A Stock with Good Chemistry

07/12/2010 12:00 pm EST


Vahan Janjigian

Editor, Bottom Line's Money Masters Stock Report

Vahan Janjigian, editor of Forbes Growth Investor, says Dow Chemical has the right mix of businesses to keep earnings and the share price growing.

Dow Chemical (NYSE: DOW) supplies plastic materials and chemicals to customers around the world, but North America is its largest geographic market, producing 36.4% of first-quarter 2010 revenues.

DOW operates eight business segments. Basic Plastics is the largest, responsible for 22.5% of sales, followed by performance products (20.9%); performance systems (12.4%); health and agricultural sciences (10.2%); hydrocarbons and energy (9.6%); electronic and specialty chemicals (9.4%); coatings and infrastructure (8.9%), and basic chemicals (5.3%).

The company makes over 5,000 products, which are used by virtually all major industries and markets, including transportation, technology, medical, agricultural, energy, telecommunications, packaging, consumer, commercial construction, home building, industrial manufacturing, and marine.

Product offerings include coatings, resins, and polymers imbued with special properties; metal plating and electrolysis products; liquid dyes; biocatalysts; bactericides and pesticides; brake fluids and lubricants; adhesives, and epoxies; foam sealants and barrier protection products; packaging and protective films; wire and cable insulation; oxygenated solvents; coolants and heat transfer products; and plastic and chemical building blocks such as polyethylene, styrene, and ethylene glycol.

DOW also derives significant income from partial interests in numerous businesses including a 50% stake in silicone products maker Dow Corning. Collectively, these investments were responsible for $304 million or 43.6% of adjusted pretax income in [the first quarter].

The global economic downturn resulted in substantially lower end market demand over the past two years. Volume fell 5% in 2008 and 13% in 2009. At the same time, volatile commodity prices wreaked havoc on profit margins and earnings. Pro forma adjusted earnings from continuing operations available to common stockholders plunged from $3.76 per share in 2007 to just 63 cents per share in 2009.

DOW responded to the poor business climate by acquiring specialty chemical and advanced materials maker Rohm and Haas for $15.7 billion in April 2009. It also divested noncore businesses, eliminated jobs, and closed several manufacturing facilities.

These actions and a global rebound in demand helped [the fourth quarter of] 2009 net sales climb 14.9% year-over-year to $12.47 billion. Adjusted earnings available to common shareholders improved to 18 cents per share from a loss 62 cents per share in [the fourth quarter of] 2008.

The adjusted operating profit margin expanded to 7.95% from just 2.62% in the prior year period. Adjusted net income available to common stockholders was $491 million, or 43 cents per share, versus 12 cents per share a year earlier.

Investment risks include volatile raw material costs and further economic weakness. However, based on recent trends, we expect volume to continue rising in developed markets. Emerging market demand should also remain strong. The bottom line should benefit from high operating rates, further synergies from the Rohm and Haas acquisition, and lower debt levels stemming from additional divestitures. (The stock closed below $26 Friday—Editor.)

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