Is Dow Chemical Making a Mistake by Exiting Its Oldest Business?
In a strategic change of direction, Dow Chemical announced it will sell off a huge portion of its chlorine segment, which is the company's oldest business. Combined with other assets it intends to shed, Dow plans to sell assets representing $5 billion in annual revenue. While investors might worry, Dow is proposing an 'out with the old, in with the new' mentality that is likely to pay off. It's been a tough year for Dow, and management's trimming of the corporate hedges means investors will likely see a more focused and efficient Dow Chemical going forward.
A year of tepid growth so far
It's been a slow year for Dow Chemical. The global economy continues to sputter along, which continues to affect many of Dow's end users. Sales through the first nine months of the year are down slightly, while profits aren't nearly as strong as they appear. Dow's reported EPS has more than doubled, but that's due largely to a $2.1 billion gain related to damages awarded in the K-Dow arbitration proceeding. Excluding this one-time gain, net income is down through the first three quarters of the year.
Dow isn't the only chemicals giant seeing tough business conditions this year. Like Dow, DuPont reported much higher earnings through the first nine months of the year, but again thanks to a massive one-time gain. DuPont booked nearly $2 billion in income from discontinued operations this year, but its sales and gross profit are both up less than 2% through the first nine months.
As a result of its struggles, Dow Chemical is committed to strengthening its balance sheet and placing greater importance on high project selectivity in the years ahead. Collectively, Dow has organized its strategic priorities in an initiative termed the Efficiency For Growth plan. The goal of this is to strengthen the company's balance sheet as well as optimize its working capital, and there's evidence the strategy is already working.
In 2009, Dow Chemical's net debt to total capital ratio was more than 4x. That same metric sits at roughly 2x today. Its EFG program, as well as significant cost reductions, led management to project $35 billion in cash from operations between 2009 and 2015, and the company is well under way in achieving this objective.
For investors who'd rather not gamble on whether Dow Chemicals' new strategic initiatives will succeed, consider Monsanto . Monsanto is firing on all cylinders right now, thanks to its heavy exposure to agricultural chemicals. Sales rose 10% in fiscal 2013, thanks to strong results from its corn seeds segment, which is the company's largest unit by far. Corn seeds and traits, where sales grew 13% in fiscal 2013, account for more than 60% of Monsanto's revenue. Strength in Monsanto's core business is likely to propel solid results next year as well: Management projects 2014 will be another year of growth.
Asset disposals are all part of the plan
For some time, Dow has pledged to deliver shareholder value by selling off assets the company deems non-critical, and focusing instead on investing in only the most promising opportunities. Prior to this most recent announcement, Dow had shed $8 billion in under-performing businesses. At the same time, Dow simultaneously acquired specialty chemical maker Rohm and Hass, which the company believes will produce higher returns and margins going forward.
Look forward to a leaner, better Dow Chemical
This isn't Dow Chemical's first divestment since it unveiled its Efficiency for Growth plan, and it may not be the last. Management has advised investors for some time that it fully intends to cut underperforming businesses, even those that hold a long history with the company. What matters going forward is how the company uses the cash proceeds from the asset sales.
Dow will likely keep funneling cash back to shareholders through share repurchases and its generous dividend program. In addition, the company will grow through acquisitions of businesses that it believes hold more potential than the ones sold off. Investors should monitor these asset sales closely in the future, but it seems shareholders are likely to benefit from Dow's forward-looking strategy.
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The article Is Dow Chemical Making a Mistake by Exiting Its Oldest Business? originally appeared on Fool.com.
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