Dow Chemical Co. (DOW) Q3 2013 Earnings Conference Call October 24, 2013 9:00 AM ET
Doug May – Vice President-Investor Relations
Andrew N. Liveris – President, Chairman and Chief Executive Officer
William H. Weideman – Executive Vice President-Investors Officer and Chief Financial Officer
John P. McNulty – Credit Suisse Securities LLC
John E. Roberts – UBS Securities LLC
Peter E. Butler – Glen Hill Investment Research
David I. Begleiter – Deutsche Bank Securities, Inc.
Duffy Fischer – Barclays Capital, Inc.
P.J. Juvekar – Citigroup
Robert A. Koort – Goldman Sachs & Co.
Frank J. Mitsch – Wells Fargo Securities LLC
Rob Walker – Jefferies LLC
Mark W. Connelly – CLSA Americas LLC
Kevin Mckarty – Bank of America Merrill Lynch
Good day and welcome to The Dow Chemical Company's Third Quarter 2013 Earnings Results Conference Call. (Operator Instructions) Also today’s call is being recorded. I’d now like to turn the call over to Doug May, Vice President of Investor Relations. Please go ahead, sir.
Thank you, Lauren. 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, any redistribution, retransmission or rebroadcast of this call in any form without Dow's expressed 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, Investor Relations.
Around 7 AM this morning, October 24, 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 any forward-looking statements during the quarter. If you would like to see 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. 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 I’ll now hand it – hand the call over to Andrew.
Andrew N. Liveris
Thank you, Doug and good morning everyone and thank you for joining us.
Turning to Slide 4, this quarter was another solid proved point in Dow’s earnings growth momentum and our focus on executing self help measures. Both strategic moves as well as tactical interventions to achieve top and bottom line gains in a perpetually slow-growth world.
Here are the highlights, adjusted earnings per share grew 19% year-over-year, representing our fourth consecutive quarter of EPS growth. We delivered $1.4 billion of cash flow from operations, a 27% increase year-over-year. year-to-date we’ve generated an additional $3.1 billion of cash flow from operations versus the prior year. As strong cash flow and strategic actions are allowing us to fund our organic growth and additional shareholder remuneration.
I’ll focus on debt reduction, $200 million in the quarter and $2.4 billion year-to-date droves our net debt to capital ratio down to 34.7% below the low-end of our historical range. We delivered solid EBITDA improvement led by our Performance Plastics franchise, where high margin market focus and cost advantage enable us to deliver EBITDA growth of more than 30% and notably our Coatings and Infrastructure, and Electronics and Functional Materials businesses also delivered EBITDA gains up 15% and 5% respectively.
We continued to be proactive and as you’ve seen through our consistent and persistent actions over the last 12 months. Dow has a number of key catalysts in place that are fueling momentum, enhancing return on capital and driving higher returns for our shareholders.
We've a number of strategic business transitions in motion, including the signed transaction on your Polypropylene Licensing and Catalysts business.
Today, we announced additional financial milestones aligned with further actions we are taking to go narrower and deeper into attractive markets and proper pools and deselecting portions of value chains that are no longer core to our business.
But first, I will turn it over to Bill for more detail on our financial and operating results in the quarter.
William H. Weideman
Thank you, Andrew. Turning to Slide 6, sales increased 1% or 2% on an adjusted basis to $13.7 billion. EBITDA was $1.8 billion and earnings was $0.49 per share or $0.50 per share on an adjusted basis. This compares with earnings of $0.42 per share in the same period last year.
Now moving to Slide 7, we will see the key drivers of our results this quarter. We drove aggressive price actions across all businesses. However, the full benefit of these actions was offset by higher and volatile raw material costs.
Equity earnings grew $147 million year-over-year led by our joint ventures in Kuwait. Further, our cost reduction actions continue to gain traction, reaching $320 million year-to-date and remain on track to deliver $500 million in EBITDA by the year-end and $1 billion on a run rate basis by year end 2014.
Now, let me take a moment to dive deeper into price and volume trends on Page 8. We saw a strong performance in emerging geographies, where both price and volume increases drove revenue gains of 5%. We also delivered strong revenue gains in key end used markets including Electronic and Functional Materials, Coatings and Infrastructure, Performance Packaging and Agricultural Sciences.
Volume grew 5% in Latin America and 3% in Asia Pacific, offsetting currency headwinds in both regions. Developed geographies volume declined, primarily due to previously announced shutdowns, weak chlorine chain industry fundamentals and a lighter feedstock slate in Europe.
Now turning to the operating segments, starting with Electronic and Functional Materials on Slide 9. Sales in Electronic and Functional Materials were up 5% as volume growth of 6% more than offset a 1% decline in price. Ongoing strong demand for functional films and OLED materials and mobile devices grew volume increases in Dow Electronic Materials. Functional Materials delivered gains due to healthy fundamentals in the energy and home care sectors.
Now turning to Coatings and Infrastructure Solutions, which grew sales 6% year-over-year; this is particularly notable given the significant headwind this sector has faced over the last several years. EBITDA and EBITDA margins were up 15% and nearly 120 basis points respectively, reflecting the benefit of our targeted cost actions as well as improving conditions in the construction market.
Sales gains were broad-based with increases across all businesses and all geographic areas. Dow Building and Construction grew volume in all regions. Strong sales in architectural coatings drove growth in Dow Coating Materials and sales rose in Dow Water and Process Solutions to the healthy demand in reverse osmosis technologies in Asia Pacific.
Now turning to Agricultural Sciences, which reported third quarter sales of $1.4 billion, up 8% versus same period last year. Crop Protection sales increased 10%, representing a new quarterly record. Seeds, Traits and Oils sales and EBITDA declined as cool, wet weather in the Northern Hemisphere led to higher seed returns in the quarter.
Now moving to Performance Materials where sales were down 3% versus the years ago period. Volume gains in Dow Automotive Systems, in Propylene Oxide and Propylene Glycol were more than offset by decline in other businesses, most notably Epoxy, driven by weak industry fundamentals.
We achieved price gains in most business units, however this was more than offset by higher raw material costs leading to margin contraction in portion of a chlorine value chain, particularly Epoxy or Chlorinated Organics, Polyurethanes and Propylene Oxide and Propylene Glycol.
Now turning to Slide 11; sales in Performance Plastics were $3.6 billion, up 3% compared to the same quarter last year or 6% excluding the impact of divestures. Double digits sales gains were achieved in North America and Asia Pacific, with strong sales growth in Latin America. Dow Packaging and specialty Plastics delivered strong sales increases in flexible foods and specialty packaging.
EBITDA for this segment was up 32% versus the same period last year driven by broad-based pricings across all geographic areas. And Feedstocks and Energy sales were $2.3 billion down 7% versus the prior year. Price was flat while volume declined 7%, volume decreases were driven by lower operating rates and lighter feedslate mix in Europe. Limited product availability in caustic soda associated with planned turnarounds in the Gulf Coast also contributed to the decreased volumes in this segment.
Now let me turn to our cash flow and balance sheet, were we have made great progress. During the quarter we generated $1.4 billion in cash from operations, a 27% increase versus the same period last year. Our net debt to total capital improved to 34.7% down from 36.4% last quarter. Since 2010, we have reduced gross debt by $5.2 billion. We were also delivering steady progress against our previously announced divestiture targets.
As you know in October we announced the signing of the divestiture of our Polypropylene Licensing & Catalysts business. As our cash flow and interim earnings continue to grow, we remained focused on our three priorities: rewarding shareholders, funding organic growth, and further reducing debt.
Before I wrap up, let me provide a few additional comments for modeling purposes. We expect to see the normal seasonal slowdown in the fourth quarter. We expect strong margins will continue in Performance Plastics. So we will continue to monitor Propylene to Ethylene margins as we entered the winter months. We expect to see on-going growth in Agricultural Sciences.
We expect equity earnings will be in the mid-200 range and our restructuring cost reduction actions will continue to ramp as we move into the fourth quarter, and we expect per tax rate to be in the 26% to 28% range.
And now I’d like to turn it back over to Andrew.
Andrew N. Liveris
Thank you, Bill. Dow delivered another solid quarter and remains in a strong path forward. Our earnings and cash performance demonstrate our ability to execute in the phase of uncertainty and the debt reduction, cost control and divestiture progress Bill just discussed, are further proof we’re deploying every tool without disposal to effectively control the controllable.
However the reality remains. We are operating within a global business environment that still is not stabilized. We have volatility and uncertainty cleared the new norm. So if you turn to Slide 14, we anticipated this ongoing volatility which has fundamentally changed the way global markets behave and the way our business must be prepared to respond. This is why over the previous twelve months, we’ve maintained a steady focus on driving improvements in return on capital to release value and we have consistently provided progress reports on this plan, for example at our Investor Forum in 2012 using ROC as our lens, we shared our view on segment specific plans to enhance value. We then follow this for the closer look and how our focus on ROC was driving our investment decisions and as a result in the first quarter of this year announced plans to divest $1.5 billion of non-strategic assets.
In the second quarter we reviewed additional work we had undertaken on underperforming units unveiling plans for broader portfolio optimization activities, mostly in the Performance Materials segment. And just last month, I shared specific next steps with respect to these actions including anticipated transactions with portions of our point change and our commodity derivatives. As a result of this steady ongoing focus and our deeper drill into ROC challenge business, we turn to Slide 15, today we are announcing that we will accelerate our intermediate divestiture financial goal moving from our initial target of $1.5 billion which is well under way and expanding that to a financial milestone of $3 billion to $4 billion over the next 18 to 24 months.
The additional divestiture proceeds will come from the strategic decisions we are making regarding markets and value chains within our chlorine portfolio. The decisions we have taken of these last many months have been underpinned by a comprehensive analysis of the industry's and markets we serve and our competitive position in these value chains in order to determine the best market and portfolio combination to drive return on capital higher, invest in the right markets and businesses and maximize shareholder value.
Turning to Slide 16, put simply we are moving away from being all things to all markets, and going deeper and narrower into profit pools were Dow can extract value with our strong science and technology base and highly competitive cost position. More than two thirds of $40 billion of revenue of our businesses today are in high-margin attractive sectors such as electronics, packaging and agriculture to name just a few. In these sectors we are working closely with customers to grow our technology and leadership position.
We also have roughly $10 billion of businesses located in markets where we expect demand to regain its pre-2008 crisis footing. These are strong underlying competitive advantage and are receiving further attention to enhance our results. However, it’s gaining traction take for example, the Coatings and Infrastructure Solutions segment where our cost and pricing actions, broader feedstock integration with our recently start-up SAMCo JV in Saudi Arabia and improving market fundamentals in construction, infrastructure and housing resulted in both top and bottom line growth for the first time in more than seven consecutive quarters.
However, this analysis has also illuminated the fact that we have businesses we believe serve markets that are not best suited for Dow long-term. In these businesses we have solid low-cost competitive position and are currently using a run for cash business model and have identified the path of transaction as forthcoming to several.
So turning to Slide 17, take for example our Chlorine chain with today's downstream market choices drive our future integration needs making these choices is not an all or nothing decision. While we are driving aggressive plans to improve these businesses, we believe the different owner is better positioned to expect maximum value long-term from portions of our Chlorine and derivatives assets, such as Epoxy resins, chlorinated organics and the [indiscernible] chain.
Due to complexity associated with this collection of businesses, it might take notable steps and structures to unlock the full value of these assets. We’re very conscience in the carve out process, not to lead any stranded costs and create negative synergies. From a timing perspective, you can expect this scope to further crystallize over the next six months.
Turning to Slide 18, specifically for the Epoxy business, note that this has historically been a terrific business with EBITDA margins approaching 20% and we believe that it is capable of becoming a strong business again. However, recent and widely acknowledged industry overbuilding, especially in China, has been a significant headwind to its profitability.
In 2012, we proactively addressed these challenges head on showering nonperforming assets throughout restructuring programs and we are winding this business in a low cost, operationally excellent manner leveraging out vantage cost positions.
The team is focused and aligned with both strategic and operational plans firmly in place to deliver improvements. We are running a lean organization and running it for cash, streamlining a geographic structure, driving clear accountability against share and increased earnings and prioritizing R&D investments in favor of reliably delivering core products to the Epoxy market. All firmly in place to aggressively further reduce additional costs across the business.
And while we have a dedicated team focused on fixing and improving profitability by $100 million in the near-term, as I mentioned in September, we are evaluating various options to reduce our participation in the Epoxy based value chain. Put simply, we believe these are great assets.
However, as we have carefully evaluated the markets served by the Epoxy business, it is clear these markets no longer align with Dow strategic priorities. Therefore, we are looking to transact this business either by a joint venture or a sale and we see this transaction taking place in the near-term. We have and we’ll continue to give you updates as we progress on this dual track plan.
Turning to Slide 19, and to our Polyurethanes franchise which serves a broad range of sectors. We remain convinced that through our chemistry and material science capabilities we can win in select end markets that offer attractive growth. And as we go narrow and deeper into these strategically aligned markets, we continue to optimize our participation across their value chains.
First, we have real teams that focus in the four key sectors shown on the slide drilling deeper were value is highest. Second, we are optimizing our participation in every step of the value chain. We are focusing on operational excellence in our components businesses and rightsizing our systems business for new market realities, particularly in Western Europe. We have shut six assets over the last 12 months and reduced structural costs through streamlining the organization. Going forward, we expect our cost reduction actions in Polyurethanes to provide an additional $100 million of benefit to the bottom line.
And third, we’re investing for higher and more sustainable margins over the long-term by securing attractive, cost advantage feedstock positions through both our PDH project on the U.S. Gulf Coast, as well as our Sadara joint venture. Bottom line, we are confident that the fixed actions we are taking now would deliver meaningful improvement for polyurethanes and the longer term fundamentals of our portfolio remain attractive for earnings growth.
Turning to Slide 20, these portfolio actions and many other previously stated self-help measures of the cost and cash intervention type complemented by value drivers such as Sadara and our new earning streams including the U.S Gulf Coast plus new EBITDA from innovation totaled more than $3 billion of EBITDA in the near-term. These catalysts plus several external factors, including lower pension expense, leverage from higher operating rates and tightening of the ethylene balances will allow our EBITDA trajectory to go north of $10 billion. These actions are in motion and fully funded in our CapEx and expense plans and therefore we are confident that we have the projects and programs to deliver this near-term earnings growth.
Turning to Slide 21, in fact when you combine our strong cash flow from operations with which we aggressively paid down debt and reduced interest expense the cash generation from our embedded catalyst was just mentioned. And finally, the cash from our accelerated divestiture targets this company is well positioned to execute against our stated cash priorities, reduce interest expense for the balance sheet, fund our organic growth agenda and reward our shareholders.
So let me now turn to our outlook where the global economic recovery has been hesitant and growth has been slowed and spotty as best. On Slide 23, despite a number of positive underlying market fundamentals political uncertainties in key regions continue to hinder economic recovery. China is stabilizing and looking ahead we see fundamentals improving with stronger growth in 2014.
However, heading into the fourth quarter, we are yet to see a clear uptick in holiday export demand. A weaker yen is bolstering exports in Japan. The resulting increase in investor production momentum is possibly impacting industries, such as automotive. We view a corresponding uptick in consumer and manufacturing confidence as a positive catalyst for business investments in the region. Conditions in Europe remain soft. However, in our view the market has found bottom and we expect to see more positive singles in the near-term than in the previous three years, especially in the Northern Zone countries.
Volatile currency conditions are driving cautious purchasing patterns in Latin America, especially in Brazil. However, the fundamentals in particular for agriculture and packaging remain quite strong in this region. And finally, despite recent paralysis in Washington, the U.S is on the whole demonstrating stable, albeit slow growth with demand in a number of key end-use markets including automotive, durable goods, residential new construction, agriculture and packaging.
We remain concerned that the ongoing dysfunctionality will cause you as GDP to slow versus the original 2014 forecast of 3%. So against this backlog of uncertain and above our global environment we are focused on controlling what we can control and we will continue to demonstrate significant progress. These self-help measures is a strong bridge to the new EBITDA streams that will stop surfacing in a big way once our Sadara plan starts up in 2015 and the other aforementioned value drivers kick in.
We remain squarely focused on three key areas: selecting and winning in the right markets, going deep, not wide; adjusting our portfolio; and driving unrelenting financial and operating discipline using ROC as our lens and distributing surplus cash so as to maximize shareholder value.
Dow’s intense focus on higher operating performance coupled with the ongoing ramp up of our self-help measures, we have all the right levers in place and we’ll be undeterred in our actions to further increase shareholder returns.
With that, I will turn things back over to Doug for Q&A.
Great. Thank you, Andrew. Now we move on to your questions. First, I would like to remind you that my comments earlier regarding forward-looking statements and non-GAAP financial measures apply to both, our prepared remarks and the following Q&A. Lauren, would you please explain the Q&A procedure.
Earnings Call Part 2: