- Citigroup recently increased its target price on Dow Chemicals to $57 from the current market price of $49.80.
- Dow is now targeting $4.5-$6 billion from the sale of non-core assets. The divestment plan is strategically planned to deliver long term value.
- The proceeds from the divestment are likely to be utilized in better performing business segments.
- The plan of constructing four new performance plastics production units signifies the company’s plan to take advantage of the economical supply of gas.
- Dow’s vertically integrated production allows it to achieve low cost production of end products for higher margins.
Dow Chemicals (NYSE:DOW) recently announced it would raise an additional $1.5-$2 billion from asset sales bringing the total target to $6 billion. The additional target will come about by adding the divestment of slow growth, low margin commodity businesses, mainly Chlorine and epoxy. The figure below demonstrates the pre-tax proceeds of the company.
Source: Company's Presentation
The ongoing divestment actions would unlock greater value for shareholders as the company aims to divest its resources towards and focus on more rewarding segments such as Performance Plastics. The division includes the products made of elastomers, polypropylene, and other products that are widely used within the electrical, telecommunication, and packaging industry such as semi conductive and insulation material for power cable insulation, functional polymers, and fiber grade resins.
During 2013the sales contributed by Performance Plastics increased by 1 percent to $14,645 million primarily due to increased prices. However, the EBITDA was significantly higher at $4549reflecting an increase of 34 percent from $3018 million in 2012. The increase was primarily driven by lower feedstock cost and lower raw material cost.
Source: 10 k filling
Going forward, the availability of lower cost US shale gas is expected to continue to provide a competitive advantage for the business. Similarly, increased export volumes in the Asia Pacific region and Latin America will drive volumetric growth and will result in improved margins.
Similarly, with the Sadara production facilities coming online in the second quarter of 2015 and the restart of the ethylene facility in Louisiana the company will be enjoying low cost production.
Low Cost Advantage
Ethylene is one of the most important inputs for Dow's largest business, Performance Plastics. Dow is vertically integrated and manufactures its own ethylene. It produces approximately 90 percent of ethylene consumed by the Performance Plastics business. Similarly, the cost of producing ethane has halved since 2010.
In addition to ethane, another key input is gas and Dow is aggressively putting efforts into sourcing low feedstock. During August of 2013 the company announced the construction of four new Performance Plastics production units to be built on the US Gulf Coast. With the prime location of these production units Dow is well positioned to take advantage of the low feedstock position from US shale gas.
Fundamentally, the cost advantage is here to stay. Going forward, the low cost of producing ethane coupled with ample amounts of ethane highlights increased low cost production which in turn will ensure higher margins.
Increased Shareholders Return
The company increased its dividends by 15 percent and tripled its share buyback program during 2013. The increased shareholders return can be seen in the figure below. Going forward, the company is on track to deliver top and bottom line growth and I believe it will further increase the dividend.
Source: Investor Presentation
Currently, Dow has been trading at a dividend yield of 3.00 percent that is higher than that of Du Pont's (NYSE:DD) 2.68. Moreover, the PEG ratio is 1.52. Given the future growth prospects I believe that the stock is inexpensively priced and that sooner rather than later the market will correct the price.
The divestment of its non-core assets will allow the company to focus more on the well performing Performance Plastics division. The division is positioned to drive further margin expansion and earnings growth. Moreover being one of the largest producers of ethylene, Dow is well positioned to meet increasing global demand for plastic products at low costs.
Similarly, the completion of four ethylene facilities in the US Gulf Coast bodes well for the company as the access to uninterrupted and economical gas supply will further strengthen the lower feedstock base of Dow. In addition, the company is offering a nice dividend yield of 3 percent and has been trading at a discount to its peers. Therefore, I recommend buying the stock.