive in the United States and Canada as a result due to our Flexi-crackers. So, to your generic point, we do believe that it has elevated the performance of the business to a new level when you throw on top of it, the low-cost feedstocks we have available to us in places like Kuwait and Argentina. So, the doubt strategy of asset-like low-cost feedstock plays elsewhere to do Petroceuticals [ph] to use your famous term actually, plus of course the in–market competitiveness from on top of that, the first question from PJ on natural gas and then you asked me arbitrate point has given the business a new level of performance in short-like conditions.

There is still upside based on basically price volume maximization. You know, we are too way below peak margin levels, so there is still upside.

Sergey Vasnetsov – Barclays Capital

Okay. And so, to apply this question specifically, that was my follow-up, it seems like Dow again making more money today at 83% capacity utilization, if I were to compare the data points over the past, do you think this model you are able to lower your breakeven point or cost of doing business so that you can make more money, the same operating rates compared to the past?

Andrew Liveris

Yes, to make sure I get lots of questions in today, the answer is going to be just a yes. We have lowered our breakeven point with all of the $2 billion of cost reductions in the combined company plus restructuring, the answer is yes.

Howard Ungerleider

Thanks Sergey. Karen?

Operator

Next, we will go to Robert Koort with Goldman Sachs.

Robert Koort – Goldman Sachs

Thank you. Andrew, it seems to me you generated about $1 billion of incremental EBITDA year-over-year and the bulk of it was from commodity and markets although I guess now we are seeing little bit better pickup on the specialty side, do you expect a bit of a seesaw as we go into the second half where the commodities make you paid versus some pretty good numbers last year, or do you think those can sustain while the downstream business has continued to expand in terms of profit?

Andrew Liveris

Yes, I mean, thank you Bob. There is no question the mix if you look at the leverage we have for economic recovery right now, and the statements we have made in particular around global recovery in North America and Europe in particular, the propylene envelope and all of its downstream and you pick your favorite once, polyurethane, acrylics, emulsions also of course epoxies. There is definitely margin inflation in the first quarter that we will start to recover as the year goes by, in let’s call the semi-commodity part of the mix. If you really look at the downstream part of the company now, electronic materials, specialty materials, if you look at Ag, that’s independent of the question. So, really, we have a third of the portfolio that’s independent of the hydrocarbon story. We have another third that should see better improvement in the specialty side as the year unfolds, and then the third that’s Basic Plastics, in particular, and routinely polyethylene should see some margin compression in the back half of the year as excess supply comes on.

So, the performance as you say moving parts to the performance side as the year progresses, which is by the way on strategy.

Robert Koort – Goldman Sachs

Got it. And a quick one for Bill, if I might, are we right to read that there was 200 million to 300 million of employee comp that hit that other corporate line that might not be so big in the remaining quarters, is that the way to think about it?

Bill Weideman

Yes, we are not disclosing the exact amount, but that’s fairly close, but it was largely driven by the employee stock purchase plan. In the corporate, right, corporate segment went up I think about $400 million and that as I point out my comments, a year ago, we had the results of Morton in there. So, that’s part of it. And we then we had a very strong participation on the employee stock purchase plan, which we think is great news. It also reflects the fact that our value of our stock has also gone up. So, yes, you are in the ballpark, but I would say, I would like to point here, going forward, think about that segment if you will, being in the 150 to 250 range.

Robert Koort – Goldman Sachs

Thanks.

Andrew Liveris

Thanks Bob.

Operator

And John McNulty with Credit Suisse has our next question.

John McNulty – Credit Suisse

Yes, good morning.

Andrew Liveris

Good morning.

John McNulty – Credit Suisse

Just a quick question with regard to your R&D pipeline, if I remember correctly back in November, Bill Banholzer had highlighted that he thought over the next three years or so, you would have about $2 billion of revenue coming from your R&D pipeline. How does that compare with your implementation part of the R&D pipeline you just highlighted earlier at $5.6 billion, is it just or is that roughly about the same type of timeline that we should be thinking about and has that number gotten bigger or how should we compare the two?

Andrew Liveris

Yes, the $2 billion revenue number that Bill referred to comes from both gross synergies and the organic R&D pipeline, and the way you should think about that slide we had in the deck is that the NPV risk-adjusted is derived from revenue margin projections with firm stage gates between now, 2012, and beyond, but clearly those projects that are at or near commercialization tilt the number very much to the now $2 billion, 2012. So, at the end of the day, John, that’s the same number.

John McNulty – Credit Suisse

Okay, so the $5.6 billion still corresponds with the $2 billion that will actually materialize?

Andrew Liveris

That’s the way we are thinking about it. There is some upside on stock earlier in the pipeline, but it’s risk-adjusted. So, the answer is yes.

John McNulty – Credit Suisse

And then just as a follow-up, it looks like your risk-adjusted number went up from the November timeframe where you were talking about $10 billion back then, it looks like I add all these up, you are getting to $12.5 billion, any major new projects there or is it just a lot of new things kind of coming to fruition or you are getting closer to the implementation, so the risk is going down?

Andrew Liveris

Really, all of the above. I mean, some new, but lots of little new and lot of stuff that’s now moving through the next stage games.

John McNulty – Credit Suisse

Great. Thanks.

Operator

Next, we will go to Paul Mann with Morgan Stanley.

Paul Mann – Morgan Stanley

Andrew, you are obviously seeing lot of raw material inflation in the performance division during the quarter, can you quantify the effect on the margins that’s had in the performance products division?

Bill Weideman

Yes, Paul, this is Bill Weideman. Yes, actually if you look at our performance businesses, we had about $200 million of margin compression in the second quarter, and as you know, our results show better than that, that was because of the continued realization of synergies, but roughly it was about $200 million of margin compression. As we anticipated, as we mentioned before that we have a lot of 60 to 90 day lag in increasing prices there. But as you know, going forward, if propylene goes down, that trend should change and we should see margin expansions.

Paul Mann – Morgan Stanley

Okay. Thanks. And just one follow-up question, it sounds like (inaudible) perhaps you could just talk in which markets you are seeing significant growth in place?

Andrew Liveris

There is Europe, I would characterize as lagging behind the US, so I don’t want to overplay the statement. I think depending on where you were in Europe, we are seeing in particular Germany with its export orientation being quite strong as the Euro keeps dropping because of the issues around sovereign debt. Germany is doing quite well and well for us. And there is a plethora of different ways we see it. We see it for example in our installation business, energy efficiency measures that have come through government stimuli not just in Germany, but across other countries in Europe like France in particular, northern Europe and also over into eastern Europe, and in fact we are seeing eastern Europe coming back stronger, that’s a quicker rebound than western Europe, but that helps Western Europe, in particular it helps Germany in particular. So, there is no one particular market other than I would say to you generically, it’s in the areas of infrastructure and transportation and exports.

Paul Mann – Morgan Stanley

Okay. Thanks so much.

Andrew Liveris

Thanks Paul.

Operator

Next, we have David Begleiter with Deutsche Bank.

David Begleiter – Deutsche Bank

Thank you, good morning.

Andrew Liveris

Good morning David.

David Begleiter – Deutsche Bank

Now, Andrew, given the strength of your innovation pipeline, how much fast should the performance businesses grow as multiple GDP over the next, perhaps three to five years?

Andrew Liveris

Yes, as you know, there is so many performance businesses, they all have their own demand driver, electronics material for example should be a 2X GDP number. So, that’s you know, I need to say, because Jerome mentioned it, but when you come to May 18th, sector day, you are going to see the power of the synergies in electronic materials. We have lowered the cost point, because of the synergies on the cost side, but the GDP growth out in Asia in particular and all of the stuff that we are doing is seeing double digit twice the size of GDP growth rate. Ag should be about one-and-a-half times, and performance systems probably a little lower than that, 1.3 to 1.4 times GDP, and performance products is probably around one times GDP.

David Begleiter – Deutsche Bank

And just on those subjects looking at rice store and your China cold chemicals project, how important are those two projects for your growth, over the longer-term basis?

Andrew Liveris

Critical, I would say. We have one project ahead of those two, which is the tide project. That should come on in the next year, or year-and-a-half. That will be great for our expansion out in the far eastern growth markets out there. There is a range of different good products we are building there. And then the next one will be Russia [ph] and then the following one will be China, and these are all asset life projects, all building blocks projects that will help feed Jerome’s business, help feed performance systems and make sure that we have the downstream value add that the strategy speaks to.

David Begleiter – Deutsche Bank

Thank you.

Howard Ungerleider

Thanks a lot. Karen, next?

Operator

Next, we will go to Frank Mitsch with BB&T Capital Markets.

Frank Mitsch – BB&T Capital Markets

Good morning. Thank you. I was just looking at some math here, and I was just trying to rectify or clarify the 83% operating rate that you did back in the second quarter of ’08 versus the 83% today, and obviously on an EPS basis, it was better back then, the company looked a little bit better, but I was looking through some numbers on a pro forma basis, I actually think that the company performed a bit better back in the second quarter of ’08 with Rohm and Haas. Are the numbers wrong here? What might be the differences here that we should expect as the operating rates move up that we will get that are performances and what was generated back a couple of years ago?

Andrew Liveris

I mean, frankly there is a couple of lots of moving parts, right. So, the number of assets that have been taken down especially on the commodity side, the hydrocarbon and energy, compression that’s occurred in this quarter versus the quarter back then, propylene in particular, the question that was asked earlier on propylene cost base, propylene cost base is going up. There is lot of moving parts. So, I think the way we look at product, in 2008, that quarter was 93% operating rate, we had lowered the cost point of the company on structural cost by the combined company by the two big restructurings that were taken, one by Rohm and Haas, one by Dow, when you put those two together, that’s about $750 million takeout of costs and structural costs. And then the $1.3 billion of synergies, that $2 billion will be out of the combined cost base that you saw back in the first quarter of ’08.

That will then in turn mean the volume, once you get the volumes up there, that will all drop to the bottom line. And one way we have explained it is reuse ’07. If you take $6.5 billion of EBITDA in ’07 from Dow, $2.5 billion of EBITDA Rohm and Haas, that’s $9 billion. Add the $2 billion of EBITDA from cost savings, that’s $11 billion. And then if you add and subtract, add the equity earnings, then will have Dow Corning’s expansion (inaudible) that gives us up to around $11.5 billion, subtract the solvent businesses, that’s $10.7 billion of EBITDA or $4.50 a share. That $10.7 billion of EBITDA, when will that be attained? If you make the assumption of the 12, it will look like 7, then we are on the run rate to that number based on the current asset footprint, not counting any of the growth pipeline.

Frank Mitsch – BB&T Capital Markets

Okay. Terrific. Thank you. And if you could just – while you are talking about some of the synergies with Rohm and Haas, you mentioned that you guys are around $0.5 billion in sales from the growth synergies, which businesses are we seeing that play out?

Andrew Liveris

Across the board. I have covered a few of them, will be at a fast pace, in one of my slides, in my deck, but by size, the water business, wet strength resins supply, I mean AkzoNobel and coatings, industrial coatings, emulsions, architectural coatings, just to name a few.

Frank Mitsch – BB&T Capital Markets

All right. So, there is not just one area that is showing up it’s really broad-based?

Andrew Liveris

Broad-based.

Frank Mitsch – BB&T Capital Markets

Thank you.

Howard Ungerleider

Thanks Frank. Next question, Karen?

Operator

Next we have Kevin McCarthy with Banc of America/Merrill Lynch.

Kevin McCarthy – Banc of America/Merrill Lynch

Yes, good morning. How are you? Andrew, just a follow-up on Ross, there have been reports out of the Middle East that the project could be relocated and possibly downsized, are those accurate and perhaps you could update us the feedstock considerations there, and your latest thoughts on capital requirement?

Andrew Liveris

Thanks Kevin. Yes, there has been a lot of press reports, the partners have not made a statement. Clearly, one of the things that the both partners have examined long and hard is the capital burden of such a huge project to get go, even though it’s a live structure for us and for them. We have made no decision yet on any move – it has been assessed as interesting alternative, that’s been made available to the partners. We are basically within a few months of making final decisions on the feed, which is obviously the big commitment to go to the next step, order long-term equipment. And in fact, stock details is adding (inaudible) So, we will have a lot to say, give us a few months.

Kevin McCarthy – Banc of America/Merrill Lynch

A follow-up, has the more favorable ethane dynamics on the US, Gulf Coast change your higher level paradigm or in terms of capital investments toward the Middle East?

Andrew Liveris

One of the things we are working very hard on that, the premise of your question is you know we are a leader in talking about energy policy in this country and we are trying very hard now with this revised energy and climate change bill that’s coming out of the Senate, this KGL bill to ensure that we can lock in sustainable energy policies around natural gas in this country for many years to come. There is a couple of things that we have been saying about it. We are not yet certain we can lock it in, that’s why we are not as bullish as those statements suggests. We want to be, we want to recreate an investment dynamic here in the US around our asset base, based on long-term predictability of natural gas.

Kevin McCarthy – Banc of America/Merrill Lynch

Okay, understood, thank you.

Howard Ungerleider

Thanks Kevin.

Operator

Next, we will go to John Roberts with Buckingham Research.

John Roberts – Buckingham Research

Good morning guys.

Andrew Liveris

Good morning John.

John Roberts – Buckingham Research

Gauging downstream inventories from Dow is always sort of hard, but I look at Praxair reported this morning and they do a manufacturing index with end markets and they had manufacturing owing up 1% globally versus last year’s first quarter in spite of the easy comparisons, and that excluded chemicals. So, your growth is much, much higher than what they were reporting as a manufacturing index growth. Do you think there is some pre-borrowing or buildup going on in advance while the price increases that have been going on?

Andrew Liveris

Absolutely not. I haven’t looked at their numbers. We think it’s about 7% industrial production year-over-year comparative, which means our volumes even more impressive. When you look it by sector, you look at things like automotive, it’s up incredibly high year-on-year. There is no question in our mind that this is beyond the restocking, this is now consumer-led demand recovery.

John Roberts – Buckingham Research

Okay, thank you.

Operator

Next, we will go to JP Morgan’s Jeff Zekauskas.

Jeff Zekauskas – JP Morgan

Hi, thanks very much.

Andrew Liveris

Hi Jeff.

Jeff Zekauskas – JP Morgan

Hi, usually you are kind enough to say how much your energy cost change year-over-year in the quarter, what was that number this quarter?

Andrew Liveris

Our purchased H&E costs were up approximately 700 million quarter-over-quarter.

Jeff Zekauskas – JP Morgan

Okay, great. And then lastly it sounds like you have a different point of view toward your US petrochemical businesses because of sustainable advantages due to feedstocks, is that right? Do you no longer want to sell that business?

Andrew Liveris

We have a very clearly stated strategy. The strategy is to move Dow’s portfolio to downstream value-add businesses. Businesses like Jerome’s, businesses like the Ag business. We have preferential investors, our R&D budget, CapEx budget is all going that way, but we need building blocks for those businesses. We will do them in an equity-like, asset-like structure. And then over these next many quarters, we hope that we can get a higher value for our joint venture with our Basic Plastics unit, but we haven’t changed strategy.

Jeff Zekauskas – JP Morgan

Thank you very much.

Howard Ungerleider

Thanks Jeff. Karen, we have time for one last question.

Operator

We will take our last question from Bill Young with ChemSpeak Advisors.

Bill Young – ChemSpeak Advisors

Thank you.

Andrew Liveris

Hi Bill.

Bill Young – ChemSpeak Advisors

Andrew, I hear that polyethylene exports have dropped off, maybe inventories have overbuilt based on higher prices here. I wonder if you could bring us update on that? And separately, with your $2 billion goal on divestitures, is that a way to say, well, we don’t expect the K-Dow, the deal to be done this year?

Andrew Liveris

Let me answer the second question first, because this was a follow-on from a previous question from Jeff. We don’t know when the deal will be done. We don’t’ count as you quite rightly put it, the $2 billion number. We don’t count the replacement deal to the K-Dow deal in our numbers, that’s correct. However, the timing of any such deal for us will be based on maximum valuation. I mean, I think what you should be hearing on this whole strategy, we are very pleased with the PE business. It’s number 1 in the world, it’s actually, technologically advanced. There is a right partner out there with feedstocks that, that business should be joint ventured with, but we are not counting on it this year. That’s the area we are going to interpret it, Bill. In terms of export windows from the US on polyethylene, I believe we moved significant amount outside to China and Asia in the first quarter, about 20%. We look very closely at pre-buying the pervious question, we don’t see any signs of inventory builds based on perspective price drop.

Howard Ungerleider

Thanks very much Bill. That ends the Q&A portion. Before we end the call, I would like to ask Andrew to just make a few closing comments.

Andrew Liveris

Yes, I would like to just, firstly thank you all for listening to the call and Q&A. If you really look at the summary, of the way we feel about things, we think this revenue run rate, we had a substantial revenue beat in the quarter, reflects this by giving signs of a new Dow and in fact an economic recovery with volume growth to the upside, not only of course in the emerging world, but now the US and to a certain extent, parts of Europe. There is demand pool going on, not restocking.

We believe Rohm and Haas was a great acquisition for us and we are demonstrating it earlier than anyone expected on not only the bottom line but also the topline, which speaks my revenue point, and the two things that we were asked on the column of Q&A, our cost reductions give us great leverage to economic upside and economic recovery, and then growth will in fact drive the upside, and our innovations and the agenda around R&D and I really urge you to come to May 18th, sector day with Jerome because he’s going to show growth in all of its colors. Thank you for listening to us.

Howard Ungerleider

All right. Thanks very much for joining us this morning, and we really appreciate your interest in the company. We look forward to speaking with you again soon. Thanks again.

Operator

Once again, that does conclude our conference for today. Thank you again for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: The Dow Chemical Company Q1 2010 Earnings Call Transcript
This Transcript
All Transcripts