Dow Chemical Q2 2007 Earnings Call Transcript

Jul.27.07 | About: Dow Chemical (DOW)
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Dow Chemical (NYSE:DOW)

Q2 2007 Earnings Call

July 26, 2007 10:00 am EDT

Executives

Mr. Andrew N. Liveris - Executive Chairman, Chief Executive Officer, President

Mr. Geoffery E. Merszei - Chief Financial Officer, Executive VP

Mr. Michael R. Gambrell - Executive VP of Basic Plastics & Chemicals and Manufacturing & Engineering, Director of MEGlobal of OPTIMAL Group

Mr. David E. Kepler II - Chief Information Officer, Chief Sustainability Officer

Mr. Fernando Ruiz - Corporate VP, Treasurer, Chief Executive Officer of Liana Limited

Analysts

Robert Koort - Goldman Sachs

Kevin Mccarthy- Banc Of America Securities

Jeffrey Zekauskas- J.P. Morgan

Prashant Juvekar- Citigroup

Don Carson – Merrill Lynch

David Begleiter – Deutsche Bank

Peter Butler – Glen Hill Investment Research

Frank Mitsch – BB&T Capital Markets

Sergey Vasnetsov – Lehman Brothers

Mark Connelly – Credit Suisse

Presentation

Operator

Good day and welcome to the Dow Chemical Company’s Third Quarter Results conference call. Today’s call is being recorded. At this time I will turn the call over to Corporate Director, Investor Relations, Kathy Fothergill. Please go ahead, ma’am.

Kathy Fothergill

Good morning, everyone, and welcome. As usual, we’re making this call available to investors and the media via Webcast. This call is the property of the Dow Chemical Company, and any redistribution, retransmission, or rebroadcast of this call in any form without Dow’s express written consent is strictly prohibited.

On the call with me today are Andrew Liveris, Dow’s Chairman and CEO; Geoffery Merszei, Dow’s Executive Vice President and Chief Financial Officer; and Jeff Tate, Manager in Investor Relations.

Around 6:30 this morning, July 26th, our earnings release went out on PR newswire and was posted on the Internet on Dow’s Web site, Dow.com. We have prepared some slides to supplement our comments on this conference call. The slides are posted on our Web site, available on the presentations page of the investor relations section, or through the link to our Webcast.

As you know, some of our comments today may include statements about our expectations for the future. Those expectations involve risks and uncertainties. We can’t guarantee the accuracy of any forecasts or estimates, and we don’t plan to update any forward-looking statements during the quarter. If you would like more information on the risks involved in forward-looking statements, please see our SEC filings. In addition, some of our comments may reference non-GAAP financial measures. A reconciliation to the most directly comparable GAAP financial measure and other associated disclosures are contained in our earnings release or on our Web site. Our earnings release, as well as recent 10-Qs, 10-Ks, and annual reports, are available on the Internet at Dow.com in the financial reports page of the investor relations section.

Starting with the agenda on slide three of the presentation, Geoffery will lead off with an overview of the second quarter. I’ll discuss the results of our operating segment. Then Geoffery will update you on actions we’ve taken to advance our strategy and describe Dow’s outlook for the months ahead. After that we’ll move to your questions for Andrew and Geoffery.

Before we start I’d like to point out a change in our geographic reporting. Given our strong international presence and focus on growth in emerging geographies, we’re providing you with more detailed information on our regional activities, with sales, price, and volume data on North America, Europe, Asia Pacific, Latin America, and our India/Middle East/Africa region. The press release contains this data for the current period and the year-ago period. The appendix to the slide presentation provides more historical information on the same regional basis.

Since you’re seeing this regional data for the first time, you may have a question about the volume decline in the India/Middle East/Africa region. While this region is strategic to Dow for a number of reasons – joint venture opportunities, growth in these emerging economies – our sales in the region are relatively small at present, so the divestiture last December of our polyethylene and polypropylene businesses in South Africa had a significant impact on year-over-year comparison.

Now, Geoffery, let’s move to slide four and your comments.

Geoffery Merszei

Thank you, Kathy. Good morning, everyone. This was another very good quarter for Dow. Once again we secured tremendous benefit from a strong international presence, our diverse business portfolio, our commitment to joint ventures, and our focus on price volume management. We delivered solid earnings in the face of significant challenges, and in the process set a new quarterly sales record for the company. We recorded healthy cash flow, which supported investments in organic growth and acquisitions, as well as $400 million in share repurchases. And we took actions in a number of fronts to move further ahead with our strategic agenda. I’ll return to each of those themes in a few moments, but first let me run through some of the second quarter highlights and details on slide five.

Sales for the quarter passed $13 billion for the first time in our company’s history, rising 6% from the same period a year ago, to reach $13.3 billion. Our three performance segments and basic classics set new quarterly sales records, while geographically revenues were up significantly in Europe, Latin America, and Asia Pacific. Volume was up in each of Dow’s performance segments, with substantial gains in the number of businesses, including Dow AgroSciences, Dow Automotive, Specialty Plastics, and Design Polymers, and price increased 6% for the company as a whole, with improvements in all operating segments, all geographic areas, and virtually all businesses.

Earnings for the second quarter edged slightly higher from a year ago, rising from $1.05 to $1.07 per share, and that was achieved despite a remarkable increase in the cost of purchase feedstock and energy, which climbed more than $550 million compared with the second quarter last year. And on a sequential basis the increase was even higher; the highest on record by almost $700 million. So when framed in this context, the company’s ability to achieve such strong results is pretty impressive.

Now while it is fair to say that we anticipated an increase in our hydrocarbons bill, a surge of this magnitude was considerably more than we had expected. The dramatic increase in cost over such a short period of time accounts for much of the decline in EBIT within our Performance Chemicals and Performance Plastics segments, where movements and selling price tend to lag changes in raw material costs. But while these businesses were unable to keep pace with the hydrocarbon increases this quarter, second quarter if those costs remain relatively stable we can expect to see some margin recovery as we move through the current quarter.

Across the company as a whole we can mitigate a portion of the hydrocarbon increase through our feedstock flexibility and our hedging activities. But frankly more important is price volume management, requiring us to navigate that fine line between retaining volume and improving margin. Clearly during the second quarter we navigated well.

Volume held steady versus the same period last year, with healthy demand across many performance businesses, which collectively improved 3% year-over-year. And although our basic segments were down, this was principally due to the impact of asset shutdowns, divestitures, and plant turnarounds. Of particular note was the turnaround at Dow’s joint venture refinery in the Netherlands, which reduced the availability of refinery byproducts for sale in our hydrocarbons and energy segment. The turnaround also hit volume in Europe, causing an overall decline of 2%, overshadowing a solid increase of 5% to the other operating segments in the European region. We also saw strong growth in the emerging regions, with Asia Pacific up 8%, and Latin America up 4%.

So with this robust volume growth outside North America, there’s no question that the international reach of our businesses is having an ever more significant impact on the company’s results, and we expect this contribution to continue as we reap the benefit of having assets in key regions around the globe and local people on the ground who are very familiar with doing business in their respective parts of the world.

So as we continue to build this presence, particularly in the critical growth regions of China and India, selling, administrative, and research and development expenses will increase. Let me stress that this increase is entirely consistent with our expectations as we move ahead with our transformational growth strategy. SARD for the second quarter increased to 6% of sales, up from 5.5% in the same period last year. Most of this rise was focused on activities that support our performance portfolio; establishing brand, building market presence, raising the profile of the company, and increasing our investments in research and development. Rest assured, as we continue to invest for growth our financial discipline and focus on controlling costs will remain sharp.

So let me now turn to another facet of Dow’s activities that is playing an important role in the company’s success: joint ventures. Slide six, which we will include in our quarterly reviews going forward, provides a few highlights. Kathy will run through some of the dynamics of the quarter as part of her operating segment review in a few minutes, but for now let me focus on the financial highlights of our joint venture activities.

Equity earnings for the quarter were up 11% from a year ago to $258 million; while year-to-date they climbed more than 30% to $532 million. Cash contributions from joint ventures were also up significantly in the second quarter compared with a year ago. And year-to-date the increase is not so pronounced due to the very timing of the dividend payments from the various joint ventures. Note also that our cash contributions to these joint ventures so far this year have been minimal, as their activities are in fact largely self-funded.

But given the importance of joint ventures to our strategy, we will be providing more detailed information on how they are performing. Now before the end of the third quarter we plan on issuing a white paper offering greater clarity around Dow’s joint venture strategy and more insight to the dynamics that shape equity earnings.

I should point out that while Dow currently participates in more than 75 joint ventures, a relatively small proportion of them have significant impact on our financial results. Our principal joint ventures include about a dozen companies and collectively accounted for more than 90% of our equity earnings last year, 2006. These joint ventures will be the focus of our white paper, which we plan to update annually.

Slide seven is representative of the information we intend to provide on operations, as well as details on how they impact Dow’s financial statements.

So in summary, this was a very good quarter for Dow; delivering strong cash flow from solid earnings, joint venture distributions, and well-managed working capital, all of which support of further investments in organic growth and acquisitions, as well as $400 million in share repurchases. As we move forward we will continue to focus on balancing the use of our cash between investing in growth opportunities and remunerating our shareholders.

Kathy, over to you.

Kathy Fothergill

Thank you, Geoffery.

Starting with slide nine, Performance Plastics reported record sales, with gains in both price and volume. We saw continued strength in the polyurethanes group, as price, volume, and EBIT all improved versus a year ago. For polyurethane components, volume growth was restricted by tight supply of TDI, which also limited the demand for flexible polyols; however, growth in polyurethane systems was robust, made even more so by the acquisition during the quarter of Hyperlast in the U.K.

Demand for Dow Automotive products was surprisingly strong, with volume up 7% globally; substantially higher than the auto industry production, despite a significant decline in North America. While prices also increased, the improvement was not enough to offset higher costs, including raw material increases and costs associated with the consolidation of some manufacturing facilities.

Dow Epoxy posted sales gains, but EBIT declined from very strong levels a year ago, as the industry has become increasingly competitive due to recent capacity additions, and the business chose not to participate in some low-margin opportunities.

Slide ten. Performance Chemicals also reported higher price and volume, although raw material cost increases reduced margin. Designed Polymers posted strong results in water-soluble polymers, with increased demand from a variety of end-use applications, but gains in this business unit did not completely offset the impact of higher costs in some other designed polymers business units.

Specialty Chemicals also saw solid demand and higher prices for many of its products, with particular strength in ethylene-based specialty products, although higher raw material costs compressed margins. Dow Latex increased prices both for paper and carpet latex and for specialty latex, but these gains were not sufficient to offset the substantial rise in raw material costs.

Joint ventures added significantly to the bottom line in Performance Chemicals, with improved results at OPTIMAL and continued outstanding operating performance at Dow Corning, although Dow Corning’s earnings declined compared to the second quarter of 2006, which included the benefit of a favorable tax settlement.

As you can see on slide 11, Agricultural Sciences had another outstanding quarter and an excellent first half. The business posted double-digit volume gains in both ag chem and seeds and traits, and volume improved around the world; in North America, Latin America, Europe, and Asia Pacific. This growth was driven by both robust industry conditions and by Dow AgroSciences’ strong portfolio of existing and new products, including penoxsulam rice herbicide and aminopyralid herbicide for range and pasture. We’re pleased with the progress we’ve made this year with our Herculex family of traits for corn. And while the final numbers are not yet in, we believe sales of Dow AgroSciences’ corn seed in the U.S. have grown faster than the overall industry.

Moving to slide 12 and Basic Plastics, we continue to see strong results, despite the significant rise in feedstock costs. Polyethylene reported gains in price and volume in Europe, Asia Pacific and Latin America, but declines in North America on the volume side due to the shutdown of our low-density polyethylene plant in Sarnia in the second half of last year.

Polystyrene continued to raise prices, chasing ever-higher benzene costs. Very strong demand for polystyrene in Asia Pacific offset declines in other regions, where some customers delayed purchases in the hope that prices would come down. Polypropylene saw healthy demand growth in North America and Europe, offsetting the impact of the Safripol divestiture in December last year. Prices improved in all regions, but not sufficiently to offset higher costs. Equity earnings improved, with higher contributions from both EQUATE and Siam Polyethylene.

In Basic Chemicals, slide 13, better results for EO/EG and solvents and intermediates were more than offset by a decline in ChlorVinyls EBIT. While prices for caustic soda and VCM improved from the first quarter, they were down from a year ago. At the same time, energy costs increased by more than 10%, the perfect recipe for a real margin squeeze. Industry conditions have improved for EO/EG with good demand for both polyester and PET, coupled with delays in anticipated supply additions. Adding to the improved results for EO/EG were higher equity income contributions from MEGlobal, EQUATE, and OPTIMAL.

One final data point. Our operating rate for the quarter was 86%, up 2% from second quarter last year.

That wraps up the financial review of the quarter. Now I’d like to turn the microphone back over to Geoffery for his update on strategy and outlook.

Geoffery Merszei

Thank you, Kathy.

Three months ago we promised to provide a quarterly update highlighting some of the actions we have taken against each of our key strategic themes. Before doing that, let me remind you of the key components of that strategy, which are detailed on slide 14.

I have no intention of running through this now. Instead, let me outline a few of the highlights from the last few months, sticking with the same format that I used last quarter, starting with opportunities that will accelerate geographic and business growth.

As you can see from slide 15, during the quarter we successfully completed the acquisition of both Wolff Walsrode from the Bayer Group, and Hyperlast Systems business from British Vita. Following the acquisition of Wolff Walsrode, the Designed Polymers business announced the formation of Dow Wolff Cellulosics, a $1 billion specialty business focused on cellulosics and related chemistries, and serving a broad spectrum of strategic industry sectors. Also within Designed Polymers, the water-soluble polymers business announced plans to open a new application laboratory in Shanghai, China, to support the construction polymers industry across Asia Pacific.

Another new laboratory, this time in Egypt, was announced by the Polyurethanes business, focused on systems market development and prototyping, to meet the growing needs of customers across the Middle East, India, and Africa. And Dow’s ANGUS Chemical unveiled plans for a new R&D manufacturing facility at the Sterlington site in Louisiana to support the development of specialty products and processes across a range of industry segments.

Finally on growth, the company has made a significant commitment to energy conservation solutions in the rapidly-growing Eastern Europe, recently authorizing four new plants for the production of STYROFOAM brand insulation in that region.

Turning to activities within our basics businesses, which you can see on slide 16, in May we announced the start of a detailed feasibility study with Shenhua Coal for the construction o a world-scale coal-to-chemical complex in China. The same week, we signed a Memorandum of Understanding with Saudi Aramco to move further forward with the Ras Tanura chemicals and plastics production complex in Saudi Arabia. And earlier this month the two companies announced the appointment of KBR as the project management company for that feasibility study.

Now during our last earnings call I mentioned our proposed joint venture with Chevron Phillips Chemical involving assets from the two companies’ polystyrene and styrene monomer businesses in the Americas. Now that project is still moving forward towards regulatory approval. In the meantime, Dow has continued to explore strategic options for its polystyrene business outside the Americas. To that end, we are continuing to look at other options for the rest of our styrenics business, as we told you that we would during our earnings call last January.

Finally, and most recently, just last week we announced a joint venture in Brazil with Crystalsev to create a world-scale facility to convert sugar cane into polyethylene. The project not only marks a significant step forward in our sustainable chemistry endeavors, but it also serves to strengthen our presence in this critical growth region, and takes advantage of the country’s low cost feedstock, in this case, ethanol.

Looking now at innovation, slide 17, let me begin by highlighting that 33% of sales in the second quarter came from products that have been introduced by Dow in the past five years. And just as important, we’ve been investing in our products of the future as we continue to revitalize our innovation agenda. I’ve already mentioned the new application development facilities in China, Egypt and Louisiana, so let me now single out a few of our other achievements and activities in this arena.

Looking back over the past few months, we’ve reported success on a number of fronts. For example, Dow AgroSciences and Sangamo BioSciences recently announced the completion of key research milestones focused on the generation of specific traits in maize and canola. In addition, we formed a joint venture partnership between Dow, the Lawrence Berkeley National Laboratory, and the Chinese Energy Research Institute, aimed at supporting China’s efforts to improve energy efficiency and reduce energy intensity.

And it is also worth reporting that the methane-to-olefins research initiative we announced last quarter received more than 80 submissions. Ten of these proposals have been selected for an in-depth review.

The past three months has also seen the introduction of several new product lines. For example, earlier this month we launched Hypod Polyolefin Dispersions, the first in a family of products made possible by Dow’s proprietary Bluewave technology. The new products are being targeted towards a broad range of end-use applications, including paper coatings, carpet backing, fabric protection and footwear.

We are also ramping up sales of a new range of epoxy products and systems for windmill applications, addressing customers’ calls for larger blades and faster production cycles. And in Europe we announced the introduction of approximately twenty new and upgraded polypropylene products for rigid packaging and film converters. The new products, that will be commercialized as INSPIRE resins, include low odor and taste grades with food application approvals.

Now moving to financial discipline, you’ll find out on slide 18 capital spending for the second quarter was slightly north of $460 million, bringing the year-to-date total to $792 million and keeping us well within our full-year $2 billion target for cap ex. Now on shareholder remuneration, I spoke earlier about investing $400 million in our share buyback program during the second quarter. This more than offset dilution. And let me also mention that the 12% increase in dividend payments that we announced last April is now in place and will be reflected in dividend payments on July 30th.

Now looking at portfolio management, I’ve already mentioned the two acquisitions that we completed during the quarter, namely Wolff Walsrode and Hyperlast.

Moving on to working capital management, day sales outstanding in receivables remained at a very low level of just 40 days, while day sales in inventory ended the quarter at 62 days. Working capital management, and in particular inventory management, remain an important priority for us.

Now in terms of our performance against financial metrics, Dow’s return on capital and return on equity through the first half of this year were 16% and 23%, respectively, both comfortably ahead of our long-term targets.

And so finally let’s turn to Dow’s outlook. We continue to expect overall global GDP growth to be quite healthy in the current year, at or above 3%. The U.S. is expected to show slower growth than last year, principally because of headwinds from the housing and auto industries, although the sharpest declines in residential construction appear to be behind us. Growth in Europe should be solid, while emerging regions are likely to be stronger still, particularly in China, which we expect to continue to grow at double-digit (inaudible) and regions. So with supply growth limited, industry supply and demand should remain balanced, particularly in the ethylene chain. On the other hand, as we have said before, chlor-alkali industry conditions may weaken later in the year, impacted by capacity startups later in the year or early 2008.

For Dow we anticipate solid demand through the third quarter. Our Agricultural Sciences business is likely to see a typical seasonal decline, but with our strong product portfolio and good momentum we expect to report another quarter of favorable year-over-year comparison. Feedstock and energy costs are expected to remain high and volatile through this quarter. Nevertheless, our performance through the first half of the year and our outlook for the second reinforces our view that our strategy is working and that we will continue to deliver strong results and cash flow for the company and our shareholders.

Thank you very much. And over to you, Kathy.

Kathy Fothergill

Thanks, Geoffery. Well that wraps up our prepared remarks. For your reference, a copy of these remarks will be posted on Dow’s Web site later today. Now we’ll move on to your questions.

Before we do, though, I’d like to remind you that my comments on forward-looking statements and non-GAAP financial measures apply to both our prepared remarks and to anything that may come up during the Q&A.

Janelle, would you please explain the Q&A procedure?

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question today from Don Carson from Merrill Lynch.

Don Carson – Merrill Lynch

A question on ag. You had very strong ag results. I’m just wondering to what extent did you see any pull-forward in Brazil, because I know other players down there are talking about a bit of a pull-forward in input purchase. And, Kathy, you mentioned that you think you gained share in corn seed. Can you just quantify that and then talk about how you think that positions you to expand your corn seed business?

Kathy Fothergill

Okay, let me answer some of that. As far as the Brazil, we did see strong growth in Brazil, but I wouldn’t characterize that, at least our currency was we didn’t see that as a pull-forward of third quarter sales. We just think the conditions down there were quite strong.

As far as our market share, as you know, it’s not all final yet; we haven’t had returns. But we think that our sales growth rate was maybe two or three percentage points above the industry growth rate. I don’t know what that does actually for share of market, but we do think we were ahead of the industry growth rate. You know, our Herculex traits are doing quite well, and so we think that bodes well for the future.

Don Carson – Merrill Lynch

And getting back to Brazil, so is that the key reason, Geoffery, why you think you’re going to have strong year-over-year comparisons, would just be strength down in Brazil? And how strong could that second-half year-over-year comparison be in ag?

Geoffery Merszei

Well, I mean Brazil obviously plays an important role, but overall the momentum is very strong across all the regions. So we expect on a comparative basis year-over-year a positive result in most of the regions. And the fundamentals in Brazil overall – as you know, the economy there is doing very well and there’s a lot more liquidity today than what we’ve seen over the last few years, and that gives us a great opportunity to maximize our current products as well as the launches of new products.

Andrew Liveris

Let me just chime in. So we talked Brazil; also Argentina, and there’s an insecticide run in Canada for wheat aphid that’s beginning. So even though U.S. insecticide is maybe not as good, but the insecticide run in Canada – remember third quarter is a down quarter, right, so we’re off the major part of the ag production. But the momentum in ag, Kathy mentioned share point gain in U.S. corn. We can quantify it more exactly, but we were better than industry based on Herculex. And Brazil was strong and no (inaudible).

Don Carson – Merrill Lynch

Andrew, can you address the strategic issue of – I mean you’re making advances in corn seed, you’ve got some interesting traits, especially in healthy oils; how does that position you to sort of significantly grow your seed traits business via joint venture or via an acquisition?

Andrew Liveris

Well I think, Don, it’s kind of hierarchal in its order of hierarchy in what we’ve been doing. We are the most profitable ag chem. company out there today in terms of returns. That was the last three or four years worth of work that Jerome and his team have done.

Second, we put in a huge amount of investment from the ag chem results into traits and that is starting to pay some dividends. Of course, Herculex is just the legacy trade really in working with our cross licenses there. The key, the next hierarchy then is what you homed in on, which is seeds and channel. We’ve got good agreements across the sector. We anticipate we’ll have more of those to say, but we’re also, you may not have noticed we bought a little company in Austria. We’re picking off seed companies when and if they become available to take our next generation traits, including the molecule stacks.

So we can become a legitimate player in our own right, beyond the need to do anything significant in terms of a large JB or alliance or even divest or acquire some business model that you guys ask us about all the time. Said another way, our ag business has become quite a performer, even though it doesn’t necessarily have the scale of a market leader. I think it does put punch above its weight, and as a consequence of that we’re going to continue to keep investing the way we’ve done in the last few years. And I think over a course of a timeframe we will find the right structure for the organization and the company as a whole.

Operator

Our next question today comes from David Begleiter from Deutsche Bank.

David Begleiter – Deutsche Bank

Andrew, we’ve seen really massive M&A in the chemical space. You’ve largely stayed on the sideline, absent a couple of small transactions. What’s your thinking going forward on down in terms of bulking up in the specialty or differentiated chemical arena over the next 12 to 24 months?

Andrew Liveris

Dave, I mean you’ve characterized us right; we actually haven’t used the term “financial discipline” to use that characterization. I think you’ve seen us do little deals. Wolff was not all that little, but it’s a good example. In fact, the largest in five years, Geoffery just added. But the expectation that we can do a bigger deal in the specialty space is certainly there. We’d like to, but frankly the prices and what you have to pay, you really have to have a strategic story that fits.

We’ve been very clear about the sorts of places we want to grow in in the end-use market domain. I’ve talked about water and I’ve talked about coatings and adhesives and downstream businesses that we’re good at, but we could go further downstream and help dampen our earnings cyclicality and use this massive cash flow. We’re a great cash flow story if you keep following us, so our cash flow is doing great. We have the firepower to add, but we want to make sure that we’re disciplined when that happens. It takes two to tango and we’re going to make sure that when we do the deal it will be one that you guys stand back and say, “Boy, that fits. That really fits.” And frankly, rather than react to what’s available, we’re going to be patient and do it the right way and the way our shareholders demand of us, which is what we demand of ourselves.

So medium to large, there are just not that many properties that really make sense. But however, we do do a lot of deal churn; we look at lots of things, and we will do the right deal at the right time.

David Begleiter – Deutsche Bank

Andrew and you guys, you did mention the SG&A being up substantially. Is this a new high-level spending going forward for Dow?

Andrew Liveris

Yes, I think Geoffery’s well in his prepared remarks. We are in an invest mode; you will expect to see R&D spending up on some of these new things he was talking about as we seek to diversify our input footprint. You notice some of the alternative, feedstock, energy, some of the projects in that domain. Of course, application side we are investing in key market areas, like duning, like water, etc.

The acquisitions themselves bring SG&A. So we’re doing growth-oriented acquisitions, so when we do year-on-year comparisons you’ll see that go up. Again, consistency here is that we’re going to put it all in the performance downstream businesses. That’s what you’re seeing. And yes, we’re creeping up a little bit, but I will tell you this, we are dashboarding this every two weeks so that we understand where to invest and where’s stuff we can actually take out so that we can actually portfolio manage this so that over time we monetize businesses or we actually take out costs in businesses we’re running for cash.

All the increases that you’ve seen in the second quarter are planned. Actually, year-to-date we’re better than planned. So frankly, the board and us, as a management team, are investing. You’re quite right to characterize with that, but we are keeping a very tight watch on what goes up, and in fact what can come down, to help mitigate.

Operator

And next from JP Morgan we’ll hear from Jeff Zekauskas.

Jeff Zekauskas – JP Morgan

You went out of your way to say that your cap ex is about $800 million for the first half, which will be comfortably below depreciation at $2 billion if you annualize it. But you’ve also made a large acquisition in buying Wolff and you’ve got Hyperlast as well. So maybe all that comes out to be something close to $3 billion by the end of the year; I don’t know, something on that order. Can you talk about what kind of levels of investment you wish to make over time, and in particular whether some of your investments in Saudi Arabia or in the Mid East will drive up your cap ex above your level of depreciation or whether you expect it to remain below over time?

Andrew Liveris

Jeff, the strategy here is to meet our longer-term financial targets, which includes an EPS growth rate of 10% over the next ten years. If you look at the composition of our cap ex as well as the composition of growing through acquisitions, it is all in areas where either we secure (inaudible) feedstock on the basis side, and in fact in most cases certainly on the acquisition side it is in the performance sector that is helping us to meet these financial targets. So it’s a matter of balancing out the organic growth as well as the acquisition.

Now we are generating a very strong cash flow and don’t forget that our joint ventures – and I think I made reference to that – the joint ventures are also generating a very healthy cash flow, and in fact are being self-financed. So the expansion in the Middle East – and not just the Middle East, also in Thailand, for instance, in (inaudible) cement, where you have both growth investments on the basics as well as on the performance side and have primarily in the performance side; and that again is just being self-generated. So we need to do a combination of that in order to meet our ultimate goal, which is to improve not just the consistency of our earnings, but also the growth of our EPS.

Jeff Zekauskas – JP Morgan

I’m sorry; in your comment you said that your goal was to have 10% EPS growth over a ten-year period. That is 10% average annual EPS growth?

Andrew Liveris

That’s correct.

Jeff Zekauskas – JP Morgan

So you’ve moved from being a cyclical model to a growth model. Is that the idea?

Andrew Liveris

Well, we have not – Jeff, we have had this target now for quite a few years. We haven’t changed them. As you know, we also have a return on capital and return on equity target of 13%, 3% above a cost of capital, as well as 20% return on equity. We have been very close to meeting those targets. The one area where we have failed over the last ten years has been on EPS growth. And so clearly we want to accelerate that measurement as well as mitigating the cyclicality on our earnings.

Operator

And next we’ll hear from PJ Juvekar from Citi.

PJ Juvekar - Citigroup

Andrew, your performance result, EBIT was down. As U.S. economy slows are you seeing more pushback on pricing from your customers?

Andrew Liveris

Well, you know, performance is – as you know, PJ – it’s a huge, huge sector and I really can’t do great justice to your question across a generic comment. But I will say this; the huge sequential quarter increase on hydrocarbons and energy, feedstock and energy for making chlorine derivative products, which of course feed the performance sector; I mean that was really a large, large sequential increase, our largest in history. And as you know, performance businesses lag in their ability to get price increases.

A lot of the performance businesses have price increases out there; some of them are taking hold. To your point on North America, no question that the order of housing sector in North America is weak and so therefore pricing in North America remained a weak spot. But remember, we also have a large presence internationally and our performance businesses are very present in places like China, for example. In fact, in China, if you look at our revenues there, over 70% are in the performance sector. So there is a regionality to the question, even though North America is weak.

We still anticipate – conversely, I think we’ve said this quite a lot, if oil price stabilizes or in fact keeps going high, that actually provides a sustained air cover for our ability for our performance businesses to finally give price increases out there. And I think we expect that that would happen in the third quarter with the current scenario on oil and naphtha.

Fourth quarter ’06 and first quarter ’07 are examples of margin expansion in our performance business when it was sustained high input costs. And I think that’s what you can expect to see going to the third.

PJ Juvekar - Citigroup

Geoffery, can you talk about your unusually high sundry income and a lower tax rate?

Geoffery Merszei

And the tax rate. Well let me start with the tax rate. The underlying tax rate is in fact very similar to where it was in the first quarter, roughly about 25%. We did have an unusual tax item; well, we have many, as you know, as a global company, where we in fact have facilities and realize gains and losses in very (inaudible) sections. In this case we have a tax law change in Texas which increased the value of our tax credits in that state and that had about a $50 million impact. So that’s on the tax rate side.

Oh, by the way, going forward you should also use an underlying rate of approximately 25%.

Now on the sundry income, over the last couple of years we’ve been averaging about a $70 million amount. Now of course that does swing every so often, and in this case the big delta between what we saw in the past year over year, as well as the first quarter, is some Forex hedging activity where in fact a year ago we had some Forex losses and this quarter we had some gains, and that then created this relatively wide swing.

PJ Juvekar - Citigroup

So the sundry income we should factor in something like $70 million. Maybe you add another $50 million from Forex hedging this quarter.

Geoffery Merszei

That’s correct.

Operator

And next we’ll hear from Bob Koort from Goldman Sachs.

Bob Koort – Goldman Sachs

I wonder if you could talk a little bit about what the holdup or potential holdup might be in the styrenics joint venture. And then it seems as if numerous companies in the industry are trying to do something about that business. Can you give us some hope for what it might look like in the next couple of years or will we have a cyclical downdraft that sort of neutralizes the self-help efforts there?

And then secondly, could you just comment on an update on what you’re doing in Oman? Thank you.

Andrew Liveris

Yes, styrenics, as you know, has been a sustained downdraft for some years now. The new world order of naphtha and benzene and gasoline clearly has affected the styrenics change. We’re very excited about our joint venture with Chevron Phillips here in the Americas because of the styrene/polystyrene match that that provides when we made that announcement. It’s moving through the FTC approval process, and that just takes time. I mean this is an industry consolidation that will in fact get its level of scrutiny; however, it’s just the right thing to do for all sorts of reasons, I believe some being our customers, because our customers in the Americas need to sustain source that’s comparative here in the Americas.

That’s true globally. I do think the entire world order of styrenics is going through those evaluations and making announcements. Some people here on the continent of course have announced the same sort of deal. In fact, this happened in Europe recently with BSS. So I do believe that at the end of this is a better value change from input, which is benzene and obviously ethylene and obviously therefore naphtha and anything that gives us ethylene, and then beyond that of course, for the customers, because you’ll have a viable sustainable enterprises in the value chain.

Dow has said that we’re not committed to being a full owner, not committed to even being a half-owner. We’ll do what it takes to upgrade the value of these businesses going forward to make them reinvestment grade. I think that was really key.

On Oman, that article in Chemical Week was stale, it was old, so really what’s going on is our partners and us are still in discussions. We have ways forward to of course overcome what’s happened there. We’ve always said it was delayed. It’s not canceled. We are working on the right configuration for that project going forward. There are the two issues; one is the capital costs, which of course we caught the wave there, so unlike our Kuwait project, we’ve delayed it based on the high capital costs. We are working our way through that. At the same time the gas supply, which is very unique to Oman’s situation, and our partners and ourselves remain committed to finding a viable project there in the medium term.

Bob Koort – Goldman Sachs

Great. I also want to applaud you for providing more disclosure on the JVs and the slides for the conference call; it’s quite helpful.

Andrew Liveris

Thank you, Bob. We’re listening and we’re doing our best. I know you guys want more, and we’ll do our best to keep giving it. Part of our continuous improvement program here.

Operator

And our next question comes from Glen Hill Investments, Peter Butler.

Peter Butler – Glen Hill Investment Research

I think we can go back to when Paul Oreffice was CFO and he would be proudly pointing out that our receivables are in great shape, but those operating guys are pretty sloppy with their inventories. Why is this such a long-term congenital problem? Are you guys really serious about doing something about it? And what could you reap there in terms of improving your working capital?

Geoffery Merszei

Peter, that’s a nice question for me to answer. Peter, inventory management is critical, as we’ve been saying, and it has been a challenge. I think one of the reasons why we’re having a little bit of a tough time, there’s a volatility frankly in the marketplace. As part of managing the exposure on the feedstock side sometimes it’s advantageous to keep it low, sometimes it’s high; it’s part of the price volume management. And so this is not an ideal time to frankly or necessarily have low inventory. For one time in the quarter it may be advantageous; by the end of the quarter it might not be advantageous. But I think the key issue here is that we are focusing on it and we’re going to improve on it.

Andrew Liveris

Peter, one thing, if I could chime in, seeing you evoked Paul. One thing he didn’t have that we have is then all of our – everyone has is that word, globalization. The transparency provided to the customer base around the world on what the terms and conditions are in China versus Brazil versus Poland versus Columbia versus U.S. maybe has become quite a deterrent, being an efficient working capital manager vis-à-vis the volatility of inputs that we have to suffer that Geoffery made. Having said that, we’re determined to use the total supply chain so that we don’t have to carry it on our books.

Peter Butler – Glen Hill Investment Research

Andrew, are you pushing the ball forward on doing a MEGlobal type deal in your U.S. basics?

Andrew Liveris

Yes, at the start of the year, Peter, I said that this would be a transformational year for the company. I remain committed to making it a transformational year in the company. I also remain committed to do the very best for our shareholders so that we don’t just do any deal. And we have been working very hard and doing deals that we fit. MEGlobal is a classic example of a deal that fits. Similarly, some of these projects we have announced I think fit that criteria. And we have a very powerful basics franchise that we’re not just going to monetize with short-term endeavors. We’re going to marry and joint venture because it makes strategic sense and improves the returns and cash flows to our shareholders. As you can see in the transparency that Bob Koort referred to in our JVs, these are tremendously strong cash flow, high-return enterprises we’re setting up, and you ain’t seen nothing yet. And the answer to your question is yes, we are working diligently on the right deal for the right reasons.

Operator

And next we’ll go to Frank Mitsch from BB&T Capital Markets.

Frank Mitsch – BB&T Capital Markets

Andrew, if I understand your comment on CNBC correctly this morning, can we expect to see kangaroo on the menu at Dow’s cafeteria soon?

Andrew Liveris

Frank, if kangaroo starts to appear on the menu at the New York City or wherever, I’m going to really start worrying about the U.S.’s health concerns here, okay.

Frank Mitsch – BB&T Capital Markets

I understand that it’s rather stringy.

Andrew Liveris

It didn’t sound very good to me.

Frank Mitsch – BB&T Capital Markets

No, it did not. The question on slide 14 of a list of things that Dow is doing, the bottom of the list was “return value to shareholders.” I assume that that’s not the bottom of things that you’re looking to do. And in that vein, you spent $400 million on share buyback in the second quarter. The stock is now at a level, is pretty much at the lowest level that it was throughout the second quarter. Can we look for share repurchase to accelerate, particularly at these levels throughout the year? And if you could give us some guidance there, that would be very helpful.

Andrew Liveris

Frank, I’m just going to make reference to what I said in the first quarter. We have been – in fact we’ve been consistent since last year. Number one, we do want to balance investments and remunerating our shareholders, but we also said when we announced the new program, the $2 billion program at the end of the year, that we plan on having it completed by the middle of next year. I think in the first half of this year we spend over $800 million on it and you can make your own calculation as to what it’s going to be between now and middle of next year. So I think we are consistent and we’re going to continue buying back our shares.

Frank Mitsch – BB&T Capital Markets

Okay. And any chance that you might look at increasing the size of that program, given, as Andrew referenced before, the solid cash flow generation at Dow?

Andrew Liveris

Well, don’t forget we also have a priority, which is to grow, both organically as well as through acquisitions. If we go ahead and aggressively accelerate this program, then we also may be precluding some interesting growth opportunities on the acquisition side.

So I think the answer is still, Frank, is still a balanced approach. But having said that, $2 billion over a relatively short time I think makes a statement.

Frank Mitsch – BB&T Capital Markets

All right, terrific. Then lastly, on the M&A front, Huntsman and Hexion look like they’re going to be combining here. What do you think that’s going to do to the competitive dynamic in epoxies? And may something come out of that transaction from the FTC perspective that might allow you to grow your own business in picking up some pieces there?

Andrew Liveris

Epoxy, Frank, definitely is a growth business for Dow and we are doing a lot to actually put the epoxy business in the same value chain the urethanes business has successfully done, which is really go downstream into systems and adhesives and all the things that we can do with those great, great functional chemicals. So our strategy is to make that business more and more downstream, and Patrick and his team are doing a great job there. We’ll always look for pieces that can actually keep globalizing it while making it go downstream. Of course, whatever happens out of the newly announced transaction will be of interest, but we won’t comment in terms of anything specific other than to say what I just said; it’s a growth activity we want to keep investing in.

Operator

And Kevin McCarthy from Banc of America Securities has our next question.

Kevin McCarthy – Banc of America Securities

Andrew, would you update us on your market-facing businesses? How many have you established? What ones might be next? And most importantly, how can we assess, or how can you assess the impact on profitability as you transform the way in which you interact with your customers?

Andrew Liveris

Yes, clearly, Kevin, we have announced – we’ve got, right; these were not announced – as an ag farm food nutrition business is an established one. Auto was established, booting was established; so those aren’t in the category of announce there, and category of reaffirmation. Water was announced, as you know, and we got – that was last year. Now coatings and footwear were just announced and we’re evaluating two or three others this year.

What we’re going to be very conscious of, to answer your specific question, is where – and this is back to transparency – Geoffery and I and the teams are working on market value-add mechanisms for their metrics which are based on gross margins and investments in sod so that we can track it. I mentioned dashboard on the comments earlier on another question. We’re going to be basically tracking them in terms of invest versus grow, top line and margin growth. We’re going to be very conscious we don’t over-announce and over – add too many of these, at the same time focusing in on areas that have discontinuities of the marketplace. So as time goes by we’ll do more on acquisition.

So right now we probably have no more to announce for a little while, to answer that specifically, Kevin.

Kevin McCarthy – Banc of America Securities

(Inaudible) consolidation recently among commodity chemical players in North America. I’m wondering does that shrinking list of players provide any greater opportunity for Dow to extend your asset light strategy to some of your larger commodity businesses, like polyethylene or perhaps even chlor-alkali? Are you seeing any increased interest or activity there, Andrew?

Andrew Liveris

I think the answer to that is that because we’ve made the statements we’ve made that Peter referred to, now over a year ago, and reaffirmed them in January, we remain the prize partner, if I can say it that way, Kevin. So for the right reasons there are a lot of players out there who would want to do a deal with us for the right reasons, and I mentioned those earlier, whether it be in the chlor-alkali chain or whether it be in the ethylene chain.

As I’ve always said, we’re not going to do those lightly because they are so key to our value-add performance businesses. So those are not cleave-off strategies; these are kind of partnering strategies, joint ventures so that we can remain competitive in the downstream value-add businesses. So long story short, I think we remain a prize property. We are not short of people talking to us. And at the same time, what’s going on in the North American market, remembering we’re at global play.

Global play has a different ramification to anyone who joint ventures with us than just the North American play. So we’re not short of people to talk to. I think the consolidation is good for the sector and I think it will continue to bring us opportunity.

Kevin McCarthy – Banc of America Securities

I mean, when do you decide to fish or cut bait on coal gasification in China?

Andrew Liveris

Fish or cut bait is probably too early. Maybe I’d use a kangaroo analogy. We’re hopping along and we’re going to do the phaseability study with great rigor. And a year from now we’re going to know a whole lot more about the economic feasibility of colder liquids and colder chemicals. China’s very committed to that program.

Operator

And next we’ll hear from Sergey Vasnetsov from Lehman Brothers.

Sergey Vasnetsov – Lehman Brothers

I have a couple of questions on your tables from page eight and nine of the press release. I’m trying to reconcile some price and volume data. Starting from Europe, what would be the impact – what would be the volume in Europe if you stripped out the impact of turnaround and acquisitions? And secondly, when I’m looking at the North American prices increasing by only one-percent and looking at the divisional level, the minimal increase was essentially 2% in North America. How could North America be so much lower than every single division?

Kathy Fothergill

I’ll answer the question on Europe, Sergey. Not a big impact, I don’t think from M&A, but without the turnarounds, without the hydrocarbons impact, volume in Europe would have been up 5% instead of down 2%. So it’s a huge impact. That’s where we fell all the refinery byproducts; those sales are in Europe.

And then your other question was on North America, which price?

Sergey Vasnetsov – Lehman Brothers

Right.

Kathy Fothergill

Yes, price increase was relatively model. I mean, we had a few things up, but most of the businesses were flat or even down in North America compared to a year ago. Europe will have embedded in it the impact of currency, which accounts for some portion of that. It depends on the business; it might be a half in some businesses or it might be a little less than that in others. So I think that’s probably the reason.

North America has the weakest supply-demand balance of the regions right now, and so that gives you less pricing power.

Sergey Vasnetsov – Lehman Brothers

Okay, that’s helpful. And, Kathy, could it translate the 7%, the delta on volume in Europe into a financial impact for you? How many millions was this in the quarter?

Kathy Fothergill

I can’t; I really don’t know. I don’t know. This is the refinery byproducts; there are not necessarily huge margins on this.

Operator

And Mark Connelly from Credit Suisse has our next question.

Kathy Fothergill

Mark, I just want to tell you, I think we’re running past time, but you’re in and I think we’re just going to have to call that the last call.

Mark Connelly – Credit Suisse

Well, and I’m only going to ask one question too.

Kathy Fothergill

That’s okay.

Mark Connelly – Credit Suisse

With respect to Brazil, given the extra energy process steps and capital to get from sugarcane all the way to ethylene, can you talk about the relative advantage versus a typical naphtha cracker?

Andrew Liveris

It’s an in-market play, which means it competes against indigenous or imported naphtha, to your point. So it’s definitely not a Middle East-oriented gas play, so that’s your first line of question.

It is advantage versus indigenous naphtha. We won’t say much; no one has competition to know. But how do we get there, to answer the kind of framing question you asked? But partnering with Crystalsev, they’re an integrated ethanol producer today.

The difference between Brazil and the U.S. in this whole world is U.S. is building its ethanol infrastructure; Brazil hasn’t. And so as a consequence, I went over there last week, I toured their ethanol facility, which is very much integrated with their sugar milling process and the cane fields. Highly automated, large-scale, great, great product diversification, great energy efficiency; selling 85% of the output of the entire power plant that they have there, which uses the (inaudible) to the grid. So compared to a conventional naphtha cracker it uses 15% of the energy as a whole.

So long story short, the extra steps of ethanol to ethylene and polyethylene are going to be very small power consumers. So this is a very energy-efficient process because of its integration, which we love.

Kathy Fothergill

Okay, well that concludes our conference call. Thank you for joining us today. We look forward to talking with you again on our next conference call in October. Goodbye.

Operator

And this does conclude today’s conference. Again, we thank you for joining and have a great day.

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