Dow Chemicals (NYSE:DOW) recently reported its second quarter earnings report. The company declared its adjusted earnings per share (EPS) of $0.74 reflecting y-o-y growth of 16 percent. Moreover, it declared revenue growth of 2.3%bringing the revenues to $14.92 billion. Most of the revenue growth was driven by both the performance plastics and performance materials divisions. The revenue growth was only 2.3 percent but the better than expected results were primarily driven by adjusted EBITDA margin, which improved by approximately 40 basis points. However, the question that comes to mind is whether or not these operating divisions can continue to perform well in the future. Therefore, it shall be desirable to discuss the future outlook of these operating segments in detail.
With the help of the performance materials division, Dow Chemicals serves a wide range of market sectors inclusive of but not limited to agriculture, mining and construction. During the second quarter the division's revenues increased by 1.5 percent year over year. However, the adjusted EBITDA margin improved considerably. The segment reported EBITDA of $386 million reflecting an increase of 36 percent from the previous year. The company expects to resume this trend in the future as it is expecting to expand its EBITDA margin by approximately 400 basis points by the end of 2017.
The company could be one of the industry's best growth stories. Its long term growth potential and its valuation are significantly dependent upon the successful implementation of the margin expansion plan in the short to medium term.
The adjusted EBITDA of the performance plastics segment increased by 57 percent. During the second quarter, performance plastics reported adjusted EBITDA of $1.1 billion. The segment's sales increased by almost 2 percent but the margin expansion was primarily driven by increased average pricing. The company was able to capitalize on the growing demand for packaging and plastic products and as a result the segment witnessed an increase of 7 percent in average pricing.
Going forward, the company expects to continue to lower its raw material cost. Given the robust growth in the production capacity of ethylene on the U.S Gulf Coast, I believe that the company will witness further expansion in the margins of its performance plastics segment. All in all, the company expects the adjusted EBITDA margin to improve by 200-400 basis points by the end of 2017.
Divestment Synergies will be Beneficial
In addition to increased operational efficiency, the company has been putting efforts into increasing its focus on more profitable and stable operating segments. In doing so, the company plans to divest its slow growth, lower margin businesses. The divestment hopes to raise around $4.5 - 6 billion. The company did not disclose the specific details of the businesses to be incorporated in the divestment plan. However, it did disclose that the focus would be on businesses that fall under the chlorine value chain such as the chlorinated organics and epoxy businesses that generate single digit EBITDA margins.
It is also certain that the raised capital will be utilized for the more profitable segments. The divestment will result in increased focused on the company's prime operating segments such as performance materials and performance plastics.
Dow's Growth Story
Dow Chemicals reported higher second quarter earnings because of wider margins. The company managed to post wider margins due to higher pricing and cost savings. Moreover, productivity improvements and higher capacity utilization also played their part in higher earnings. Going forward, I believe that the company has been putting aggressive efforts into ensuring better efficiency of operations. The company's performance plastic segment is positioned to increase revenues as there is fast-growing demand for packaging and specialty plastic products driven by the increasing need to reduce food waste and a growing focus on consumer convenience. Similarly, the increasing oil and gas production capacity of the U.S will help Dow to maintain low costs.
The divestment policy of the company seems to be a strategic move aimed at creating more efficient operations. Given the above mentioned arguments, it seems that Dow Chemicals has ample potential to deliver long-term value to its shareholders.
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