Dow: Comments On Q2 Earnings Results

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Dow Inc. (NYSE:DOW) just released its three months result. Here at Mare Evidence Lab, we have long had a buy rating on the American chemical giant. Following our initiation of coverage, we reiterate our conclusion thanks to the Bernstein conference, which provides us with some support. As a reminder, we based our thesis on two important assumptions:

  1. A new revenue recognition model;
  2. And what we called “the economy of scale disruption”.

Last time we concluded that: “after the COVID-19 outbreaks, basic chemical companies started to sell their products through spot price contracts. In addition, these contracts contain clauses that provide no possibility to be detrimental in case of raw material price decreases. Moreover, another interesting consideration was about the economies of scale disruption (the more you buy, the more you pay)”. Therefore, we were positive in evaluating Dow as having less exposure to a cyclical economic downtrend and basing our valuation on Dow’s ability to generate more cash over the long term.

Before jumping to any conclusion, and after having carefully analyzed Dow’s half-year results, we believe that the company was not able to pass through the higher energy cost. This does not mean that our thesis isn’t valid. Q2 results disappointed us, but we are looking at Q3 performance.

So, what happened?

Looking at the Wall Street analyst estimates, Dow adjusted EBITDA was higher than consensus. The company recorded an EBITDA of $3.06 billion compared to an average estimate of $2.85 billion. More important to note is the fact that Dow’s management provided a forecast EBITDA of $2.95 billion during the Q1 call and the company managed to beat its own internal estimate. This outperformance was also recorded at the EPS level ($2.3 versus $2.13).

Concerning the specific divisions, here below our main key takeaways:

  1. Industrial Intermediates and Infrastructure division was one of the weakest. In this segment, the operating profit margin decreased significantly. This was mainly due to inflationary pressure and maintenance activities. Lower earnings were partially offset by higher selling prices.
  2. Packaging and Specialty Plastics EBITDA was almost 10% above Wall Street analysts’ expectations. Output increased by 5% and price by almost 14% (considering also a negative FX). As mentioned in the press release, Dow managed to pass through price increases in all regions. Despite that, the operating margin declined from 28.3% to 17.4%. Sadara export into China negatively impacted the result compared to the same period one year ago. This was mainly due to the prolonged Chinese lockdowns.
  3. Performance Materials and Coatings outperformed during the period. EBITDA reached $758 million versus analysts’ estimates of $660 million. Despite a lower demand from China, the company was able to increase the price over cost and as a result, Dow achieved an operating profit margin of 18.7% from 9.1%.

Industrial Intermediates and Infrastructure results

Packaging and Specialty Plastics results

Performance Materials and Coatings results

Valuation and conclusion

Dow is currently trading at a 4.4 multiple based on EV/EBITDA, and we believe this is not justified. As a reminder, before the spin-off, the company was trading at an average multiple of 6.5x. The American chemical corporation has no significant debt maturities over the next five years, and thanks to the latest results, Dow has never been more solid. Last time, thanks to our stats team, we concluded that Dow is also well positioned for higher oil prices (and we believe this is going to be the case over the medium term). Based on the latest company’s indication, we reiterate our buy rating.