Seeking Alpha
Research analyst, oil & gas, tech, mid-cap
Profile| Send Message|
( followers)  

Dow Chemical (DOW) announced impressive fourth-quarter results led by strong growth in the performance plastics segment. The segment reported a 66.7% growth in earnings before income taxes, depreciation, and amortization (EBITDA), as compared to the previous quarter. In the fourth quarter, the plastics business generated 26.8% of the company's total revenue and accounted for almost 70% of the company's total EBITDA. Going forward, the performance of the plastics business will play a crucial role in driving the company's growth.

The performance plastics segment sells a number of products that have applications in electrical, communication, packaging, and other industries. Plastics such as polythylene (NYSE:PE) and polyvinyl chloride (PVC) can be derived using ethylene as feed-stock. Dow Chemical is the largest producer of ethylene, which gives its plastics business a regular supply of raw material and a low-cost advantage. Ethylene can be produced from steam cracking of either naphtha or ethane. However, the cost of producing ethylene from ethane in the U.S. is less than half the cost of producing ethylene from naphtha. As a result, Dow stands to gain from its upcoming ethylene production facilities in the U.S due to the presence of abundant and cheap shale gas. The company is running a $4 billion expansion program on the U.S. Gulf Coast, which includes a $1.7 billion ethylene cracker in Freeport. Once operational, the new facilities are expected to increase the company's EBITDA by $2.5 billion.

Dow is also expanding its performance plastics business through a joint venture in Saudi Arabia. The facility is expected to begin production next year and achieve full production by 2016. Once operational, the company anticipates the Saudi Arabia JV will increase its EBITDA by $500 million per annum. With an overall PE capacity of 1100 kilotons, or 2.4 billion lbs per annum, the plant will help meet the PE demand in Asia and the Middle East. This is in addition to the 3 billion lbs of PE that will be produced from the U.S. Gulf Coast expansions. Both of these projects will help the company meet the global PE demand, which is expected to grow at a compounded annual growth rate (OTCPK:CAGR) of 4.5% until 2018. The expansions in the U.S. and Saudi Arabia will further improve the plastics segment's profit margin due to lower energy costs in both countries.

On analyzing the company's quarterly earnings, it can be seen that the plastics business has consistently posted better margins than the company's overall margin, with the second quarter being the only exception. In the second quarter, the company received a settlement of $2.16 billion from the K-Dow arbitration proceeding, which was recorded as sundry income, thereby increasing the company's margin.

Parameter

1Q 2013

2Q 2013

3Q 2013

4Q 2013

Company's EBITDA margin

15.4%

28.5%

13.3%

16.2%

Segment's EBITDA margin

27.2%

27.5%

26.8%

41.9%

Segment's EBITDA as per cent of total EBITDA

42.9%

24.2%

52.9%

69.5%

The performance plastics business has posted healthy EBITDA margins, and the segment's share in the total EBITDA has increased. Going forward, I expect the segment to report better performance driven by the growing plastic demand and lower energy costs.

Reducing the burden of debt

The steady performance from the plastics business has helped the company improve its cash flow position. Dow has managed to post increasing cash flows in the last three years, helping it reduce its total debt from $21.6 billion to $17.9 billion. The company generated $6 billion from operating cash flows in 2013, excluding the amount it received from the K-Dow settlement. In 2013, the company reduced its total debt by $3 billion, which reduced its interest expense by $170 million. As a result of increasing cash flows and reducing debt, the company's debt management has improved with an increase in its operating cash flow to debt ratio.

Parameter

2011

2012

2013

Operating cash flows (in $ million)

3,879

4,075

6,000

Total debt (in $ million)

21,600

20,987

17,960

Cash flow to debt ratio

0.18

0.19

0.33

Apart from reducing debt, the company is also focusing on increasing shareholder wealth. Recently, Dow Chemical tripled its share buyback program from $1.5 billion to $4.5 billion, and it will execute the program by the end of this year. The buyback program was approved in early 2013, and the company has completed $0.5 billion of repurchases since then. As a result, the company will be buying back $4 billion of its outstanding shares in 2014, and assuming the average repurchase stock price to be the current price, it would translate into a buyback of 87.7 million shares. This will help increase the company's earnings per share in 2014. Moreover, the company increased its first quarter dividend from $0.32 to $0.37, thereby enhancing shareholder returns. The company's stock already offers an impressive dividend yield of around 3.3%, which could rise further with increase in dividends.

Conclusion

Dow Chemical posted a good performance in 2013 led by its performance plastics business. The company's new production facilities are expected to come up by 2017 and will further improve the plastics segment's performance due to lower energy costs. Moreover, the company's debt position has improved over the years, allowing it to take more steps towards increasing shareholder wealth. Its stock price generated a return of 34% in 2013, and I expect the stock to continue its good performance in 2014.

Source: Plastics Will Continue Driving Dow Chemical's Growth