With uncertainty surrounding the global industrial economy, many investors are naturally reserved about the chemical industry. The Street currently rates Monsanto (MON) a "buy" versus a "hold" for Dow Chemical (DOW). Based on my multiples analysis, review of the fundamentals, and DCF model, I find stronger upside at Dow.
From a multiples perspective, Dow trades at a respective 16.7x and 9.9x past and forward earnings while Monsanto trades at a respective 25.1x and 19.6x past and forward earnings. In addition to being cheaper by this measure, Dow also has a dividend yield that is 140bps higher dividend yield at 2.9%.
At the fourth quarter earnings call, Dow's CEO, Andrew Liveris, noted a solid response to macro headwinds:
As you know, the fourth quarter presented our industry with a challenging operating environment with new uncertainty driven mostly because of the sovereign debt issues in Western Europe, coupled with traditional seasonality, led to substantial destocking across supply chains, as customers reduced inventories prior to year end. We anticipate this volatility and we're prepared. Our company acted swiftly and purposefully, as we said we would. At our Investor Day last fall and during our third quarter earnings announcement, we discussed the levers we could pull and the interventions we would take if necessary. And that's exactly what we did. We cut discretionary spending. We took action to improve operating rates. We tightly managed working capital, and these actions generated cash from operations of $2 billion in the quarter. Over the last several months, we have been very focused on our interventions, which delivered results as follows: earnings per share excluding certain items were $0.25.
The market reacted negatively to the call with shares falling 1%. Much of this was due to the conservative guidance, which took away the attention from emerging market demand that will start kicking in around the second quarter. Fourth quarter results missed expectations by $0.05 largely as a result of inventory reductions. Total volumes were further flat off of growth in the preceding quarter. By the second quarter, however, plastics margins are well positioned to take off with the shift in ethane prices. Furthermore, management has so many catalysts at hand that it needed to acknowledge how it will be staying away from takeover activity and focusing on tapping into organic growth opportunities.
Consensus estimates for Dow's EPS forecast that it will grow by 8.7% to $2.76 in 2012 and then by 25% and 26.1% in the following two years. Modeling a 19.6% CAGR for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $54.66, implying 61.1% upside.
Monsanto had a great start to 2012 in several respects. Latin America is starting to showcase considerable catalysts as early orders from 2011 are flowing into 2012. The pipeline progress of Monsanto merits it trading at a premium. Furthermore, EPS crushed expectations at $0.23 with top-line expansion of 33% and margin expansion of 720bps. While declines in planted acreage are inevitably going to decline , corn demand is still getting stronger in Brazil and Argentina.