Dow: Beneficial Cost Structure With Substantial Green Tech Potential (NYSE:DOW)

Funding Thesis

Dow Inc. (NYSE:DOW) is going through a macro headwind that’s undercutting its enchantment to buyers, though it is ready to use efficient value administration to maintain its money stream and margin. Nevertheless, its long-term progress would principally come from its substantial efforts in inexperienced applied sciences and the corporate’s associated services and products to a number of industries and markets on a big scale. Though the trail is probably not easy, its progress upside ought to align with a greater inventory valuation.

Firm Overview

Dow Inc., integrated in 2018, was previously a part of DowDuPont Inc, which it separated from in June 2019. It serves as a holding firm for The Dow Chemical Firm and its consolidated subsidiaries (TDCC), which was integrated in 1947 because the successor to a Michigan company of the identical identify, organized in 1897. Dow’s portfolio contains plastics, industrial intermediates, coatings, and silicones companies relevant in markets comparable to packaging, infrastructure, mobility, and shopper functions. The corporate’s reportable working segments are Packaging & Specialty plastics, Industrial Intermediates & Infrastructure, Efficiency Supplies, and Coatings. It has 104 manufacturing websites in 31 nations.

Power

Dow has a world scale in its manufacturing and markets throughout all continents, and main positions in key worth chains. With such a vastly broad attain, the corporate might choose places and services that maximize its value discount. For instance, 65% of its manufacturing capability is positioned in cost-advantaged Americas.

This effort displays in its web revenue margin ratio to gross revenue margin, which is near 50%; about half of its gross revenue margin turns into web revenue. Though its gross margin declined by This autumn, all different margins are nonetheless at their common ranges, with free money stream inching upward in current quarters.

Though its gross margin had been declining as a mirrored image of the broader financial system in 2022, it has utilized its top-quartile value construction to decrease bills. Its working expense as a ratio to income has been steadily declining to the bottom stage in This autumn 2022. Dow, as a producer, producer, and marketer with deep and broad-based financial ties in lots of industries, is anticipated to proceed this efficient cost-control administration this yr going through a looming recession.

Then again, Dow has been actively paying down debt since its IPO. It has eradicated nearly 20% of its complete debt on this interval. At present, its debt-to-equity ratio is 0.8X. This debt discount effort has been constant, as we are able to see from the debt reimbursement historical past within the chart beneath. The corporate has been making such efforts yearly because it went IPO. It has no substantive debt maturities due till 2027, and almost all debt is at a hard and fast charge. Its annual web curiosity expense can also be secure at about $500 million per yr, with investment-grade credit score scores. This ends in the present larger rate of interest atmosphere benefitting its near-term money conservation and progress stability.

Even going by this debt discount effort, on high of paying $4.4 billion of dividends, Dow’s web money stream remains to be holding regular.

The optimistic contributors are primarily its robust working money stream of $7.4 billion and a $1.6 billion long-term debt issuance. Its investing money stream was down in This autumn, however yearly is at par in comparison with 2021 regardless that its capital expenditure elevated by 20% YoY. Total, its web money stream is secure and rising.

Regardless that its web working earnings dropped from $6.4 billion to $4.6 billion by 27% in 2022, Dow’s free money stream nonetheless stays at its larger ranges on a TTM foundation. It was as a result of each a discount in pension contribution and a rise in account receivables. It diminished its pension contribution from $1.2 billion in 2021 to $235 million in 2022, again to its stage in 2020. Within the meantime, its accounts receivables noticed a big improve, from unfavorable $2.1 billion in 2021 to $1.2 billion in 2022, and its accounts payable went from $2.4 billion in 2021 to unfavorable $1.3 billion in 2022. Total improved money conversion and diminished pension contribution have been the largest optimistic contributors. It reveals the corporate’s actively managing to remain in a wholesome monetary place.

Not surprisingly, regular money stream has helped Dow’s present ratio preserve at a sufficiently excessive stage on a historic foundation.

As an American firm with worldwide dominance, Dow is ready to seize extra progress abroad in stability with its home income as effectively. One of many driving traits out there this yr is China’s reopening and its affect on Rising Markets. If there may be extra progress on this theme, how a lot would Dow seize it?

As we are able to see from the chart above, the income contribution from the U.S. & Canada solely accounted for 35.7%, Asia Pacific solely accounted for 18.3%, and the remainder of the world accounted for 45%. The corporate noticed a couple of 6% down in gross sales in APAC in 2021, which might be worse in 2022 however higher in 2023. If the APAC area can get well 4-8% in gross sales, together with its ripple impact in different areas, it might contribute 2.5-5% to its income progress charge in 2023.

Weak spot/Dangers

Dow continued to have the ability to obtain larger EBITDA than its earnings from operation, however they each have been inevitably impacted by the broader financial weak spot and trending downwards. In actual fact, the macro headwind is a near-term concern for the corporate.

Dow had a cross-segment weaker efficiency in This autumn. Each phase reported decrease quantity, decrease gross sales on a QoQ foundation, and decrease margins on a YoY foundation, whereas solely Efficiency Supplies and Coatings had a unfavorable progress charge in EBIT margin. They have been roughly consistent with the steerage they gave about This autumn. Many of the decrease margin was pushed by decrease costs, demand, and working charges.

But additionally word that this decrease gross sales progress is constructed on a better annual foundation as a result of YoY leap of 21.5% in 2021. In absolute worth phrases, there may be nonetheless inching upward in its web gross sales and income.

As a disciplined producer, Dow’s technique to deal with that is to decrease operational prices by its versatile working fashions. Specifically, they embody lowering capability throughout polyethylene property, a world chilly furnace idling program, and idling property throughout PM&C to handle value, match demand, and so on. Completely it’s anticipated to ship greater than $1 billion in value financial savings in 2023.

To place that in perspective, its common quarterly value of income is about $1 to 1.2 billion. So it’s nearly equal to saving 20-25% of its value of income. If its income drops lower than 20% YoY in 2023, its general profitability might nonetheless enhance. Dow’s efficient bills and value management, which we alluded to earlier, will proceed saving it in margins in annoying instances.

For Q1 of 2023, Dow gave modest steerage that the top-line progress to be flat to unfavorable within the segments. The anticipated web gross sales to be $11-11.5 billion, which is simply $500 million decrease than This autumn 2022’s web gross sales. It appears the corporate sees stabilizing market circumstances and demand in Q1. In accordance with the corporate, they see resilience from clients in agricultural, pharma, and power markets, whereas shopper durables, constructing & development finish markets are below strain.

Inexperienced Tech and Sustainable Progress efforts

Dow’s analysis and growth bills as a ratio to its complete working bills have at all times stayed round 30% and have regularly gone up lately. It’s contributed by each the decline of working bills and growing R&D efforts.

The corporate’s patent portfolio stays strong, particularly in the remainder of the world, the place its technological edge is most advantageous.

What’s Dow busy researching and creating? We imagine the brand new inexperienced tech initiatives take up a big chunk of it. Within the current JPMorgan 2023 Industrial Convention, Dow talked so much about its inexperienced tech. The administration talked about “decarbonizing” 20 instances, “recycling” 3 instances, “emission” 2 instances, and “web zero” as soon as. The theme of its inexperienced tech efforts is all through the presentation.

Past the inexperienced options of merely planting bushes to offset emissions, Dow’s sustainability efforts have profound ramifications for its clients and its backside line. The supplies it produces and the way it produces them are essential to many industries turning into extra sustainable and environmentally pleasant. This course of occurs to be monitorable and measurable at Dow since it will possibly do it on the precise scientific stage, and might have a direct impact on the merchandise and their customers. In its 2021 ESG report and 2022 ESG Strategy Overview, we see some highlights that may be immediately tied to income growth. It outlined six completely different areas the place the innovation can happen throughout all three of its main segments.

All through the upgrading efforts of those segments, Dow has outlined a path to its decarbonizing progress with a transparent goal.

Right here we need to spotlight the market potential of the segments inside the sustainability efforts. For instance, in its core enterprise phase, the corporate’s implementing “Shut the Loop” goal, and it’s monitoring its progress in direction of enabling 100% of its packaging software to be reusable and recyclable by 2035.

If we check out the inexperienced packaging market, its measurement is anticipated to double in market measurement by 2030.

Decarbonizing is the core technique addressing sustainability progress and merchandise for Dow.

And the low-carbon supplies market is anticipated to develop by nearly 50% by 2030.

On a broader scale, the world is more and more going through acute water scarcity stress. In accordance with World Meteorological Group, the hotspot on the planet are the next:

Dow has positioned its websites in half of those eleven hotspots. In these websites, it developed the capability to scale back the freshwater depth and speed up water options within the textile business, comparable to partnering with Ralph Lauren (RL).

Final however not least, in waste administration, Dow will remodel plastic waste and different types of different feedstock to commercialize 3 million metric tons of round and renewable options yearly by 2030. And the corporate’s effort in turning automotive waste into new automotive merchandise helps automotive producers meet their market and regulatory calls for for extra round merchandise.

Together with its acceleration of utilizing higher-efficiency, lower-emission expertise and deepening its analysis in trans-formative, next-generation applied sciences, Dow might experience the wave of a quickly rising inexperienced tech market, whose progress in North America alone is anticipated to nearly triple by 2029.

Inexperienced expertise typically implies extra effectivity and fewer waste, which is at all times good for the underside line. As a world materials and chemical firm, Dow can make the most of its analysis and industrial capability to seize this wave of innovation and its market-driven software. And that is all a part of its “Decarbonize & Develop” Technique, with particular near-term progress levers outlined in every phase, whereas saving $300 million in 2021 and trying to save one other $300 million by 2025. The newest announcement that Dow will construct a primary grid-scale superior nuclear reactor on considered one of its websites to supply long-term, dependable low-carbon power reveals the corporate is making a strategic effort essentially.

It expects its annual underlying earnings to develop by greater than $3 billion by 2030, which is about 50% greater than its present earnings. Its 2021 whole-year phase income contribution is as the next:

Combining the potential market progress potential of the areas we highlighted above, if we assume a gradual path P&SP grows by 6% yearly, II&I grows by 2-3%, and PM&C grows by 3%, then the whole annual progress of income can be about 37% by 2030. Together with its cost-saving advantages from improved effectivity, which it dubbed “Effectivity Levers”, to attain nearly 50% progress in earnings is formidable however solely out of attain. However the progress path is rarely linear, particularly for a commodity-intensive firm that’s extremely versatile from the affect of exterior markets. To realize that objective, it can’t have a single yr of unfavorable money stream progress. That may be unlikely given the weak macro we’re at present in, the corporate might have already got unfavorable money stream progress for 2023 and 2024. We are going to ponder on this when assessing its valuation.

Monetary Overview

Valuation

We’re nonetheless this present day, which suggests there are macro headwinds forward for Dow. We think about all of the evaluation above and use our proprietary fashions to evaluate Dow’s truthful worth by projecting its progress prospects ten years forward. We used a price of fairness of seven.46% and a WACC of 6.21%. In our bullish case, the corporate faces earnings and money stream contraction in 2023 and 2024 as much as double digits as a result of decrease income progress and better prices, with additionally double-digit progress in later years as soon as the financial system recovers; it’s priced at $93.75. In our bearish case, the corporate has steeper unfavorable progress as a result of impacts by macro weak spot in ’23 and ’24, and has extra risky progress afterward, it’s priced at $75.01. In our base case, it nonetheless has unfavorable money stream and earnings progress in ’23 and ’24, however phases regular restoration in the long run within the double digits with volatility remaining; with decrease upside but additionally decrease volatility, it was priced at $83.55. Normally, even accounting for the near-term weak spot and impacts from risky exterior components, Dow nonetheless has robust upside potential for the long run. The present inventory value is beneath all of our estimates. We imagine the market is simply too bearish on the corporate.

Conclusion

Dow’s world scale and various end-market software of its merchandise present a powerful income stream to assist its steady progress. The corporate can climate the downturn higher with its versatile value and expense management. Essentially the most important future growth of the corporate will come from its inexperienced tech initiatives and the associated services and products as a mixture. Though the trail is rarely simple, the upside stays attainable with the robust analysis and growth efforts the corporate is dedicated to. We predict the market’s too bearish on the corporate’s volatility and macro headwind and we suggest a purchase.