The Dow Chemical Company (DOW) Q2 2013 Earnings Call July 25, 2013 9:00 AM ET
Doug May - VP of Investor Relations
Andrew Liveris - CEO
Bill Weideman - CFO
John Roberts - UBS
Robert Koort - Goldman Sachs
Hassan Ahmed - Alembic Capital
Frank Mitsch - Wells Fargo Securities
Duffy Fischer - Barclays
Chris Nocella - RBC Capital Markets
David Begleiter - Deutsche Bank
Kevin McCarthy - Bank of America Merrill Lynch
Jeff Zekauskas - JPMorgan
Don Carson - Susquehanna Financial
PJ Juvekar - Citi
Good day, and welcome to The Dow Chemical Company's second quarter 2013 earnings results conference call. [Operator instructions.] I’d now like to turn the call over to Doug May, vice president of investor relations. Please go ahead, sir.
Thank you, operator. Good morning, everyone, and welcome. As usual, we are making this call available to investors and the media via webcast. This call is the property of The Dow Chemical Company and any redistribution, retransmission or rebroadcast of this call in any form without Dow's express written consent is strictly prohibited.
On the call with me today are Andrew Liveris, Dow's chairman and chief executive officer, Bill Weideman; executive vice president and chief financial officer; and Dale Winger, associate director of investor relations.
Around 7 a.m. this morning, July 25, our earnings release went out on Business Wire and was posted on the internet on dow.com. We have prepared slides to supplement our comments in this conference call. These slides are posted on our website and through the link to our webcast.
Now, some of our comments today include statements about our expectations for the future. Those expectations involve risks and uncertainties. We cannot guarantee the accuracy of any forecast or estimates and we don’t plan to update on forward-looking statements during the quarter. If you would like more information on the risks involved in forward-looking statements, please see our SEC filings.
In addition, some of our comments reference non-GAAP financial measures. A reconciliation to the most directly comparable GAAP financial measure and other associated disclosures are contained in our earnings release and on our website.
Unless otherwise specified, all comparisons presented today will be on a year-over-year basis. EBITDA, EBITDA margins, and earnings comparisons exclude certain items. The agenda for today's call is on slide three.
And now I’ll hand the call over to Andrew.
Thank you, Doug, and good morning everyone. Thank you for joining us. If you turn to slide four, this was a strong quarter for Dow, and our results reflect the deliberate actions we’ve taken and continue to take across our portfolio. We are pleased with our performance, despite ongoing macroeconomic headwinds in most parts of the world.
Notwithstanding this strong performance, we will continue to stay focused and keep taking proactive measures to maintain this strong trajectory and deliver earnings growth. Our action plans are working, and we are squarely aligned behind what we need to do in the next 12 to 24 months to maintain this earnings momentum.
So here are some highlights from the quarter: adjusted earnings per share of $0.64, representing a 16% increase year over year. The receipt of the K-Dow award cash payment was a critical accomplishment this quarter. In line with our stated cash priorities, we immediately applied these funds to pay down debt. Our cash flow from operations saw significant improvement, up $2.8 billion year over year, driving our net debt to total capital ratio down to 36.4%, achieving levels not seen since 2008.
These actions are immediately accretive in value and go right to our bottom line. In total, we expect to deliver interest expense reductions of approximately $150 million year over year in 2013. And, as you think about our strong balance sheet, we now have the flexibility to move forward and evaluate additional opportunities to remunerate our shareholders.
On the top line, our company delivered 7% growth in emerging geographies, which represented 34% of total company revenue in the quarter, and in the agricultural sciences segment, we achieved record second quarter sales with double-digit growth.
And of course, there is our performance plastics segment, which delivered $1 billion of EBITDA and expanded margins by 700 basis points, driven by our tremendous low-cost feedstock advantage on the United States Gulf Coast and our focus on higher-value markets. Here, as you know, we have significant investments in place in this region that will drive further EBITDA growth and margin expansion as we grow our packaging franchise and build on our competitive advantage.
All of this enabled us to deliver EBITDA growth and margin expansion at an enterprise level: strong results delivered by a very focused team. All of these accomplishments during the quarter, the strong operating discipline; the focus on cash, cost and capital; plus the K-Dow award cash payment, had delivered a balance sheet that is back to strength.
This fact, plus our ongoing $1.5 billion stock repurchase plan, have us poised to deliver increased shareholder remuneration in the next 12 to 24 months. I’ll have more to say on this later in the call, and in subsequent shareholder communications.
But now, let me turn it over to Bill for more detail on our financial and operating results in the quarter.
Thank you, Andrew. Let me begin by providing a financial overview on slide six. Dow reported earnings of $1.87 per share, or $0.64 per share excluding certain items. Certain items in the quarter included a charge for the early extinguishment of debt as well as a gain from the K-Dow arbitration award.
Adjusted EBITDA rose nearly 9% in the quarter, reflecting savings from our 2012 restructuring programs, and these savings will continue to ramp as we move forward. Our advantaged market and feedstock position continues to drive strong margin expansion in performance plastics, particularly in North America, and we saw improved performance in our joint ventures.
Now turning to price and volume trends on slide seven, volume gains were reported in most regions and most operating segments. Our agricultural sciences segment, once again, reported double digit sales growth this quarter, achieving a first half sales record of nearly $4 billion, reflecting the strong pipeline of new products that we have in place.
Emerging markets demonstrated ongoing strength this quarter, achieving a 9% increase in volume, led by strong performance in Latin America and Asia-Pacific. North America also saw increased volume. However, conditions in Europe continued to be weak, demonstrated by nearly 3% declines. However, excluding the impact of our asset rationalizations, volumes in Europe were actually flat.
Price declined 2%, driven by a declining raw material environment, primarily in feedstock and energy, and ongoing currency headwinds, which represented nearly one-third of the decline in price.
Moving to slide eight, overall we grew earnings and expanded margins due in large part to our ongoing strength in performance plastics. The company’s cash and cost improvement actions also continued to deliver benefits. I’ll speak more to this in a moment.
Another positive driver of results this quarter was equity earnings, which were up year over year due to improved performance at our MEGlobal joint venture, as well as improvements in [NAFTA based] margins in Asia
Now turning to our operating segments, starting with electronic and function materials on slide nine. Sales of electronic and function materials were flat as volume increases were offset by price declines. Electronic materials’ strong growth films and OLED contributed to sales increases in display technologies. However, this growth was offset by the sales declines of semiconductor technologies, which experienced softer demand.
In function materials, Dow microbial controls grew sales in all regions, achieving a new quarterly sales record. Coating infrastructure solutions sales were flat for the quarter. Dow coating materials sales increased as construction conditions in North America continued to strengthen. This was offset by lower sales in building construction due to ongoing weakness in the construction market in Europe.
Now turning to Dow Corning, we believe that market conditions in polysilicon have stabilized. We also expect the impact of the July 18 preliminary [unintelligible] ruling will have minimal impact on operating equity earnings going forward. We will continue to carefully monitor these dynamics in this value chain and if conditions worsen, Dow Corning will take further actions as appropriate.
Now turning to agricultural sciences, which reported a 10% year over year increase in sales. In crop protection, sales of new products grew 14% in the quarter. In seeds, traits, and oils, sales were up 4% versus the same period last year and year to date sales are up 23%, driven primarily by strong farmer demand for smart [stack] corn hybrids.
EBITDA for ag sciences was down slightly from last year’s record second quarter EBITDA due to a shift of seasonal buying patterns, increased growth investments, and unseasonably cool and wet weather across the northern hemisphere. Yet despite this, the segment still achieved a first half EBITDA record of $774 million.
In performance materials, volume increased, driven by gains in our polyurethanes chain. Prices declined 3% due to lower propylene costs and EBITDA was impacted by industry challenges in epoxy, chlorinated organics, propylene oxide, and propylene glycol.
Sales in performance plastics were $3.7 billion. Dow Packaging, especially plastics, demonstrated a strong performance during the quarter with improved sales in North America, Latin America, and Asia-Pacific, which more than offset lower sales in Europe, which reflect the previously announced shutdown of our high-density polyethylene plant in Tessenderlo, Belgium.
Performance plastics delivered $1 billion of EBITDA in the quarter, which is up 33% versus the same quarter last year and expanded EBITDA margins by 700 basis points. In feedstock and energy, [unintelligible] [monomer] costs let to price declines, while volumes remained flat.
Volume gains in EOEG were offset by decreases in hydrocarbons, which were driven by a lighter feed slate in Europe. Equity earnings increased due to improving NAFTA margins in Asia as well as improved performance by MEGlobal, reflecting lower turnaround costs year over year.
Moving to slide 12, we continue to drive targeted ROC improvement actions by tightly managing pricing and prioritizing R&D investments. Our cost and cash actions are on track, with the target we laid out at the end of 2012.
To date, we have shut down 18 of our committed 29 assets, and this quarter we idled another Dow-formulated systems asset in Europe. Our workforce reduction targets also remain ahead of schedule.
These actions have already delivered $170 million year over year EBITDA improvements and will continue to ramp in the second half of the year, placing us firmly on track to deliver a $500 million EBITDA improvement this year.
We also remain committed to our divestiture targets. In March, we increased our divestiture target to $1.5 billion over the next 18 months. We’re currently in the process of selling three businesses as we previously announced: Dow Plastic Additives, Dow Polypropylene Licensing Catalyst, and a small fumigants business in our agricultural sciences business. We’re making excellent progress, and we expect to close all three transactions by the end of the year.
Just as we remain on a solid path to deliver on our portfolio commitments, we have also remained focused on reducing our debt, and the second quarter represented a series of milestones in this regard. As you know, in May we reached a final resolution of our K-Dow arbitration award. This resulted in Dow receiving a direct payment of approximately $2.2 billion from PIC.
In the second quarter, we applied this award to debt reduction, which drove our net debt to total capitalization down to 36.4%. This action significantly enhanced our balance sheet. As our cash flow and earnings continue to ramp, we remain committed to rewarding our shareholders as we move forward.
Now looking forward to the second half of the year, we have a number of actions currently in motion that will further boost Dow’s 2013 performance. We expect healthy margins will continue in performance plastics. Here we expect to see the year over year improvement throughout the rest of 2013. We expect to see ongoing growth in agricultural sciences, as this segment remains on track to achieve its sales and EBITDA objectives for the year. And our restructuring actions will continue to ramp in the back half of the year.
From an operations perspective, the majority of our large planned maintenance activities have been completed in the first half, which means turnaround spending will continue to trend downward in the remainder of the year. And the contributions from the restart of our St. Charles operations cracker will increase in the second half of 2013.
And finally, as interest rates increase, we would expect to see a pension tailwind in 2014. For modeling purposes, the 100-basis point upward trend in interest rates is equal to approximately a $250 million decrease in pension expense.
And now I’d like to turn it back over to Andrew.
Thank you, Bill. If you go to slide 16, as you can see, we delivered a strong second quarter and continue to make notable progress against the objectives we laid out for you last call, executing on targeted portfolio actions, growing our high return businesses, and focusing on improving our lower return businesses.
Now, we unveiled this concept last investor day in late 2012, so let me update you on where we are in upgrading our portfolio and indeed improving our returns. Slide 17, first our higher performers. Recent business reviews have shown us that these are clearly all located in high growth value pools, as you can see in the slide, where our share of profit can indeed grow because the market is growing.
These included the agricultural and food sectors. These include packaging, as well as electronic and personal care markets, and they represent more than $25 billion of high-margin revenues with strong IP technology fundamentals. We will continue to invest in and grow these businesses.
On slide 18, in the performance materials and coatings and infrastructure solutions segments, we have been analyzing vigorously on how to improve returns. The good news is that we have businesses such as Dow Water and Specialty Chemicals within these segments that are already high return and growing.
We also have businesses that are performing below our expectations, where we expect meaningful signs of improvement from our direct interventions and actions. Notably, our acrylics Dow [unintelligible] business, and our polyurethanes franchise, which will benefit from our Sadara and PDH investments, as well as improving global construction and coatings markets.
We also have areas in our portfolio where we see results below our expectations. For example, in our epoxy business, and in our European building and construction business, as well as our commodity chlorine derivatives. Here we see the need for more dramatic interventions. Therefore, these businesses are in the fix-take action mode, which includes exploring all possibilities, including joint venturing or divesting them.
These last two slides are illustrative of the six months of portfolio work that has resulted in clear outcomes and destinations for underperforming businesses. We have more specifics on these actions, and we will have more to say on these in the next several months.
Equally important to keep in mind in these portfolio management actions is ensuring we do not lose our previously discussed integration benefits. Dow is a fully integrated chemical, biological, and materials science company, with both physical and capability integration.
Carve-outs, therefore are not easy. Having said that, we have done them before, most recently with our Styron divestment. This was a highly complex carve-out on 20 Dow sites, with hundreds of residual service agreements to ensure that there were no stranded costs. Dow has the expertise and demonstrated track record to execute a highly complex, integrated carve-out successfully, with Styron as a recent, strong example.
The bottom line is this. We have divested over $8 billion of revenue of low-margin businesses over the last several years, and our analysis suggests that we will move formally on the path of doing more so as to release even more value for our shareholders.
So turning to slide 19, and turning to our balance sheet, which Bill has talked about, where we are clearly and aggressively delivering against the commitments we’ve made. First and foremost, our balance sheet is strong, and we are delivering solid cash flow gains.
Between 2012 and 2013 year to date, we’ve generated more than $8 billion in cash flow from operations. With the application of the K-Dow award, we’ve made substantial progress in further strengthening our balance sheet due to our aggressive debt reduction actions during the quarter.
Year to date, we’ve reduced net debt by more than $2.5 billion, and we’ve reduced net debt by nearly $6 billion since 2009. As a result of these actions, our net debt to total capital ratio is below 2008/2009 levels, and our annual interest expense has declined by nearly $350 million since that time period, with more than $60 million through the second quarter alone.
Let me summarize our balance sheet view and priorities. We have allocated funds for the growth we need for the next decade. We have paid down debt to pre-’08 levels. We have identified new ways to release more cash and value from the balance sheet and portfolio. We are generating strong cash flows and have a strong balance sheet that will get stronger. And, we do not need any M&A.
Said another way, we have not, and will not, waver from our relentless execution against our priorities for cash. We have reduced a significant amount of debt and still have plans to reduce more. And as we create and liberate additional cash, we will deploy the surplus cash to you, our shareholders, generating strong returns for, and rewarding, our shareholders remains our singular focus going forward.
Let me turn to the outlook on slide 21. As you know, heading into 2013 we held the view that, from a macroeconomic perspective, this year would largely be a replay of 2012, and calibrated our business plans accordingly. Looking at global market dynamics again this quarter, this continues to be the right view.
Having said that, there are promising signs out there. For one, the U.S. continues to be a bright spot, with the housing market recovering and signs of life with the consumer. Secondly, emerging markets are a surprising pillar of strength, and we expect there will be growth in the second half that was not seen in the first half, especially in Asia with China appearing to be stabilizing.
The leadership there is in place and very focused, and we are confident they will course correct, with positive signs beginning even in this recent quarter. However, we maintain the view that while growth continues in China, we all have to reset expectations below historical rates. And the downside continues to be in Europe, where our view remains unchanged, as the weakness continues with no material signs of improvement on the near term horizon.
Let me close on slide 22, with our priorities for the second half of the year, where we have singularly focused on the following: strongly managing our portfolio to drive further margin expansion and earnings growth, maintaining a laser-like focus on generating ongoing positive and strong cash flow and directing the significant portion of this cash toward increasing rewarding shareholders, and third, aggressively managing and continuing to evaluate every aspect of our enterprise to release and deliver even further value for our shareholders.
You saw additional granularity on the way we are releasing new value from our portfolio earlier in this call, and you can expect to hear more in the coming months. Taken on the whole, we continue to deliver against the commitments we have made, making calculated decisions and delivering strong results in the face of what remain uncertain market conditions. We will be focused on delivering strong earnings and cash flow and remunerating our shareholders. Nothing more, and nothing less.
And with that, I will turn things back over to Doug for Q&A.
Thank you, Andrew. Now we’ll move to your questions. First, however, I’d like to remind you that my comments regarding forward looking statements and non-GAAP financial measures apply to both our prepared remarks and the following Q&A.
Operator, would you please explain the Q&A process?
Earnings Call Part 2:
- Investment & Company Information
- The Dow Chemical Company