Tuesday, April 3, 2007

Dow Chemical (DOW): Looking Back To See The Future

I had promised to break down and comment further on Dow Chemical's (DOW) CEO Andrew Liveris's letter to shareholders a week ago and now that the Altria spin is over and I have been able to clear out my inbox with Altria (MO) related emails, it's time to comment. These letters are very important if for no other reason it allows us to discern what is important to the person at the top and, are they managing the company in a way that directs it towards them. I read these for the same reason I read the Earning Call Transcripts on Seeking Alpha, numbers only tell you so much. Because of this, I will dispense with most of the sales and revenue numbers and deal with what is important to us. This is a great letter because he first reviews the goals he set in 2006, updates his progress towards them and then after proving that he is good to his word, lays out the future for Dow.

When I bought and recommended Dow I did so because they were doing 3 key (among other) very shareholder friendly things: increasing dividend, decreasing debt, share buybacks.

From the Letter:
"We reduced debt by $1.2 billion, lowering our Company’s debt-to-capital ratio from 39% in 2005 to 34% by year-end 2006. Today, our Company’s financial position is as strong as it has ever been. We also raised our dividend by 12% and repurchased more than 18 million shares, and our repurchase program is continuing. In October, we announced an additional $2 billion share buy-back program."
So far Liveris is delivering on his fiscal goals and the additional share repurchases show this will not subside in 2007. Now let's look at some of the goals he set for the various businesses in 2006 and see what progress was made. From the letter:

Setting Public Goals
Early in 2006, we put some public stakes in the ground regarding our future plans. We said then that we would remain a diversified, integrated, global company, and we think our 2006 results bear out the wisdom of that statement. To bolster our Performance portfolio, we said we would launch two to four more market-facing businesses—businesses that focus on our most promising markets and bring the full power of our Company’s capabilities to them. We also said that we would make bolt-on acquisitions to support them. With that in mind, let’s examine what we did in our Performance portfolio.

  • We launched our new Dow Water Solutions market-facing unit, which offers world-class brands and technologies to the water treatment industry. With Dow’s existing technologies and the July acquisition of Zhejiang Omex Environmental Engineering in China, this platform advances our capabilities in desalination, water purification, contaminant removal and water recycling.
  • We also started up a new plant in the United States for the production of FILMTECTM membranes, substantially increasing the production capacity of our reverse osmosis membranes used in water treatment.
  • In Dow AgroSciences, we doubled capacity for our canola and sunflower oil seeds, affirming our growth strategy in the healthy oils sector.
  • In our Building Solutions unit, we expanded our capacity to produce
  • STYROFOAMTM brand insulation, and we added a new composite product for decking that is superior to wood in durability and maintenance.
  • In Greater China—where our sales increased from $2.3 billion to $2.7billion—we committed to the construction of a new glycol ethers plant, as well as a $200 million investment in our epoxy business for new manufacturing capacity and a new epoxy R&D center. And we began construction of our major new technology center in Shanghai.
  • In our Water Soluble Polymers business, we launched a new line of dietaryfiber products that help combat the problems of excessive blood glucose,cholesterol and insulin, as well as obesity. We also announced the planned acquisition of Bayer’s cellulosics business, which would increase the sales of our Water Soluble Polymers business by more than 60 percent to roughly $1 billion a year.With the Basics portfolio, as with our Performance portfolio, we will continue to take aggressive action throughout 2007, including new business models that will make our Basics portfolio more “asset light” and more competitive for the long term.
Revitalizing Innovation
Dow has a long history of strong innovation, and in 2006 we added some exciting new chapters to our story. And here let me note that we have been silent for a few years in order to avoid the trap of “overpromising and underdelivering.” So, rather than focusing on a handful of rifleshot projects, we announced that we are funding more than 600 projects that either strengthen our position in key franchises or break into entirely new areas of technology. These projects have a potential yield of $2 billion in additional EBIT by 2011. We intend to talk about all of these projects as they approach commercialization, and we will explain them in the context of broad themes. Three themes we launched in 2006 include:

  • In alternative feedstocks, we are pursuing the use of methane as a raw material to manufacture basic building blocks like ethylene and propyleneand to use natural oils, from soybeans for example, as raw materials for polyolplastics. Done on a broad scale, these alternative raw materials would significantly reduce the cost of our feedstocks.
  • In healthcare and nutrition, we are concentrating on projects such as Dow Agro Sciences’ healthy oils, and a new ingredient delivery system for medicines that uses water-soluble films.
  • In building and construction, with its renewed emphasis on energy conservation and a focus on eco-friendly building materials, we are working on projects ranging from the elimination of ozone-depleting blowing agents used in the manufacture of STYROFOAMTM brand insulation to new roofing systems that harness the sun’s energy at a much greater rate than current technology allows.

As I mentioned at the beginning of this letter, the surest method to increase the value of our Company to you, our investors, is to change our earnings profile. And to do that, we must draw a greater proportion of our earnings from Performance businesses.
So going forward, you can expect more of what you saw in 2006

  • More innovation
  • More market-facing businesses,
  • More asset-light joint ventures,
  • Continued financial strength and flexibility,

Finally Liveris writes:

"...we believe 2007 will be even more significant. We will continue to take action to transform the profile of our Company’s portfolio in order to change the profile of our earnings, including both strong growth (which we have historically achieved) and greater consistency (which, as a cyclical company, we have not).

The letter illustrates that Liveris is intent on moving Dow heavily into areas that demonstrate huge growth potential. If you have watched the news lately, several themes have been a constant:
  • Water, while plentiful in the US, is needed desperately in the rest of the world. Dow Water Solution has the inside edge and is addressing this need in China. This is severely overlooked by the mainstream media when talking about Dow.
  • Raw material costs. Dow is addressing this issue by finding and using bio solutions for production (natural oils in place of petroleum)
  • Asset-light ventures. These are the key. Why? It involves less investment which has the immediate effect of keeping debt levels low and increasing cash available for either further investment or being returned to shareholders. Another oft overlooked key is that these ventures allow both parties to maximize the strengths of each other. For instance, a new chemical plant in India allows Dow to take advantage of a much lower cost structure and the relations that the local company has in India to reduce production inputs while at the same time giving the Indian company access to Dow's vast and experienced sales network and technical expertise. A win -win.
  • China, China, China. Dow has several very large projects there for chemicals that will directly address China's ability to continue to grow, demand here will be huge.

Based on emails I have have been getting recently I was anticipating something to be announced by now. I would be VERY surprised if a major announcement was not made before April has ended and no, it will not involve a sale of the company. Assets, maybe, the whole company, no.

In this era of shareholder distrust of management, we shareholders of Dow are fortunate not to have that worry. Liveris has not done anything that should make us doubt his word or the direction he is taking the company. 1st quarter earnings will be webcast 4/26. I for one cannot wait.

When he says "2007 will be a significant year", I believe him. You should to.

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