Dow: The Right Chemistry for a Turnaround

02/03/2014 8:00 am EST


George Putnam

Editor, The Turnaround Letter


Our latest turnaround stock traces its roots back to the 1890s when Herbert Dow came up with an innovative process to extract bromide from brine; it is now the largest chemical company in the US, suggests George Putnam, editor of The Turnaround Letter.

In early 2009, Dow Chemical (DOW) paid $16 billion to acquire specialty chemical producer Rohm & Haas, taking on a heavy debt burden in the midst of the last recession. This debt burden has weighed on the stock price for several years.

In addition, while Dow has a long history as an innovator in the chemical products area, over time, its innovations tend to become commodities. This brings down margins and profits, and hurts stock performance.

Dow recently announced a plan to exit several slow growing commodity chemical lines to focus on specialty chemicals with higher margins and more growth potential.

The company will sell off its epoxy and chlorinated organics businesses. This will result in the sale of 40 facilities at 11 different locations and reduce headcount by about 2,000.

It will allow the company to devote more resources to its performance plastics, electronic and functional materials, and agricultural sciences businesses, all of which have stronger patent protection and higher growth potential.

In addition to reinvesting the proceeds of the asset sales in its more promising businesses, Dow will continue to reduce debt. The company has already reduced total debt from nearly $24 billion in 2010 to less than $19 billion at the end of 2013.

As it has reduced debt, the company has devoted increasing sums to building value for shareholders. Since 2010, Dow has increased its annual commitment to dividends and stock repurchases from about $600 million to $1.6 billion.

Not only do we think that Dow's strategy will increase profitability, but we like its prospects for revenue growth as economies around the world are rebounding. With nearly two-thirds of sales coming from outside of the US, Dow is well-positioned to take advantage of renewed global growth.

It is worth noting that Warren Buffett holds $3 billion of Dow convertible preferred stock. Buffett made the investment several years ago to help the company after the Rohm & Haas deal, but he hasn't made any move to get out of it. We suspect that he probably likes the shift away from commodity chemicals.

Dow's recent strategic moves position it favorably to take advantage of its powerful global franchise to enhance shareholder value. Even if it takes some time for the strategy to boost the bottom line, shareholders get compensated by the decent dividend yield while they wait.

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