Let’s look at the information gleamed from Dow chemical’s (DOW) Q2’s release and call and do a little projection for Q3.
In the call the following exchange was had:
Jeffrey Zekauskas – JPMorgan
“Good morning. On average shouldn’t your raw material costs be down sequentially in the third quarter? Natural gas has gone from — I don’t know — $12 to $9 and oil has come from $135 to $125?”
Geoffery E. Merszei – Executive Vice President and Chief Financial Officer; Member of the Board of Directors
“Yeah Jeff, this is Geoffrey here. Just to take oil, Brent crude average price as of this morning, let’s say, $124, $125. At today’s level it is still higher than our average cost during the first quarter. The average cost in the first quarter was around $122. I’m using crude as a reference point. And we are already towards the end of the first month of one-third of the quarter. So if you use an average rate for the third quarter of let’s say around $125, $126 then you are talking about over $0.5 billion additional cost for the company to absorb.”
It would look like that based on current demand for its products every $3 plus or minus in its cost of oil results in about a $500 million cost increase or decrease.
Dow’s Q2 average was $122 and change and oil now sits at $117. What is also of interest is the price increases announced earlier this summer were only about 40% implemented during Q2. By the time Q3 is finished, they ought to be fully implemented which means revenues ought to post another record quarter assuming no dramatic demand destruction (unlikely).
What does it all mean? Should oil prices remain lower than $122 for the quarter and with the price increases now fully implemented, the 66 cents a share earnings that analysts anticipate are beginning to look as though it is far too low.
Where are we at? July crude averaged $134 and August so far is at $120 and falling. On ought to expect that to fall father as July’s numbers were boosted by the early spike to $145 a barrel and to this point in August we have been below $120 for most of it. Of course one should also assume Dow may be entering into more contracts at lower prices now and that this will reduce the average purchase below just a simple daily average reading.
What if oil stays high? Let’s go with the scenario that oil ends up at the same $122 a barrel for Q3. We still have the implementation of the price increases coming through the system that will boost revenues.
This is a fun exercise but when you look at it, as the year goes by it becomes far less necessary. Dow has essentially traded 50% interest in its oil dependent commodity business to Kuwait for Rohm and Hass (ROH) in its entirety and picked up Berkshire Hathaway’s (BRK.A) Warren Buffett as an investor to boot. Not a bad deal when you look at it that way.
It is still only 1/2 way through the quarter but I am thinking there are going to be a whole lot of shareholders very happy with the earnings surprise Dow turns in after Q3 is over…
Disclosure (“none” means no position):Long Dow, None
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