Dow Chemical Turns in Profit & Drops Bombshell

Dow did a fantastic job in Q1 managing the business and then dropped what I consider a bombshell on investors..

First the news (projections were for a $.20 LOSS):

· Earnings were $0.03 per share, or $0.12 per share excluding certain items(1), as cost control actions and price/volume management mitigated the effects from the worst global recession in decades.

· Agricultural Sciences set quarterly records for both sales and EBIT(2). Sales for the segment increased 10 percent on a year-over-year basis, reflecting a 10 percent increase in volume.

· Purchased feedstock and energy costs were down 49 percent compared with the same quarter last year, contributing to a 20 percent decline in selling prices, with the majority of the decline in the Basics segments.

· EBIT excluding certain items improved sequentially, with the largest percentage improvement coming from the Performance segments, above and beyond the seasonality of Agricultural Sciences.

· Rapid actions to reduce operating costs in the quarter resulted in a decrease in spending of $270 million year over year and sequentially. Capital spending was down 35 percent in the quarter, in line with the Company’s pre-acquisition 2009 capital spending commitment of $1.1 billion.

Here are the presentation slides:
Dow Q1 Earnings Slides

8-K Filed With SEC

CEO Andrew Liveris:

“There are some signs that the pace of global economic decline is moderating. The broad diversity of Dow’s product mix enables us to have better visibility on true market demand, especially in parts of the world, such as in China, where domestic stimulus programs are beginning to take hold.

“Having said that, it’s prudent to expect that 2009 will still be a recessionary year globally, and we are not counting on material improvements in economic conditions in the near term. We remain focused on managing what is in our control, namely reducing costs and capital spending, delivering on our action plan to de-leverage our balance sheet, and smoothly and successfully integrating Rohm and Haas into the new Dow. These actions are paramount to our long-term strategy to transform Dow into an earnings-growth company.”

The bombshell? DowAgro Sciences may be sold or divested in an IPO. This is unacceptable under any circumstances. Dow Ag, as CEO Andrew Liveris told me is the crown jewel of the company.

Q1 would have experienced a large loss were it not for Dow AG. It is the only segment of the company growing (11 straight quarters) and still has a blockbuster product, Smartstax coming online either late next year or next. In other words, the best for Dow Ag is still to come.

The options given were and IPO, or a outright sale. Either option is a slap in the face to investors who have stuck by the company through its recent turmoil. As previously twittered, recently I purchased large amounts of Dow at $6.80 and again at $9 share (current price $15) despite the uncertainty surrounding the company at the time.

Why?

Dow Ag. At those share prices I was paying for Dow AG, and getting the rest of the company for free (Basic Chemicals, Specialty Chemicals, and Rohm and Haas)…..for FREE. I can’t say I would have made the decision were Dow Ag NOT part of Dow at the time.

Any decision to sell Dow Ag without extreme consideration for existing shareholders I cannot back or accept. Agrcultural products are going to be valuable for decades as the world population grows, farmable land remains fixed and biofuels take more of a center stage. That means the future earnings power for Dow Ag may just possibly dwarf most other areas of their business. Just look at the last two quarters, the worlds economy by any measurement fell off a cliff yet Dow Ag increased earnings double digits, not through cost cutting, but through volume gains (sales).

Results like that have a value that cannot be captured in the current environment buy a potential buyer.

For three years Dow has professed to want to change the earnings profile to a more stable/specialty focused one. Dow Ag fits perfectly into that. The retention of Basic businesses and the sale of Dow Ag runs counter to everything that has been portrayed as a goal.

The IPO/Sale plans say this: Dow is going to trade Dow Ag for Rohm and Hass. Since the proceeds are going to be used to pay of the Rohm purchase, at its most basic level, that is the deal for shareholders. I think if anyone is being honest, Dow Ag has more value that Rohm in terms of growth.

Sell anything else…..anything

Perhaps a partial IPO of Dow Ag? After speaking with people familiar with Dow’s plans, they have insinuated that is a realistic option. That would surely raise the necessary funds to cover the bridge loan due in a year. Still a repugnant thought….

Am I selling? No. The loss of Dow Ag would hurt greatly long term but short term would provide a boost as it would remove debt issues from the company. Shares would rally and provide those looking to exit much higher prices than current.

Part of the reasoning on the call was that “it is an Ag business with a commodity multiple” (because it is part of Dow Chemical) and that selling it would provide shareholders with the multiple return. Well, if that is the concern, spin it to us and let us realized the multiple expansion of it AND participate in the future growth. Dow could keep even 50% of it recognize the new multiple in the increase in the asset value. I would wager that if 50% were spun to shareholders to trade publicly, the 50% left at Dow would be worth what the whole is today.

However, the reverse of that is true also. As Dow Ag grows and commodity businesses are sold off, Dow Chemical becomes a Chemical company with more of a AG multiple. Long term, this is the direction I want.

The total loss of Dow Ag would most likely mean the loss of me as a shareholder and would, based on last years statements cause those shareholders left to most likely doubt anything coming out of HQ for years to come…rightly so..

Liveris said on the call today a decision will be made “30,60 or 90 days”. We’ll see…

Disclosure (“none” means no position):Long Dow