Dow’s Impressive Earnings, Upcoming Merger Make It Interesting Going Forward

Dow Chemical Company (NYSE:DOW) recently reported its Q1 2017 results, and there was a sharp rebound in its revenue. We had earlier stated in our pre-earnings note that the first quarter of 2017 may mark the beginning of a growth revival as pricing pressure eases off, volume growth continues and the adverse impact of currency fades away. Dow exceeded our expectations, as average pricing jumped 7% and drove most of the 11% top line growth that the company saw, excluding the impact of the Dow Corning consolidation. On the flip side, margins declined slightly as feedstock cost increased. Dow expects the commissioning costs in the U.S. Gulf Coast to continue to weigh on margins in the 2nd quarter too. However, we expect some price initiatives over the coming quarters to offset some of the increased feedstock costs.

Our price estimate of $69 for Dow Chemicals implies 10% premium to the market. We are reviewing our price estimate and will update it shortly.

Biggest Business – Performance Plastics – Did Exceedingly Well

Dow performed strongly across all segments except agriculture. Dow’s performance plastics division, which is its biggest segment, saw a massive revenue growth of 20% with an impressive 15% jump in average prices. The prices increased in response to higher feedstock and energy costs, and it appears that the increase in price did not affect the volume growth much.

However, agriculture was a different story, as soft demand continued to weigh on results. Nevertheless, what excites us about Dow is the upcoming merger with DuPont, which appears to be progressing well and could be a catalyst for the stock. DuPont’s stronger agriculture performance, coupled with Dow’s strength in other areas, along with significant potential synergies, can unlock a great deal of value.

DuPont Can Calm Dow’s Agriculture Woes

Despite a reasonably good performance in Q4 2016, Dow’s agriculture revenue fell nearly 5% in the first quarter of this year. While the prices remained flat, volumes declined. This is in stark contrast to the previous quarter, when Dow saw an increase in both volumes and prices, driven by growing demand for corn seeds in North America and Latin America, and higher volumes of crop protection products in EMEA and Latin America. So what went wrong this time? Except for Latin America, Dow’s agriculture business suffered in all regions.

The demand for herbicides reduced in Asia Pacific and North America. In Asia Pacific, the underperformance may be transitory, as much of it was driven by an inventory overhang due to flooding in the last season. Increasing resistance to current products also played a role, but we expect Dow to compensate for that with the launch of the new Rinskor herbicide which uses a different mechanism. In North America, however, the corn acreage is declining and there is a visible shift to soybean plantation. This has impacted herbicide demand. In addition, the demand for corn seeds in North America and that for sunflower seeds in EMEA and Latin America suffered this quarter.

But Dow has something good to look forward to. Its proposed merger with DuPont has crossed a lot of regulatory hurdles, and DuPont is doing reasonably well in agriculture segment. DuPont’s agriculture business saw nearly 4% growth in Q1 2017, half of which can be attributed to price increases driven by gains in Brazil and the expansion of Pioneer brand seeds and Leptra crop protection products. In a way, DuPont can plug the gap in Dow’s business, and together, the combined entity will have greater pricing power and wider R&D asset pool.

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