Don't Miss The Boat On Dow Chemical

 |  Includes: DOW, MON
by: Vincent Fernando, CFA

Most people know that Monsanto (NYSE:MON) is an 800-pound gorilla in the biotech crop space. And most investors agreed that the company has a bright future as well, as shown by the company's PE of 41x. Annual revenue and EBITDA comes in at $7.3bn & $1.8bn respectively vs. a market cap of $28bn. Thus there's a nice multiple for Monsanto no matter which way you cut it.

But perhaps its less realized that Dow Chemical (NYSE:DOW) , a company punished with a PE of 10x due to growth uncertainties and the vagaries of its cyclical chemicals business, also has its own agrifoods and biotech unit- Dow Agro, a large business which generated 2005 sales of $3.4bn and 2005 EBIT of $540m. Still, this segment goes somewhat unnoticed since it accounted for only 10% of DOW's overall 2005 EBIT.

Nevertheless, if we were to put Dow Agro on Monsanto-like EBIT multiples, we'd have an $8.4bn company. On Monsanto sales multiples we'd have a $13bn business. Strip the Agro segment out of DOW's current $40bn market cap and the remaining company is trading at a sub-10x PE.

Yes, Monsanto may be ahead in the level of sophistication of its agricultural portfolio and Monsanto is seeing better near-term growth than Dow Agro (Dow Agro's EBIT was down for the 9M06), but we recommend investors keep an eye on this relatively small DOW segment, as it could become quite a growth engine in the future- and become a business which deserves Monsanto-like multiples. And once its recognized then its too late, we've missed the boat.

Looking to history, we came to a similar conclusion with the company Syngenta (NYSE:SYT) a few years back, one which turned out to be the case- Syngenta became increasingly viewed as a Monsanto peer as its Agro products became more sophisticated and its biotech business was realized. SYT's PE multiple expanded along with earnings and the stock has done quite well. Also, investors might be able to get in now and wait comfortably since the overall company is at only 10x PE and sports a 3.7% dividend yield (a dividend never reduced since 1912, and recently increased, we might add).

Finally, there are other bullish arguments (and well yes a few bearish ones as well) for DOW, beyond it's Mini-Monsanto business alone. Lower energy-based feedstock costs could send the stock rebounding, for example. But Mini-Monsanto is perhaps a lesser-known reason to take a look at DOW shares.

DOW 1-yr chart