Good times for Dow Chemical?

Published: February 06, 2017

The Dow Chemical Company has reported strong fourth-quarter results and gave an upbeat forecast, while expressing confidence about solving regulatory issues relating to the company’s merger with DuPont. In addition, start-up for Dow’s ethylene plant in Texas is on schedule, just in time for global ethylene pricing to strengthen, and Praxair has just started up a hydrogen facility for Dow Chemical company on the US Gulf coast. It all looks good… but should investors remain cautious?

Dow Chemical’s stock gained more than 5% following its Q416 earnings announcement at the end of January. In part, increased investor confidence can be attributed to Dow Chemical’s insistence that its merger with DuPont will proceed despite regulatory scrutiny. Other contributory factors included Dow Chemical beating consensus estimates for the fourth quarter, and its results reflecting the growth in demand for its products. While there was much to be happy about, analysts at Trefis Solutions advised that investors should remain cautious. They pointed out that, despite Dow’s reassurance, its proposed merger with DuPont remains uncertain. Additionally, the company expects its margins to take a hit in Q1 2017 due to the expenses related to the ongoing merger efforts.

Let’s take a look at available facts, and some of the company's recent news for a snapshot of how things seem to be going for Dow Chemical right now.

Q416 results
The company reported strong fourth quarter results, with adjusted earnings of 99 cents/share, up 6% year-on-year and 11 cents above analysts’ average estimates (Thomson Reuters, New York). Net sales rose nearly 14% to $13.02 billion, also beating expectations of $12.38 billion. Dow Chemical's move to take full control of its Dow Corning venture, and its focus on consumer markets, are thought to have helped boost its results in the fourth quarter. Performance plastics is Dow Chemical’s biggest segment and accounted for more than 35% of its fourth quarter revenue; this segment saw revenue growth of more than 4%, with sales volume increasing by a similar percentage. The company also saw volume growth of 7% in consumer solutions and 5% in agricultural science in the fourth quarter of 2016.

This good news was reported despite Dow Chemical swinging a net loss due to a one-time $1.1 billion charge, reflecting a voluntary change in the way the it accounts for legal costs associated with defending against asbestos claims.

Looking ahead, Dow Chemical is optimistic for the current quarter, saying its focus on consumer markets is likely to benefit from improving economic growth worldwide. In particular, improving growth in the United States, Latin American and Europe, and steady Asia growth, are expected to boost demand in its packaging, consumer care, electronics, automotive and agriculture businesses.

The Merger
Unless you have been living in isolation for the past few months, you will be aware that Dow Chemical and DuPont's $130 billion deal, announced in December 2015, has drawn considerable regulatory scrutiny, particularly in the European Union. The main concerns stem from an overlap in their seeds and crop protection businesses. In a conference call with investors, DuPont CEO Edward Breen said Dow and DuPont are working on a “remedy package” to satisfy European authorities. Although he did not back off promises that Dow and DuPont would achieve cost savings of $3 billion in the combination, he said they “are not reducing at all the scientists that work on discovery and new product development.”

In his call with analysts, Dow CEO Andrew Liveris added that he was “confident” Dow and DuPont could solve their issues with the European Commission, and that other country regulators would approve the deal once that happens.

The deal is now expected to close in the first half of 2017.

Ethylene plant on schedule
Dow Chemical is expecting ethylene supply to tighten and pricing to strengthen as US polyethylene expansions come online in 2017, the company has said. The Texan plant is now at "95% mechanical completion" and start-up in mid-2017 remains on schedule. The new facility is expected to add 1.5 million mt/year of ethylene capacity. In addition, Dow plans to increase its low-density and linear-low density polyethylene capacities at the site by 1.05 million mt/year in the second half of the year.     
"The ethylene chains looks like it's staying where it is in terms of operating rate, if not tightening up as we move into the year," said Dow Chairman and CEO Jim Fitterling. "We've seen some tightening in Asia-Pacific and we know that things are going to balance a little bit in North America as we move through the year… There's been really some length in the ethylene in North America ... that is going to dry up and you'll start to see ethylene [pricing] strengthen."

Dow Chemical is one of several companies planning to grow production of ethylene and derivatives throughout North America amid ample supply of low-cost ethane. All told, an additional 4.2 million mt/year of North American polyethylene capacity could be realized in 2017, should planned projects by several producers hit their respective target dates.

"Polyethylene capacity has ... constricted, a little bit, the ethylene capacity," Fitterling explained. "As you have more polyethylene capacity come on, that ethylene is going to tighten up. I don't see this as a trough, I see it more as an adjustment to all of these increments in all of these capacity adds that are coming on."     
Hydrogen and nitrogen supplies
Praxair announced on 1st February that it has started up a hydrogen facility on the US Gulf Coast, with the intention of supplying high-quality hydrogen to Dow Chemical in order to meet the company’s needs across Southeast Texas. In addition, the Tier One corporation has signed a long-term contract to supply Dow Chemical with nitrogen for use in its chemical facility (starting in 2019).

Dow Chemical will use both gases to support the production of a number of specialty chemicals used in end-markets such as automobile manufacturing, coating applications and chemical intermediates. The deal is seen to support Dow Chemical’s growth in the US Gulf Coast.

… but LDPE resin plant behind?
Dow chemical has not yet begun producing prime low density polyethylene (LDPE) resin from its recently restarted line in Argentina, a source with knowledge of company operations is reported to have said (here)."We have no new news regarding the performance of the plant," the source said. "We are still in the [restart process]."

The LDPE restart was confirmed by a company source January 3 following a nearly 14-month shutdown after a fire at the Bahia Blanca plant in November 2015. The company source previously said that prime resin could be available as soon as 2 weeks after a restart.

The Bahia Blanca plant has an LDPE capacity of 90,000 mt/year and is Argentina's only source of LDPE production. Argentina as a whole has a deficit of 91,000 mt/year of LDPE, according to Platts Analytics data. Dow Chemical has repeatedly said it will continue to meet its customers' needs via imported LDPE during the line restart.

However, the outage at Bahia Blanca helped lead to extended tightness of LDPE in Latin America, with CFR Brazil (import) and FAS Houston (export) pricing reaching 15-month highs between August and October.


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