Dow – Good Quarter Understates Potential – Particularly If Dow Can Stick To the Path

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Dow Chemical managed to show growth in Q2 2014 despite a couple of headwinds, some of which were discussed and some were not.  Weaker crop markets and plant closures were discussed but the company also raised a second issue that was not really quantified but could be meaningful.

Dow is spending a great deal of time and money working on divestments and working on new builds in the US and in the Middle East.  We know from DuPont how much it is costing to carve out Performance Chemicals (well over $100m) and these costs are likely to be higher for Dow given the more integrated nature of facilities. This is not the only divestment that the company is talking about and so this is also elevating costs.

Consequently – SG&A and other costs at DOW are likely well above trend today and will come down significantly once these moves are made. The company talks about productivity gains and it is likely that costs are coming down at the operating business level and have scope to come down further – as we have discussed in the past, DOW probably has an overall cost cutting opportunity that would be similar to DuPont. The real operating cost run rate could be as much as $200-250 per year lower than it is today, before any major cost initiative. Unlikely that we would see any of this before the divestments are completed – so before end-2015.

Separately, Dow continues chase gains from divestments and Andrew Liveris made some interesting comments today suggesting that Dow is interested in coming to the negotiating table to talk about further consolidation within Ag.

We have suggested more than once that an open and candid conversation between Dow and DuPont might yield some interesting solutions for both companies:

  • A Morris Trust type transaction involving Dow’s chlorine business and DuPont’s Performance Chemicals business.
  • A JV on Ag.

In our comparison between LyondellBasell and Dow Chemical, published in April, we suggested that DOW has far more available levers to pull than LYB and in work published in February we come up with an $80 value per share if Dow could get it all right.  The risk is the same as always – every time that Dow has moved to an improving return on capital trend over the last 40+ years something has happened to cause a correction back to a very poor trend.  Some causes have been macro and others have been “own goals”.   It is hard to see that risk today, particularly with the focused message, but it was equally hard every time in the past also.

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