Is Dow Chemical A Buy Over Eastman?

|
Includes: DWDP, EMN
by: Winning Strategies

Summary

Chemical industry is moving on momentum.

This industry is expected to grow in 2015 on the back of growth in economic environment.

Dow Chemical and Eastman are all set to generate big profits.

Chemical companies are on momentum with the growth in business activities all around the globe. Global economy is growing at an attractive rate over the past two years and predicted to grow at a better rate in the following year. Based on IMF, economic environment grew over 3.3% in this year and is likely to grow at a rate of 3.8% in 2015. Strong growth in the global economic environment has been stabilizing business activities of most of the industries including electronics, industrial, manufacturing, transportation and construction, which is generating strong demand for the chemical companies.

Chemical companies are setting strong footholds to capitalize on the increasing demand. They are making acquisition and investments on their existing business to expand their revenue base and market share. Moreover, they are also selling their non-core business to align their portfolio according to the market trends. At present, chemical companies are concentrating only on high growth business which includes performance material, performance plastic, coating, infrastructure, electronics and industrials.

Dow Chemical (DOW) is one of the best companies operating in the chemical industry. The company is riding momentum with boost in business activities. In addition, Dow has strong penetration potential in both developed and developing markets which has been allowing it to flourish its sales growth. At the moment, Dow is concentrating on high growth business including performance material, performance plastic, energy and feedstocks. In the most recent quarter, it had posted 8.5% growth from performance material businesses, 8% from performance plastic and 2% from energy and feedstocks. In addition to the strong growth in sales, these businesses are providing better margins along with organic growth potential. DOW has generated 24% increase in its EBITDA in the most recent quarter.

On the other hand, its strategy to sell non-core assets has been boosting its cash position. The company is anticipating $5B to $6B of cash from the sale of non-core assets. DOW will use this cash to fund future investments, buybacks, along with lowering its debts. Recently, it has announced a new buyback of $5B which will take the total program to $9.5B. I strongly believe that the massive buybacks will strengthen its earnings per share, dividends and share price as well. Additionally, Dow Chemical recently announced an increase of 14% in its quarterly dividends. Its cash generating potential is strong enough to support future investments and dividend payments excluding cash from the sale of non-core assets. The company had generated free cash flow of $845 million in the past quarter when its dividend payments were at $550 million.

Where Does the Other Player Stand?

On the other hand, Eastman Chemical (NYSE:EMN) has been working on acquisitions along with the introduction of new products to expand its Specialty Fluids & Intermediates, Adhesives &, Plasticizers and Advanced Materials market's share. Over the past three years, Eastman had made several acquisitions to boost its market's share including Knowlton Technologies, Commonwealth Laminating & Coating business, BP's Aviation Turbine Oil Business and a huge acquisition of Taminco at a price of $2.8B. These acquisitions are adding great value and only Taminco acquisition will add about $0.32/share to its earnings. Along with the expansion strategy, Eastman is lowering its cost of production so that it can take full advantage of improved market trends.

In the third quarter of this year, Eastman had generated 3% growth in sales and 12% growth in earnings per share. In addition, it is poised to generate double digit growth in earnings for the full year which will be its fifth successive year of earnings growth. With the integration of recent acquisitions, its earnings per share will expand significantly in 2015. Its cash generating potential is also increasing on the back of steady growth in earnings. Eastman's operating cash flows are providing complete cover to its capital requirements and dividends.

Potential Risk

Before making any conclusion, it is wise to look at any potential risk to these two companies. At present, economic situation looks optimistic to me based on IMF prediction. In addition, diversified industrial, construction, manufacturing and transportation companies are looking forward to sustain their momentum which will drive demand of chemical companies. Both, Eastman and Dow are in healthy cash position which reduces any risk of solvency.

In Conclusion

DOW

EMN

Industry Average

Price/Earnings TTM

16.2

11.7

17.5

Price/Book

2.6

3.2

3.0

Price/Sales TTM

1.0

1.3

1.2

ROE TTM

17.5

28.9

17.4

Net Income Growth (3 Yr Avg)

27.5

40.0

18.0

Forward Dividend Yield

3.45%

1.69%

-

Source: Morning.com

Chemical industry is likely to post big profits in the following quarters. Dow Chemical is heading in the right direction with the sale of non-core assets and a focus on high growth business. The company is in a healthy cash position and its $9.5B of buybacks would likely to strengthen its financial performance. Dow looks a bit pricy compared to Eastman based on price to earnings ratio. Amid this, Dow is trading at attractive valuations trading at only 16 times to earnings and only one times to sales. In addition, the company is well set to generate a double digit growth in earnings which I believe will drive its share price performance. Moreover, massive buybacks will further strengthen its stock price and dividends.

On the other hand, Eastman's is also growing with acquisitions. Its revenue base will continue to expand with the integration of recent acquisitions. It has potential to sustain dividends and double digit growth in earnings. Eastman look undervalued based on price to earnings, but pricy on price to sales and book ratio. Its dividend yield is also much lower than Dow. If I have to choose one among them, I would go for Dow Chemical due its potential to generate high double digit growth in earnings, very strong cash position and high dividend yield.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.