The Dow Chemical Company (DOW) Q1 2014 Earnings Conference Call April 23, 2014 9:00 AM ET
Andrew Liveris - Chairman, President and CEO
Bill Weideman – CFO, EVP, Finance, Dow AgroSciences, and Corporate Strategic Development
Doug May - VP, Investor Relations
Robert Koort - Goldman Sachs
John McNulty - Credit Suisse
Frank Mitsch - Wells Fargo Securities
Don Carson - Susquehanna Financial
P.J. Juvekar - Citi
David Begleiter - Deutsche Bank
Duffy Fischer - Barclays
Kevin McCarty - Bank of America
John Roberts - UBS
Hassan Ahmed - Alembic Global Advisors
Vincent Andrews - Morgan Stanley
Good day and welcome to The Dow Chemical Company's First Quarter 2014 Earnings Results Conference Call. (Operator Instructions) Also today's call is being recorded.
I'd now like to turn the call over to Mr. Doug May, Vice President of Investor Relations. Please go ahead, sir.
Thank you, Lauren. Good morning, everyone, and welcome. As usual, we're 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 and Investor Relations.
Around 7 am this morning, April 23rd, 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 also posted on our website and through the link to our webcast.
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 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 Web site. Unless otherwise specified, all of our comparisons presented today will be on a year-over-year basis. Sales comparisons excluding divestitures, EBITDA, EBITDA margins, and earnings comparisons exclude certain items. The agenda for today's call is on Slide 3.
I'll now hand the call over to Andrew.
Thank you, Doug and good morning everyone and thank you for joining us.
As you have seen from our report this morning Dow delivered another quarter of earnings growth representing in fact our sixth consecutive quarter of year-over-year increases. We delivered these results even in the midst of substantial weather and transport-related issues in the quarter and direct result of our relentless focus on operating discipline and execution, what we call self-help. That represent the latest and the steady drumbeat of performance on our march to north of $10 billion of EBITDA.
If you look Slide 3, you will see that these results were illustrative of our clear strategic priorities that are shown on this slide. We are focused on delivering on our large investments such as Sadara, the U.S. Gulf Coast projects and our new project launches. But all the while driving on productivity and cost and cash control targets so as to ensure, we meet our earnings milestones and continue to grow our shareholder remuneration, and not to forget the large carve out on other divestments we have announced.
These priorities align our entire organization as do a serious of execution steps many of which you are familiar with and some that is still to be revealed. They set the tone for delivering this year's earnings targets with a view to the large value and earnings drivers coming on stream next year. We will update you on all of these priorities later in this presentation. But for now, let me turn it over to Bill, who will discuss this quarter's financials.
Thank you, Andrew. Let me begin by providing an overview of the quarter on Slide 5.
We delivered earnings per share of $0.79 a 14% increase year-over-year and our net income increased to $964 million as a result of our cost and operating discipline. We increased sales to $14.5 billion with growth in most of our key segments led by performance plastics, coatings and infrastructure solutions and agricultural sciences where our top line growth continues to outpace the market.
From a geographic perspective, we reported volume growth in nearly all regions most notably Asia Pacific led by growth in China. EBITDA grew to $2.4 billion and importantly we continued to make progress on achieving our margin targets across key businesses with margins expanding at the company level. Further on a trailing 12-month basis, we show steady improvement in ROC delivering the fifth sequential quarter of improvement against this key metric.
We continued our strict management of cost and cash evidenced by nearly 30% increase in cash flow from operations year-over-year. And finally, with our stated priorities, we continued to reward shareholders returning $1.7 billion in the first quarter including the repurchase of $1.25 billion of our stock as part of our $4.5 billion share repurchase program, which we expect to complete in 2014.
Slide 6, shows the key drivers of our financial performance this quarter. We can see the benefit of the targeted actions we took across our portfolio. We controlled what we could in a slow growth business environment focusing on productivity and driving growth through our global reach despite a $300 million increase of feedstock and energy costs, we reduced our cost of sales as a percentage of revenue reflecting our ongoing improvement actions.
Before I turn the call back over to Andrew, let me provide you a few assumptions for modeling purposes as we head into the second quarter.
While we see normal seasonality fluctuations in the second quarter specific to turnaround activity overall market trends remain favorable, which Andrew will speak to in a moment. Plan turnaround spending will be up approximately $150 million sequentially, but essentially flat year-over-year with the majority of the expense in performance plastics, performance materials and coatings and infrastructure.
Additionally, we expect a higher seasonal turnaround activity will result in a 3 to 4 percentage points sequential reduction in the company's operating rate. And finally, as feedstock process have moderated, we expect feedstock and energy cost to be approximately $100 million lower sequentially still $150 million higher than the second quarter of 2013.
With that I will turn the call back over to Andrew.
Thank you, Bill.
We achieved margin expansion in all key operating segments and this is a solid proof point of the work we have done across our portfolio. Let me now update you on how the segments performed in the quarter and their outlook.
Turning to Slide 8, growth in Dow Electronic Materials has been driven by increasing demand for connectivity and brighter, more powerful devices. This resulted in substantial sales growth in OLED materials and interconnect technologies as well as materials that address high-speed and temperature needs for cloud computing in the quarter.
Additionally, our close to customer strategy will enable further margin expansion through its positive impact for the businesses operational productivity, including asset rationalizations in the United States and Europe. We expect full year and market in Dow growth to exceed that up 2013.
In functional materials, we are seeing continued solid demand in targeted sectors of energy, water, food and home and personal care despite lower sales on weather impacts during the first quarter. Looking ahead, we see the trend towards unit dose in both fabric and dishwashing applications driving growth within the homecare sector. Additionally, sales in Dow Microbial Control also aligned to these key sectors continues to outpace the market. The positive trend in consumer driven solutions should see year-on-year growth in this business as well.
On Slide 9 moving to Coatings and Infrastructure Solutions, strengthening global construction activity, North America, Europe and Asia Pacific was a key driver behind first quarter sales increases in architectural coatings. Further Dow Coating Materials reported its fifth consecutive quarter of year-over-year sales growth bolstered by share gains resulting from sales of novel Dow Technologies such as VOC, in fact the first vinyl acrylic VOC launched in Europe in the first quarter. In Water, demand for industrial water applications is increasing and Dow expects to realize the benefit of these increases particularly in key regions such as Asia Pacific.
Growth will be positive in 2014 versus 2013. In Dow Building & Construction, we noted strong demand for innovative materials in insulation, roofing and tile applications in North America, despite the adverse winter in this region. Japan and Europe, Middle East Africa also demonstrated signs of strength in the first quarter. This unit will see the same uptick from the same drivers as Dow Coating Materials. Collectively these increases drove profitable year-over-year growth for the business and served as a clear reflection of improving fundamentals in the construction sector. Additionally results in Dow Building & Construction are further supported by the benefit from previously announced productivity measures such as reduced structural costs and asset closures in Europe.
Turning to Slide 10, in Agricultural Sciences, which continues to be the important growth market for Dow. Record first quarter sales in crop protection reflect increasing farmer demand for innovative new molecules to combat resistance. Looking ahead, sales from new crop protection products are on track to exceed $1 billion by 2015 as technology launches ramp up. We are positive on demand in the second quarter, although this confidence is tempered slightly by higher than normal channel inventories in North America.
We have a positive outlook for top and bottom line growth in 2014. The same can be said for our Seeds business where we expect to continue to outpace the market on the strength of our differentiated technologies including SmartStax, Refuge Advanced and PowerCore as farmer demand for stacked traits accelerates importantly our Enlist launch plans progressed and remained on a firm trajectory for U.S. launch in 2015. We expect to receive the U.S. Regulatory approvals for this highly anticipated technology during the next few months.
Turning to Slide 11, in Polyurethanes and Dow Formulated Systems we are seeing signs of recovery in Europe particularly as a result of higher furniture and bedding demand as well as increased consumer confidence in the region. In the first quarter, demand in industrial and energy efficiency markets also improved globally. Overall, we are well positioned to improve profitability as a result of our increased emphasis on higher value market sectors together with business specific productivity efforts, including the six asset shutdowns completed to-date.
As we look ahead, we expect market demand to grow in the second quarter from increased construction activity in North America and EMEA while we anticipate Asia Pacific will benefit from the typical peak season in footwear. Severe cold temperatures impacted first quarter demand in North America across the Specialty Chemicals businesses. However, fundamentals remain healthy, as favorable trends in homecare products are driving growth for Dow Technologies aligned to this key end market.
Additionally, fundamentals remain robust within Dow Oil, Gas & Mining as major project fills, increased geographical scale and positive market outlook are driving growth for this business.
Looking forward, we expect to see a positive impact resulting from seasonal strength in construction, coatings and agriculture. And Dow Automotive Systems healthy transportation fundamentals are enabling growth in Asia Pacific and North America while Europe is realizing pent up demand and Dow specific technologies such as BETAMATE are driving additional share gains.
We will see above industry growth rates in this unit in 2014.
Turning to Slide 12, in Performance Plastics. Across this segment, we have and we will continue to focus on margin management to address feedstock fluctuations and deliver operational improvements. The opportunity to maximize margin with a price volume bounce is improving as their operating rates are very high and the industry operating rates continue to climb with the improving demand.
Specifically in Dow Packaging & Specialty Plastics, we are driving growth in select high margin end markets such as flexible food and specialty packaging, hygiene and medical and pipe. Asia Pacific and North America delivered double-digit sales growth in the first quarter and we expect to see continued strong demand with increased per capita demand driving growth in emerging geographies over the near term. The outlook is strongly positive for this unit.
In Dow Elastomers, global demand increases in the transportation sector and improving infrastructure markets in Europe were offset by cold weather impacts in operations in North America. Looking forward, U.S. Gulf Coast investments in the 2015, 2016 timeframe will drive growth for AFFINITY, a next generation nodal enabling share gain from substitute technologies in key sectors.
For example, AFFINITY GA is delivering greater performance in hot melt adhesives allowing displacement of EVA in packaging and hygiene applications. And in Dow Electrical & Telecommunications increased demand in the power and telecommunication markets in Asia Pacific fueled first quarter growth driven by power in China and 4G network investments. Dow captured additional margin expansion in this business as a result of increased asset efficiency together with our exit from our non-strategic joint venture. Strong demand will continue in 2014.
Turning to Slide 13, all of our segments are showing positive earnings momentum with self-help measures overcoming known headwinds. The last six months of improvement in EBITDA margins in all key segments is evident on this Slide. All of our collective actions are taking hold and showing positive trends from a range of 5% to 25% improvement.
And on Slide 14, all these actions are cumulative, product and functional materials; growth in display technologies has been and will continue to be a key driver in innovation led growth for the Dow Electronic Materials business. Across the segment, we expect to utilize a combination of innovation and productivity measures to drive 100 to 150 basis points of margin improvement as we entered to adjacent markets and further expand key brand owner relationships.
In Coatings and Infrastructure Solutions, margins are expanding as a result of ongoing productivity measures, share gains and increased sales of Dow Technologies, which collectively reflect the increasing recovery of the construction market. We expect to realize an additional 300 basis points of margin growth in this segment over the near term as these actions could continue to take hold. This margin expansion will include a significant benefit from the integration of our PDH unit in Texas.
Agricultural Sciences has also expanded margins on the back of its technology innovations and productivity aligned measures. And looking ahead, these plans are expected to contribute to additional margin expansion of 300 to 400 basis points over the near term as a result of the ongoing commercialization of the segments robust R&D pipeline together with the achievement of scale efficiency in seeds. In Performance Materials, we expect to realize the most significant improvement with 400 basis points of margin expansion expected in the near term, the largest portion of these improvements will be driven by the integration of our PDH asset together with ongoing productivity improvements across the segment.
Prioritize innovations in the oil and gas, automotive and adhesive sectors will also drive a component of this anticipated margin growth. And finally, in performance plastics currently our highest margin segment, we expect to realize near term margin uplift of 200 to 400 basis points on our key integration investments on the U.S. Gulf Coast as well as through innovation and productivity.
All of these drivers are embedded in the previously shown strategic priorities, which brings me back to these priorities. And first let me remind you that we introduced Slide 16 first during our most recent webcast in March, which took place in Saudi Arabia at the site of our world-scale joint venture Sadara. We are making tremendous headway with this key investment and we are proud to join our value partner Saudi Aramco in providing an update regarding the status and timeline for this project all of which remained very much on track. In fact, we are now more than 50% complete and slated for start-up on time and on budget in mid-2015.
Of course, this is just one the key near term strategic priorities we are driving to fuel our performance and returns higher. In our U.S. Gulf Coast investment program, we continue to achieve major milestones. For example, our PDH asset is now more than 20% complete with all major equipment on site and we continue to feel confident about its timing and its financials. I'm going to have more to say on that in a moment.
As you saw in the quarter, our cost reduction of working capital focus continues to produce results and enabling increased earnings and strong cash flow and our plain carve out of our commodity chlorine business remains on track with an update later in this deck.
Dow steady drum beat of progress is the direct outcome of our focus on these priorities as we move this strategy forward and turning to Slide 17. It's a strategy that leverages Dow's unique business model. We integrated vertically and horizontally. We are low cost across the chain shown here plus value-add as we approach markets with unique technologies. We have scaled in inputs, intermediates, and downstream products. We have scale in R&D as well as in geographic breadth. And we are relentlessly focused on EVA and capital allocation growing high ROC businesses and exiting our low ROC businesses.
Importantly, we grow by winning across these chains. We will update you regularly on all of these chains with simple and transparent metrics. And today, we will highlight the propylene value chain where over the past six months we have realized higher returns as a result of our focus on margin management and operational excellence. This is particularly clear as you look at the significant progress achieved within our coatings and infrastructure solutions and performance materials operating segments during this timeframe.
We laid our plans to improve these segments, our two largest propylene consuming segments. And we have made solid progress against these plans yet we recognize, we have more work to do. And on top of these actions, we expect to achieve EBITDA growth as a result of our near term investments with the Sadara as well as the aforementioned PDH unit on the U.S. Gulf Coast. In short, we are improving our ability to compete in the value chain for that has compelling growth proposition over both near and longer term.
Now let me provide more granularity on Slide 18, here the propylene value chain serves several key sectors and Dow is focused narrowly on several of these targeted end markets, markets with an addressable size of $80 billion and growing faster than GDP. We are taking key actions to improve our integration advantage, drive further operating discipline and prioritizing our technology investments to preferentially invest in attractive end markets such as adhesives, automotive, and energy efficiency to name a few, no way this more evident that in the polyurethanes business.
And turning to Slide 19, let me highlight this. We have achieved notable improvements through the following actions reducing costs, idling facilities, narrowing our market focus and launching new products and technologies that are shown on the slide. But let me use one example, BETAMATE, Dow Automotive Systems is directly aligned with the market trends of light weighting to improve energy efficiency and deliver safer, high performing products to the industry. This solution allows bonding of dissimilar materials with aluminum, plastic and carbon fiber notably nearly 50% of revenue of Dow Automotive Systems comes from sales of products launched within these last five years.
Taken as a whole, we will continue to reap benefits from our collective actions and we expect our innovative products and technologies, couple with our productivity actions and our strategic integration investments to drive significant margin uplift within this value chain.
But further, let me highlight our key integration investment in this chain, our PDH facility on Slide 20. First, a word on the fundamentals of this project, Dow's current outlook on the propane to propylene spread remains consistent with our regional economics and reinforces why as we see our PDH facility as delivering a further attractive value to this chain. Propane prices have moderated again after significant volatility during one of the worst winters in the United States in over 30 years.
The United States is now a net exporter of propane, and we believe the U.S. propane price must remain structurally lower than the world market price to facilitate these exports. Add to this fact, the propylene availability from refineries is coming down and the propylene value will trend towards outlook value. We expect propylene to be an attractive spread over propane. And this is precisely why our PDH unit in Freeport, Texas represent such an important part of our strategy in this value chain, once online, this project will improve integration significantly reduce third party purchases and improve our raw materials costs to Dow's derivative businesses in this value chain.
Today construction on this unit is 20% complete, we have approximately 1600 workers and 90% of the equipment onsite. Mechanical completion is on track for the end of first quarter 2015 with full run rate expected by mid-2015. In short, our long-term view on this project is unchanged and we expect the propane to propylene spread will provide an attractive returns for our PDH project, expect to contribute more than $450 million annual EBITDA at full run rate.
Turning to Slide 21, the propylene chain is just one example of how we are leveraging our strong operational focus, coupled with significant enterprise wide catalysts within our control to drive EBITDA well north of $10 billion when all are fully implemented. We have key growth catalysts, such as our investments in Sadara and on the U.S. Gulf Coast as well our innovation agenda, which collectively are positioning Dow to achieve EBITDA well north of $10 billion in the near term on our way to $13 billion and beyond.
The math of the slide shows 2014 and 2017 actions that grow to more than $13 billion in EBITDA from our current base. Items such as lower pension expense, more operating leverage and further productivity efforts are all extras to these value drivers. In addition, we are focused laser-like on delivery against our divestment targets, so they can grow ROC. So we can grow ROC by liberating capital allocation to these businesses and putting it to better use.
And turning to Slide 22, as you know, in 2013 alone we realized $850 million in proceeds from divestitures exceeding our year end goal. And in March, we broadened scope of our already aggressive targets bringing our expected total to $4.5 billion to $6 billion within the 2014-2015 timeframe.
Of course, our largest share of activity is the plant curved out of our commodity chlorine businesses. We reviewed to you in December that you can think about a 12 to 24 month timeline for this project and after just 4 months of progress the preparation period is really already well underway. Initial market response to our announcement has been positive with strong early interest with double-digit numbers of strategic parties who want to go to the next step.
Additionally, we now have our pre-marketing actions started and our team has made great progress on the separation of these business units from Dow. In fact, we expect to be in the market by third quarter of this year.
And looking at our overall program given the magnitude of our divestiture program going forward, our portfolio will continue to change and upgrade. As such, we will continue to provide increased transparency on our earnings as a result of these actions. And as we move forward, you can expect to see additional clarity on our targets, revised metrics and updated business alignments and segments that will reflect our accelerated market driven strategy with more transparent metrics yet this year.
Turning to Slide 23, the final priority I wish to speak to is the most important to all – for us that are rewarding our shareholders, an area in which we have demonstrated consistent and increasing actions over the last many quarters accommodating in the $1.7 billion return by declared dividends and share repurchases in the first quarter alone.
We remain committed to our share buyback target of $4.5 billion in total all to be completed by the end of this year. Taken on the whole, these actions clearly reinforce our commitment to accelerating returns now and as our earnings increase going forward.
Lastly on Slide 24, back to our near term strategic priorities. These remain our compass as we move ahead. Each priority is integral to the acceleration of our strategy and serves a critical step in our part to shareholder value growth. Let me be clear, Dow's performance in the first quarter represents more than a continuation of the trend of consecutive quarters of earnings growth.
In our view, it's the sum of the quality of our earnings the consistency of the performance and the strength of our trajectory that we are focused on and we will continue to deliver on as we move ahead. We are driving our actions independent of any tailwinds that exist out there which we are treating as a complete bonus.
The summary is, we intend to continue to deliver. With that Doug let's turn to Q&A.
Thank you, Andrew. Now we'll move to your questions. First, however, I would 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. Lauren, would you mind going through the Q&A procedure?
Earnings Call Part 2: