After A 2x Rally Dow Inc Stock Appears To Be Vulnerable

February 18th, 2021 by Trefis Team
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After a solid rise of over 2x from its March 2020 lows, at the current price of $59 per share, the chemicals giant Dow Inc. stock (NYSE:DOW), appears to be fully valued. DOW stock has rallied from levels of around $26 to over $58 off the March 2020 bottom compared to the S&P which moved 76%. DOW stock has outperformed the market, due to better than estimated quarterly results on the back of better pricing for its products, especially polyethylene. Also, the stock is up 19% in the last one year despite revenue falling 10% y-o-y over the last four quarters. While the gradual opening up of the economy is expected to lead to higher demand for chemicals, the stock appears to be fully valued when compared to its historical levels, making it vulnerable to downside risk. Our dashboard Buy Or Fear Dow Inc. Stock provides the key numbers behind our thinking.

Looking at a longer time horizon, DOW stock is up 21% since the end of 2018. Most of the stock price growth since 2018 can be attributed to the expansion of the company’s P/S multiple. Looking at fundamentals, total revenues declined 22% from $49.6 billion in 2018 to $38.5 billion in 2020, partly due to the impact of the pandemic on the company’s business, and continued weakness in pricing as well as volume. However, Q4 2020 in particular saw steady volumes and pricing gains, a trend that may continue in the near term, due to the expected rebound in the economic activity aiding the overall demand for Dow’s products.
Additionally, a contraction of net income margin from 5.9% in 2018 to 3.4% in 2020, meant that the company’s net income dropped to $1.2 billion in 2020 compared to $2.9 billion in 2018. The decline in margins can also be attributed to increased operating costs during the pandemic as well as increased R&D investments, when looked at as a percentage of revenues (2.0% in 2020 vs 1.6% in 2018). DOW’s EPS actually declined to $1.64 in 2020, compared to $3.80 in 2018, while its revenue per share (RPS) dropped from $66.37 to $51.60 over the same period. While the company saw its revenue and profits decline, the P/S multiple has expanded from 0.8x in 2018 to over 1.1x currently (based on trailing RPS).

Outlook

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The coronavirus crisis induced lockdowns affected industrial activity and hit the chemicals demand. Now that the economies have been gradually opening up, the demand for chemicals has increased, aiding Dow’s top-line growth in Q4 2020. Total revenue of $10.7 billion in Q4 2020 reflected a 5% y-o-y growth. Sales growth was aided by modest volume gains and improved polyethylene pricing, particularly in food and specialty packaging and health and hygiene applications. Overall volume growth of 1% y-o-y also resulted in volume reaching to pre-pandemic levels in all operating segments for Dow.

That said, the recent surge in Covid positive cases could prove to be an impediment in the path of Dow’s revenue growth. But in the absence of another wave and re-imposition of lockdowns, the company’s business will likely see steady growth. Any further recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia.

Currently, investors seem to be buoyed by Dow’s positive revenue and earnings outlook based on the expected recovery in economic activity, and that appears to be priced in the current stock price of $59, in our view. Even if we were to look at the forward RPS estimate of $58.53 for Dow in 2021, at the current price of $59, it is trading at a little over 1.0x P/S multiple, which is higher than the levels of 0.7x seen in 2018 and 0.8x in 2019, making the stock appear vulnerable to downside risk.

What if you’re looking for a more balanced portfolio instead? Here’s a high quality portfolio to beat the market, with over 100% return since 2016, versus 55% for the S&P 500. Comprised of companies with strong revenue growth, healthy profits, lots of cash, and low risk, it has outperformed the broader market year after year, consistently.

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