Dow Inc.
Moat: 2/5
Understandability: 3/5
Balance Sheet Health: 4/5
Dow Inc. is a global materials science company, producing and selling a wide range of products, including plastics, industrial intermediates, and performance materials and coatings.
Investor Relations Previous Earnings Calls
The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.
Dow’s operations are structured into three main segments: Packaging & Specialty Plastics, Industrial Intermediates & Infrastructure, and Performance Materials & Coatings. Let’s look at these segments in depth to understand the company.
Packaging & Specialty Plastics: This is Dow’s largest segment by revenue and earnings. It produces a variety of plastics like polyethylene, polypropylene, and elastomers, mostly used in packaging, adhesives, and coatings. The segment serves the consumer, industrial, and flexible packaging markets. They are focused on providing materials that improve sustainability and help create a circular economy.
Industrial Intermediates & Infrastructure: This is the second-largest segment. It sells a large variety of materials, including polyurethanes, silicones, ethylene, and propylene oxide. These products serve a variety of industries such as construction, infrastructure, automotive, and energy, providing materials for insulation, adhesives, and chemical production.
Performance Materials & Coatings: This is the smallest of Dow’s segments but is focused on high-performance and specialty materials. It produces various coatings, specialty chemicals, and silicones for a variety of industries, including appliances, automotive, construction, and personal care. This segment creates differentiated products that enhance performance and durability.
The company has a broad geographic reach with operations in North America, Europe, Asia Pacific, and Latin America. Sales are derived across multiple end markets, increasing the diversity of its revenue. The company has been affected by a major reduction of demand in the United States and Europe and have taken many measures to mitigate that.
Dow, as a global company, has a great presence worldwide and has sales in most major continents.
The most relevant trends impacting Dow’s business include sustainability, the ongoing shift to a circular economy, and fluctuating commodity prices. The increasing demand for sustainable materials and practices creates new market dynamics, that Dow is attempting to capitalize on. Volatile commodity prices, especially energy, often affects the raw material and production costs of their products and margins. Supply chain disruptions and international trade policies also impact the company’s operations. The major issue of the Russian invasion of Ukraine is also a factor. They have had a significant impairment of about $176 million related to the Russia Ukraine conflict.
Dow’s profitability has been variable. While profitability is very sensitive to input costs, this is true with most other chemical businesses. Dow’s reported net sales for the nine months ended September 30, 2023 were $35.6 billion. Net income attributable to Dow was $1.58 billion for the first nine months of 2023. This means a net profit margin of just around 4%, but it is in the industry average.
Due to the fluctuation in the price of raw material as well as demand, Dow’s margins can vary widely.
The company’s main competitors include other chemical and material manufacturers, which in most cases are larger than it. These companies tend to be very well-diversified with big global reach and strong customer relationships. Examples include BASF, Sabic, and Lyondellbasell. Because these competitors are usually larger and have a broad reach, they have greater bargaining power and are able to offer products and services more efficiently. Also, local players in some markets are quite strong, and pose a threat.
Dow’s management is not a big proponent of long term contracts with their suppliers or buyers. They prefer a more flexible approach, as this is often beneficial to the business. This leaves them exposed to volatility in the short term, however.
What makes Dow different is its focus on innovation, integration, and scale. Dow has a strong research and development team. It tries to create specialized and differentiated products that are tailored for various industries and can provide a competitive advantage. Integrated business operations allow them to reduce costs and leverage its global operations. The company also tries to optimize its production plants to be close to raw materials and customers.
The company tries to maintain a moat through sustainable competitive advantage by creating unique and differentiated products that are hard for competitors to mimic. They are trying to achieve better margins through differentiation instead of just trying to compete on prices.
Financials:
Liquidity and Capital Resources: Cash from operations was $3.1 billion for the first nine months of 2023. There was more cash use during investing activities, but a lot of it was because of debt reduction. Dow Inc. is also able to maintain readily available credit facilities and a very good current ratio. The company also has a healthy debt to total cap ratio.
Debt: The company’s total debt (including long-term debt and debt due within one year) was $14.9 billion at the end of Q3 2023. Dow has recently been issuing debt at higher interest rates to replace older debt. They are planning on decreasing their net debt to adjusted EBITDA target and they plan on spending cash flow towards deleveraging.
Cash: As of September 30, 2023, the company held $3.5 billion in cash and cash equivalents.
Moat: 2 / 5. Dow, while a large and important player in its industry, does not display a strong competitive advantage as compared to other competitors in its field. They have a great supply chain and scale, and they have a good reputation with customers. However, the products they produce are more or less commodities, and although they differentiate some of their products, competition is still significant. The industry is also fairly volatile, and thus difficult to keep the “moat” from eroding. Due to that, Dow should not be expected to earn above average returns for a long period of time, the returns are more dependent on the business cycle. They still operate as good businesses for many years and generate significant returns for shareholders.
Dow’s moat is highly subject to business cycles and commodity prices. Although they try to make innovative and special products, ultimately it is difficult to stay ahead of competition in this brutal industry. Also a new entrant in this business can quickly catch up using easily available technology.
Risks to the moat:
Technological change: New innovations in materials could make some of the existing products of Dow obsolete.
Industry consolidation: The chemical industry has been seeing a lot of consolidation over the years, which can be a factor.
Economic downturns: As a major producer of commodities, the company is extremely sensitive to global downturns, and it would quickly erode its ROIC, and therefore the moat.
Environmental regulations: As a chemical company, environmental regulations can also pose a risk.
Supply chain issues: Disruptions of global supply chains can also affect the company very significantly.
Business Resilience: Although Dow’s moat is not strong, the company can survive through tough times. Due to economies of scale, great customer relations, and the ability to produce different kinds of products, they can be expected to stay a relevant player in the future. The ability to react to changing market trends will prove crucial.
Although Dow does not have a very strong and deep moat, the company has the necessary systems to manage the business in all cycles and operate profitably.
Understandability: 3 / 5. The chemical industry and its business operations are quite complicated, including multiple segments and chemical processes. Therefore the business is a bit hard to understand. The business is difficult to comprehend for most people, but easy enough for those who have experience with these kind of businesses.
Although some things are simple to understand, an ordinary investor might have trouble understanding the different segments and operations.
Balance Sheet Health: 4 / 5. The company’s balance sheet is pretty healthy, although its level of debt is not optimal. The company has good short term cash holdings, and is also able to maintain enough credit lines to keep operations smooth. However, its debt can be an issue, in times of uncertainty.
Dow’s balance sheet is generally good, with the exception of debt.
Recent Controversies:
Dow has been trying to reduce debt, but has incurred new debt at higher interest rates, which could hurt profitability in the short term. Dow has also been affected by declining demand, specifically in some areas in Europe.
The company has also been trying to shift towards lower-cost and more sustainable methods of production. This would allow them to enhance profitability in the future.
The company management has expressed concerns over supply chain and global economic volatility. However, they are confident that their strategy will yield good results over the long term.
There is ongoing litigation with Union Carbide, specifically over asbestos, but management believes that the total cost will not exceed what has already been set aside.
The company’s CEO Jim Fitterling said in their latest earnings call: “We are seeing some green shoots in certain geographies, which is helpful to overall sentiment.” He also mentions that the company is trying to move away from commodity-type operations towards producing and selling differentiated products, which command a premium.