The Dow Chemical Company (DOW)
Goldman Sachs Basic Materials Conference Transcript
May 22, 2013 10:00 AM ET
Bill Weideman - Chief Financial Officer
Brian Maguire - Goldman Sachs
Brian Maguire - Goldman Sachs
Okay everyone. If we could get back from the break, we are going to keep it going here. Next company presenting is Dow Chemical. We are really lucky and fortunate to have Bill Weideman, CFO of the company. He’ll give us an update on how things are going at Dow. Bill?
Thank you, Brian, and good morning, everyone. I’m just going to take a few minutes this morning and kind of cover few items with you in terms of prepared comments and then I'll be happy to turn over to Q&A.
Before we get started, just a housekeeping item, I just like to point out that any EBITDA numbers I’ll be showing today exclude certain items and I’d also point your attention to our disclosures around non-GAAP financial measures and any projections which can be found on our website and also our recent SEC filings.
So now moving to the agenda, what I’d like to do is cover with you today the actions that we currently have in place that are driving our near-term shareholder value. Also going to cover the growth catalyst that we have ongoing that are going to drive our growth over the next three to four years, and then give you quick update on our outlook and priorities for 2013.
First, let me share with you on slide four here, the lands that we are using within the, the ROC lands that we are using within the company to really make our portfolio decision. These are our five key external segments. If you look at this chart, we’ve got three segments in green and two in blue, and those segments that are in green, Performance Plastics, Electronic and Functional Materials and Agricultural Sciences, those our three segments that are generating higher ROC, and those are the businesses that we are preferentially investing in for growth.
If you look at those businesses results in the first quarter, Performance Plastics had in the first quarter of over 27%, Electronic and Functional Materials has had consistent EBITDA margin in the 24% to 25% range, and of course, our ag business had all time record in both revenue and EBITDA in the first quarter. So, clearly, those three segments we are focusing in on growth.
On the other hand we have two segments, both our Performance Materials and also our Coatings and Infrastructure Solutions that have lower ROC. We’ve got specific actions in place which I’ll highlight here in a just minute to drive higher earnings and more consistent earnings in these two segments. So this is the lands that we are using within the company as we priorities assets and resources across the company, both in terms of capital and also in terms of people.
So let me talk a little bit about the ROC improvement actions that we currently have underway to improve the ROC of the company. First, as you know in the first quarter we announced our intent to divest up to $1.5 billion of asset in the next 18 months. We actually increase that in the first quarter. We started with the target of $1 billion. We increased that to $1.5 billion and made that announcement in the first quarter.
We are progressing very, very well on that. We've actually got three businesses right now that we’re in the process of divesting, give a quick update on that. We’ve got a small ag business, within our ag business, it’s a fairly small business.
We’ve already gone out with the offering memorandum on that. We’ve had our first round bid on that and so that’s progressing well. We expect that to close sometime probably in the second quarter and then signing in the second quarter and probably closing in the third quarter.
We’ve also got selling our plastic additives business, that offering memorandum have also gone out. We had strong interest and received a large number of first round bids. We have completed the management presentation and shortly we’ll receive in the second round bids on that business. So, again, we feel fairly confident that that divestiture will also be close sometime in the second or third quarter.
And the third one that we publicly announced is our Polypropylene Licensing and Catalyst business. We are actually planning to issue the offering memorandum on that business in June and we expect a lot of interest in that business.
If you take those three divestitures that we currently have underway, those three will account for large percentage of this $1.5 billion target. So we are well on our way. Also I want to refresh your memory that $1.5 billion target is defined as pretax proceeds, okay. So that’s how we define that $1.5 billion.
Next thing I’d like to highlight is how we are prioritizing our investments across the company which I highlighted briefly in the previous slide. But we are making conscious decisions on how we invest our money going forward.
So, for example, we decided to reduce our investments in alternative energy. On the other hand, we are actually accelerating our investments where we have feedstock advantage, for example, our U.S. Gulf Coast project. So we are looking at very much on that land as how we can create the most value.
We’ve also got ongoing actions in terms of how we are optimizing our assets around the globe and as of through the end of the first quarter, we’ve actually as part of our restructuring announcement last year, we’ve actually shutdown 21 facilities and plants largely in Europe as we go through and optimize and right-size our footprint around the globe. So we have all those actions underway.
So these are some of the actions we’ve got going on currently. Let me change and talk about the catalyst that we have on going that are really going to drive our earnings growth over the next three to four years.
This chart depicts those key drivers of increased earnings. So you have got the actions we are taking on the cost, the interventions that we announced last year, the $2.5 billion of interventions and I’ll give you an update on that and how we are progressing.
We’ve also got the ethylene cycle that’s coming forward and I’ll give you some granularity around that. We’ve also got our U.S. Gulf Coast project, which will contribute significant EBITDA upside between now and 2017, and we of course have our large world-scale project Sadara in Saudi Arabia.
And then we’ve also got our DAS strong pipeline of innovation projects that will be coming on stream and then we’ve got other accretive innovation project. I’m going to touch on four of these today and just kind of give you an update on and where we stand on each one of those catalyst.
So first, let me give you an update where we stand on the $2.5 billion of interventions that we announced last year. Again, as we announce those we said, those will be over a multiyear period. In 2012 we achieved $750 million of savings, those savings you could find a cost plus cash, so some are CapEx, some are cost interventions.
So again we achieved $750 million of savings last year, this year we will achieve another $1 billion of saving in ’13 versus ’12 incrementally and then the balance will be next year.
Here this slide shows the breakdown of that $1 billion that we’ll achieve. So split about half-and-half, about half of that will be EBITDA impact, which is reduction in cost and the other half will be lower CapEx spending.
To give you a quick update on how we are progressing on each of these. In the first quarter of last year we announced the restructuring program where we said we are going to eliminate 900 positions, those essentially all been completed.
In the fourth quarter we announce another restructure where we said we are going to eliminate 2,400 positions and as of the end of the first quarter we’ve eliminated 900 of those positions or over a third, and so we are well on our way there.
We also highlighted the fact that we were slowing down some R&D spend on some projects that had long payback and those projects have already been canceled, and the also discretionary. So we are well on our way here and you should expect the savings here to ramp as we move through the year.
Next think I’d like to talk a minute about is the ethylene cycle. If you look at the industry operating rate now in the ethylene chain, it's running about 87%, 88% right now. And over the next four to five years, there is very little capacity that’s coming on stream. The capacity doesn’t on stream that’s been announced until ‘17, ‘18, ‘19 kind of period, so there is very little capacity coming on stream.
So and then with even in the slow growth environment and polyethylene typically grows at about 1.4 times multiplier is our view and I believe most in the industry is the ethylene cycle is going to continue to tightened over the next three to four years.
Our view is that that ethylene operating rate, industry operating rate is going to go north of 90% in the year 2014. And so what that’s going to do is increase margins in the ethylene cycle.
When you get above 90% your margin expansion goes up fairly significantly. And so our view is that is going to continue to tighten at least for the 2017, ’18 period and so from an upside potential that ethylene cycle as we move from now to the peak has a potential of adding $2 billion of uplift in Dow’s earnings as we move to the peak.
The other thing I want to give you an update or the third item here in terms of our catalyst is give you an update on our U.S. Gulf Coast projects that are well underway. As you know, we announced each of these projects about a year ago. We’re making great progress on all of these projects.
I think Charles operation cracker started up in December of last year and it’s up and running and running, running very well, actually this year that project will add $150 million of additional EBITDA to Dow’s result in 2013 versus 2012. We want to fully ramped up on a run rate basis that will generate about $250 million of additional annual EBITDA.
The second project that we announced was adding ethane and propane additional flexibility to our Louisiana cracker. That project is also progressing well, expected to be completed in the year 2015 and that will add another $250 million of incremental EBITDA by the year 2017.
Our PDH unit, which is strict -- focused completely on replacing the purchase propylene that we have today. We’ve already started construction that project in Freeport and it’s going well.
And we expect to get that project completed by the year 2015, we’re now adding additional $450 million of annual EBITDA improvement which will go primarily to our Coatings and Infrastructure business and our Performance Materials business, which will significantly improve and bring less volatility in those businesses that we have today because currently we purchased about 50% of our propylene in the U.S. And so this will substantially improve the margin of those businesses.
And then last but not least as we have our Texas cracker project that is progressing on plan. Again that’s expected start up in the year 2017 and that will bring about $1.5 billion of incremental EBITDA. We also announced important off-take agreement on this cracker in the first quarter. We announced an off-take agreement with Idemitsu and also Mitsui where they’re going to take 20% of the output of this facility. And in turn, they are going to return back to us (inaudible) which we need in the polyethylene grades that we produce.
So this is a significant off-take agreement and a significant milestone for this project. All in, these projects will add about $2 billion of incremental EBITDA by the year 2017 and they all remain on track.
Give you a quick update on Sadara. This is our large complex and Saudi Arabia is growing very, very well. The financing -- we've secured all of the financing on this. It was well over subscribed and so the financing costs have come in well below what our project economics we’re forecasting. We’re closing up some loose ends but we expect to complete the financial close late June, early July. But the financing activity has gone extremely well.
We've also -- the project remains on track and on budget. The facility is growing up very quickly. We currently have about 20,000 contractors on site, putting that facility up and we’re approaching about 10% completion at this point and right now, we expect to start bringing up some of the plans in the second half of 2015 with the balance in 2016.
As we publicly said before, this is a high-margin, high cash flow generation project. And so our expectation is this will generate EBITDA margins north of 35%. And Dow share of equity earnings will average a little over $500 million per year over the first 10 years of operations. So this is a very large project, very profitable project and it’s going very, very well.
So now, I’d like to switch quickly and move and talk a little bit about outlook, what we’re seeing around the globe and then talk about our priorities for 2013. And then I'll open up to any Q&A questions that you might have. So we look around the globe.
Obviously, there is still lot of uncertainty out there in the global economy but a few comments, if you look at the U.S., Southeast Asia and Latin America, actually these three regions are actually showing fairly healthy demand. I wouldn’t characterize it as robust, but I would characterize it as healthy demand.
If you look at Europe, no surprise, Europe is extremely weak. In our view on Europe, it is not going to improve in the foreseeable future, no matter where you’re at Europe. Germany is a little bit stronger but overall Europe is pretty weak.
China, what we’re seeing in China is the growth rate in China has slowed versus prior previous year but it's still positive territory. In our view, it’s similar to the external view as you probably going to see China’s growth rate maybe closer to, kind of, 7% range. So it has slowed a bit.
But I'd say the bright spots out there right now, one of the strongest regions right now is U.S. and then also Latin America is fairly strong. We have a larger presence in Brazil and so Brazil still remains fairly strong. So that’s a quick, a quick flyover in terms of around the geography.
When we talk about our priorities for cash in some of the recent announcements we made. First of all, our priorities for cash are clear and they’ve been consistent which we’ve communicated for the last couple of years and then as our priorities continue to be to de-lever, reduce debt, renumerate our shareholders and fund, prioritize organic growth. So those have not changed and they will not change in the near-term.
To give you an update on a few of the recent announcements that we've made, early in the first quarter, I think it was in February, we announced $1.5 billion share repurchase program. To reemphasize, that is targeted at covering dilution and so that’s what that’s focused on. And I can’t tell you we’re started repurchasing shares already this quarter.
And so that started this quarter and will be ongoing forward. From a debt reduction standpoint, we’ve reduced as you know $900 million of gross debt in the first quarter that we’ll continue to do so and you will see us reduce more debt in the second quarter.
In terms of, let me jump to the K-Dow award. As all of you probably know about a little over a week ago, we received $2.2 billion in cash in our bank account and this brings the K-Dow arbitration process to a close. That $2.2 billion represents the full recovery of the award plus reimbursement of expenses. And so now we're moving forward in terms of our professional relationship regarding our JV in Kuwait. As we mentioned in our first quarter earnings call, these funds will be applied to the balance sheet.
Now, let me just close by talking about what our focus is in 2013. So our clear focus is on execution. We’re not expecting any significant tailwinds from the economy for the remainder of the year. That’s the planning assumption that we are using.
If we get some tailwinds that will all be upside. We’re assuming from an overall standpoint, 2013 GDP will be similar to 2012, somewhere between the 2% and 2.5% range. And so again we’re focused on execution.
The specific metrics that we are really focused on is cash, cost, capital and price. And so the specific actions that we again are focusing on is carefully managing price volume during these uncertain time and so doing the right balance between price and volume.
As you know, in the first quarter, we thought significant margin expansion as we got 1% price increase while hydrocarbons decreased $300 million. We’re going to continue to take advantage of our feedstock advantage. We’re going to deliver the $1 billion of cost and cash interventions that I highlighted before.
We’re going to realize that $1.5 billion of divestments. And we’re going to continue to reduce debt and delever as we go forward. We’re going to continue to focus on ROC. And you can expect us to continue to reward our shareholders going forward.
We made it very clear from a shareholder remuneration standpoint that as you think about our dividend, we think about that is continue to reward shareholders as our earnings continues to increase. That’s the way we think about that from a shareholder renumeration standpoint.
That completes my prepared comments. And maybe I can just turn it over to any questions that you may have.
Hey, Bill. First congratulations on getting the K-Dow award. Based on thought, it might never come but definitely it was a good surprise to get it. I wonder if you could talk about what the after-tax proceeds are, what kind of tax (inaudible) might be on it and then priorities for, I think the preferreds have been something on your mind to try and retire the preferred shares for while. And maybe update there and how long would you wait on that option before you moved on to option two or three on the use of that cash?
Yeah. So for planning purposes, what you should assume. Our preliminary view is the tax rate on those proceeds will be in the upper teen. And so roughly, $400 million would be the tax cost associated with that because those are preliminary numbers. That’s a ballpark number.
In terms of how we’re going to apply that, as I mentioned during my prepared comments, our intent is to supply that towards the -- on the balance sheet. As it goes to the preferred as we publicly said in the past, those are not callable by us. We do recognize that they are fairly expensive at 8.5% rate.
And so it’s the right time, we -- our desire is to redeem those. Right now, the premium is fairly high on those because of the low interest rates. So we’ll continue to work forward and I can show you where we are today. We will continue to have that dialogue going forward and at the right time, we’ll have discussions about retired notes at those preferreds. And so in the mean time, you could expect us to continue to pay down debt which will just give us more flexibility when we do in fact retire those preferreds.
If I could follow-up on that point, can you expand at all on what you mean when you say, we’ll apply it to the balance sheet. That could just be sitting under balance sheet as $1.8 billion of cash for period of time. You don’t really seem to want to delineate what you're going to do with those proceeds. Can you help us out some?
Yeah. We will use those proceeds in the second quarter and to apply those to the balance sheet in the second quarter. So we don’t tend to sit on that cash. As you know, sitting on cash right today, you don’t get very much interest in the bank. And so I can save interest by applying those funds. So our intent will be to apply those funds this quarter in the second quarter.
Thank you. The only reason I’m saying that balance sheet I haven’t delineated between preferreds and debt.
Both, I consider both of those balance sheet. Any other questions?
Yeah. Over here on your left. Hi.
One of the things with all this capital coming in, I think everybody worries a little bit about it that you might go on a little bit of an acquisition tinge, could you just talk about your thoughts on an organic growth?
Yeah. So, the reason we talk about organic growth is we’re trying to be very, very clear that we’re not in the acquisition mode. That really what we’re talking about any growth we funding is growth on internal projects. And as I reemphasize our priorities for cash and we’ve been fairly consistent again as the leverage as we renumerate shareholders and fund organic growth. We don’t have M&A in there at all.
Bill, I was curious about $1.5 billion sales program, you don’t include any of the JVs in there. And I was wondering what you’re thinking is surrounding that and could they possible be part of the mix at some point down the road?
Yeah. So, as you think about our portfolio, the mindset we have is a best owner’s mindset. So we’re willing to consider any divestiture and so we’re looking at all those and we also have an ongoing portfolio management process. So the ones that I was giving you an update are just once that we currently have under way but are we open to look in that different arrangements on our joint venture, yes we are. So, you could expect us to continue to show progress on portfolio management as we go forward. So this is at the end but it is just one that we have currently underway.
You mentioned the construction was underway on your PDH unit. My impression was you had not received the greenhouse gas permit for that unit yet. Am I wrong on that you have received it and construction is underway?
Absolutely. We have received it and construction is underway.
Yeah. It is still going in ground if you would have visited the site.
Sort of a macro question, all of the companies keep talking about the ethane advantage as they will go on forever. What is your assessment for how long the U.S. can enjoy this?
Yeah. Based on our projections and just based on the significant amount of money $6 billion have gone into fractionators and all the drilling and what not that our view both ethane and propane. The supply will be significantly above the demand at least out until 2018 and 2019 out there. Beyond that I started to see but certainly -- 2018 and 2019 we believe that supply will exceed demand, which will be favorable of course from a price standpoint and favorable to consumer.
Dow has been one of the more visible high profile opponents of LNG export and so we starting to see that trickle in and see how large it ends up being. But I was curious if there is an argument that higher gas prices will actually incent more drilling and then more NGLs should be trapped potentially, lower ethane prices et cetera. So, have you considered that at all or is that the higher natural gas just negative for the -- more of the (inaudible) side of the business?
Yeah. So, I think Dow position on that has been about a little bit misrepresented. So let me tell you what Dow’s position is on LNG export terminals. We’ll not actually give LNG export terminal. We actually support the decisions that was made just a few days ago about another LNG export terminal and report.
Our position is to just be methodical and measured as you as you go forward. Actually the addition of some LNG export terminals actually will encourage more drilling. And so that’s the good thing. We just want to make sure that it’s logical and measured that the government looks at it because this is a significant advantage to the United States on both from an energy standpoint and also from a job creation standpoint. We just want to make sure that, that’s a measured approach as it goes forward to benefits United States to the benefits.
So, were not against LNG export terminals. We just don’t want to be unfettered. We think that U.S. government needs to make sure they manage that. And so we create the maximum amount of jobs in the United States and also help our energy policy.
Excuse me, just two questions one just back to the JVs, going forward do you expect to have JVs as part of the portfolio in the long-term. So you will do more JVs but you'll still prune the portfolio around?
Yeah. So the question is do we expect to continue to have JVs going forward? Yeah. I do. The main reason for that is, as we get access to low-cost feedstocks around the world, actually joint venture arrangement sometime is the only arrangement that work in those local countries. So we’ll continue to have joint ventures going forward. For example, our large Sadara project will be a joint venture going forward.
And just one more real quick the, on the ethylene cycle and I think you showed how much potential EBITDA? But can you just remind us what your EBTIDA margin ranges have been in the past and where you think they can go on the commodity side?
Well, yeah, as I mentioned in the first quarter, our EBITDA margins on the Performance Plastics business was 27% and that’s without this uptake. So, well, I will give you specific number but certainly our view is that it can certainly go above 30% on a conservative basis.
I think the -- your comments around the portfolio of assets, you said that you pursue a right owner strategy for them? My question was just kind of around your ag business, do you still feel like Dow is right owner for that business, do you get proper credit in your multiple and the stock for those earnings or would some day they will be better off in somebody else portfolio?
Yeah. So, again, that right owner mindset applies to all business, including ag. And so all these discussions really revolve around timing, personally right now, as we've highlighted before, we got a very, very robust pipeline in our ag business with number of significance going up, coming out in the next couple of years.
We’ve made large investments in our seeds, traits and oil business over the last three to four years, and that business is now getting to be a critical size, where it can really make a difference and so going forward.
And so, right now, I don't believe is the right time to monetize ag, primarily because we got so much upside coming in the near-term in terms of that product pipeline that I don't believe we will get full value for right now. But I do want to make it clear that we do have a best owner mindset. We always open to discussions but time is important. Yeah, in the back?
Are you guys have extra propylene to sell when you finish your PDH or is that offering until you use?
No. That all be used internally. The other thing I didn't mentioned during my prepared comments. But if you look at our U.S. Gulf Coast projects, with the exception of the cracker those first three or four projects I talked about, though they have no market risk, and so that's important to know, because I think trials operations that starting up in the cracker in today's date, today's environment and we’re currently a purchaser of ethylene. So that’s going to moved it to position we don't need to purchase ethylene.
So there's no market risk. The PDH that I mention is going to displace purchase propylene under just current demand, so we don't have to rely on improvement in the economy to achieve those EBITDA contributions. I think that's an important thing to note. Right in the back?
Question on divestments, with respect to the divestments, what’s the approximate EBITDA associated with the three large businesses that you plan to divest?
Yeah. We haven’t disclosed that, so maybe, I’ll help you what the way to think about that. So as I previously mentioned, our target was $1.5 billion right, and I also mentioned that those three would make up a significant portion of that, and maybe the way to think about that is, is our expectation of the average multiples, so we’ll get to those businesses in the 7% to 8% range, so you can probably back into a number.
Brian Maguire - Goldman Sachs
We have time for maybe one more, if there is one and if not. Well, just thank you very much Bill for attending and presenting today.
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