Here is the whole interview…
Hello Mr. Liveris
Andrew:
Hello Todd, nice to finally put a voice to the blog. Todd its been great reading your pieces……you track us very closely.
Todd:
Thank you. In full disclosure, I have been a shareholder for a few years now and quite a bit of my sons educational accounts is in Dow stock so I’m hoping you allow us to send them to the private school of our choice, not forced to a state one.
Andrew:
(laughing) I’m in I’m in. This is one of the nations core issues, but we won’t get into that I know we have limited time. You have very thoughtfully put together some questions forward.
Todd:
Yea…let’s get started..
Todd:
With the move in production to low cost nations underway, do you see a day when $125 oil and $12 nat gas become earnings drivers for the company as the price increases you are able to push on are in excess of input price increases? For example, say I make finished OJ. If the prices of oranges are going up, so are the prices of finished OJ. But, if I partner with an orange farmer, my input prices do not rise (or if they do, at a fraction of those buying oranges from the farmer), but I am then able to either increase my OJ prices along with other producers, OR become the low cost seller to increase market share. Does the analogy hold for Dow down the road?
Andrew:
It has been an interesting phenomenon as I have watched it rise since I got appointed. I almost feel like it’s a job index, you know years in office and years of oil price rises. I don’t think I’ve seen a decline except momentarily early last year.
Nat. gas is a US regional issue but will probably become a world issue but right now its still a US regional issue. Oil though is a world issue, and to your question then, if you have rising oil prices that are global in nature and all of its derivatives and they go up steadily then your point comes true. In essence for us it actually becomes a reason to raise prices but that is only as good as the consumer’s ability to take those prices. Unlike the 70s, which was the last time this really all occurred this time around we have the Chinese consumer, and frankly that actually adds some optimism that we should be able to as a globe pay more for these precious resources in the value chain.
Now, you can’t do it overnight otherwise you will kill the consumer, but over a period of time steadily rising inputs with strong new demand from places like China and other places (India, Middle East, Europe etc) then I think margin recalibration of a high oil price input all the way through the value chain including our part becomes very, very reasonable. Actually, the margin expansion which happened in the 70’s, Dow had a whole philosophy back then if you go back and track it called Reinvestment Pricing. Others used the acronym RIP and they were having fun with us. {laughter} It really was the same scenario but at that time the buoyant demand was more the US and that actually became the big problem as it created inflation and stagflation.
But this time around we have China so there is a chance your scenario will come to pass as long as it is not surging or a surge up and then a surge down which creates volatility.
Todd:
When you make the move to the Kuwait and Saudi ventures, do you see a significant input price drop on Dow’s part?
Andrew:
Well the Kuwait venture and the Saudi projects. Yes, I mean look firstly what we do there is we take advantage of natural gas prices way below world price and where you can see from our financials we are already making a lot of money in equity income from that. That is because those countries have said “I want to diversify our economies away from just oil and gas”.
We are a great diversification hedge for them, that is why they are prepared to give us low input prices way below world price, way below US price for sure. On oil, OK the key for us there is I’d like to call it the Exxon model. I mean Exxon (XOM), which is almost like nation-state in its own right, they basically take oil at world price or they produce it at cost and when they distribute in their production systems. They are efficient allocators of resource to petro-chemicals to fuels of all sorts not just gasoline and they run their whole machine for profitability which means that net net their input costs of petro-chemicals is lower because they run the whole machine. Now with Kuwait Petroleum and with Saudi Armco that is exactly the model we’re building.
We’re building a refinery integrated petro-chemical model where the owners of the oil, Kuwait and Saudi Arabia respectively will be able to efficiently allocate the oil within that entire machine and of course we’re a half owner the shareholders will benefit from oil integration so two physical hedges the gas one which is the stranded nat. gas with nation states that want to value add the gas vs burn it and second, refinery and oil integration with nation states who have oil who want to diversify away from just exporting the oil or who want to take the oil to places like China and want to participate in refineries and petrochemicals there.
Those are great physical hedges for the Dow Chemical Co. not well understood by the investment community. We’re working really hard to make them understand it and you know the icing on the cake is that we got paid $9.5 billion for that privilege.
Todd:
So, you anticipate 2010 is the year those JV’s (Kuwait and Saudi Arabia) should be up and running. ?
Andrew:
We are being conservative Todd. My recent investor presentation I showed 2011/2012 because stuff happens you know, TPC contracts capital costs etc. We’re pretty good as project managers and so are our partners so conservatively we are saying 2011/2012.
Todd:
US energy policy. I had several questions planned here but you have been all over TV the last week and a half answering them for me..
Andrew:
(Laughing) And I am not done yet, I am determined to shake this all loose because we are just shooting ourselves in the foot very effectively as a nation.
Todd:
There was an “American Energy Production Act” Senate Republicans just introduced recently, have you seen it?
Andrew:
The drilling one right?
Todd:
Yes, they said it would produce an estimated 24 billion barrels of oil a day and 47 trillion cubic feet of nat. gas.
Andrew:
Certainly the bill recognizes the problem. It is a Republican bill and certainly I appreciate Senator Domenici’s work on it. However, the country need a bill both Democrats and Republican can support
I was in Washington yesterday and I had meeting after meeting. I actually think I might get deported here eventually [laughter] . You know I’m just screaming from the rooftops to get real with our energy policy.
Todd:
Let’s say you left Washington and they said “this guy is right, let’s do everything he said we should”. Even if they did that and they started at the earliest next spring, after the election, what kind of lag based on your experience is it 2 years, 5 years before anything they do now actually takes hold and excess production comes online.
Andrew:
Well we went through this in 2005 with the Lease Sale 181 in the inter-continental shelf of the US. The US gulf we were told that time and I think this is still very true that there are some known fields of oil and gas that can easily be tapped into current infrastructure especially on the US gulf they could be on the street in 12-18 months. Not as big as the numbers you just quoted, because on the outer edge that would be Anwar and that could be as far away at 4-5 years because of the pipeline.
We take a window and if you said “let’s go now” I think the earliest is 18 months and the latest is five years. But something else happens which is very important. The world as speculators look at supply very differently. We have a real supply issue because demand is surging and everyone thinks that there is not enough supply. Supply is bottle-necked in two places. One is availability of actual oil and gas of course in our Country we’re not accessing it and it will take 18 months to five years to accomplish that. Overseas its ships and freight and there are not enough ships on the water to get all this oil to everyone to get all this gas to everyone. So that’s one bottleneck.
The second bottleneck is refining capacity which as you know this country won’t permit refineries. I think the only one under construction today is Valero’s (VLO) in Texas. No one wants a refinery in their back yard. So you have this ridiculous situation of Reliance building the world’s largest refinery in India and all the products are for exporting to the United States.
So those two bottlenecks will take several years, if you take those two bottlenecks out by passing laws, I think there will be an instantaneous reaction to price.
Todd:
Dow Ag. Roughly a third of earnings in the most recent quarter were Dow Ag. After you sell the commodity business we are looking well in excess of that. I have not been able to find what percent of future earnings you expect them to be and what type of growth and how far out, as right now you are at about 20-25% annual EPS growth at Dow Ag. Going out 2009-2010 and beyond, to me 20% -25% EPS growth there seems sustainable if not surpassable. Accurate or no?
Andrew:
I think you are more accurate than not, remember the current % of Dow earnings is because AG is front loaded. It tends to be a first half year event for all of us because we are in the northern hemisphere and that’s whether its Dow (DOW), DuPont (DD) or Monsanto (MON). The whole year happens in the first six months. We have some southern hemisphere exposure notably Brazil and Argentina and my country Australia, but most of it is titled towards the northern hemisphere as a % of total earnings. Those numbers are distorted at this moment, but if you take the whole year and you say in ’07 Dow AG earned about 10% to 15% of Dow’s earnings but their growth rate was like you said 20 some odd percent for the last five years.
They achieved that through 2 mechanisms one of which will continue to be a big plus that will ultimate if not continue that 20% ramp up it will get very close. The first mechanism is we have been levering Dow’s considerable operational efficiencies over to Dow’s Agroscience. Even though it is a small co. $3 to $4 billion in revenue it has the power of a $50 billion co. in terms of operational excellence in its manufacturing, plants and supply chain. In its governance and share services it operates with its access to big company infrastructure, that’s number one.
That’s helped a lot of the cost line. Number two, the most exciting part is its pipeline. I mean, four years ago we made a conscious decision we said,”look, we’re never going to be a big seed co. because its too expensive, one of these days we might be able to find an answer on U.S. corn, but between now and then let’s rev up the technology engine and frankly not just in bio and seeds and traits in germplasm, but also in crop chemicals.” I don’t care what people say, GMOs will not replace crop chemicals in totality because growers will always need variety in their toolbox, its about diversity of solution and biotech cannot answer everything.
So we said “let’s put R & D in focus on the pipeline that we now have” in crop chemicals in particular things that are not just in corn, but outside of corn, in cotton, rapeoil and canola, in seed ,in soy beans and of course over range and pasture. The crop chemical R & D pipeline we have right now and what we have done in traits and in particular our new traits that we have announced plus the SmartStax agreement with Monsanto, have put us in a tremendous position. By 2010 when SmartStax gets launched, when our new traits get launched and our crop protection pipeline comes through, the R & D engine will yield real margin expansion for Dow AG.
I happen to think that Dow Ag in many ways doesn’t need to have big revenues b/c its margins at 16%, 18%, 20% bottom line margins is packing a big punch in terms of its ability to deliver margin despite its size. We’re increasing the R & D spending there. Dow Ag has a quarter of the R & D spending as a company which is a phenomenal statement when considering the size of the company we are and out thee in the future Todd we might be able to find rationalization opportunity and I will say out there, we’ll find another one. In the meantime keep making that growth story.
Todd:
That was actually the next question. Ag sector valuations are stratospheric just now.
Andrew:
Oh yea, I mean look, what were seeing now of the whole food change now started by corn and ethanol, that whole thing. Having said that, we’re seeing China, this whole point about China’s surge and as the Chinese eat more protein, eat more animals, those animals have to be nutured on agriculture, agriculture comes from feed, feed comes from corn and you know, there you go.
The food price things is real because of China’s assention and I do think that’s going to get worse before it get better and I think the world is going to have to address it. I do not know what the systems will be. I do think the poverty side of it is big. The agricultural sector and the commodity boom in agriculture is compelling valuations to stratospheres, I mean Monsanto is the great flag carrier there, they are doing great and it wasn’t long ago they were on their knees.
Todd:
So, if there is no value in Ag, and no real value in the Petro- chemical sector now, where do you see value?
Andrew:
Well, great question. Firstly, the US economy, and the housing crisis leading to the credit issues leading to, if you like, the financial sector meltdown interestingly enough has not yet pitched profits in the economy in the main, apart from the banks and financial service companies. Main Street has survived the financial issues and the housing crisis pretty well. That means equity values have not come down so, one, equities are not at 52 week highs but they are roughly 80-85% of 52 week highs. Two, US dollar based companies with the US dollar , oil, interest rate issues, overseas properties become very expensive.
So, first you have Ag expensive, Petro-chemical it is not necessarily a question of price but of quality. Most of them are not high quality properties and are privatized and run for cash. The quality properties we are JV’ing with them, the previous point. So really, if you are on the acquisition trail, US equities have not come down a lot, and overseas properties are expensive.
So, you know where being incredibly, were scutinizing everything in mean I don’t quite have a NASA control room here but on my desk in my room I’ve got stacks and stacks of tracking mechanisms to see when good, quality properties may become afordable enough that we could make more money with them being part of Dow we could make more money with them than their being on their own. Now, whether they are friendly or hostile, that is another whole conversation. The fact that we haven’t done any big deal suggests those numbers aren’t in target right now. The financial discipline we’ve put in place here, Todd, is something I am real proud of .
I think, you know, money’s not burning a whole in oiur pocket and as I’ve to investors over and over were making all the deals we ned to make and if we get to the point wher we have too much cash, a great problem to have in this environment, we’ll for sure bump up the reward to shareholders and keep increasing our R&D spending so we can do more at Dow Ag and mimic their sucess. We got a ton of R&D projects that are very promising and than do small bolt on acquisitions, we’ve done 20 in the last 24 months.
At the right moment, maybe equities will come down and on our radar screen are a dozen or so properties than when the time is right, we’ll move on. But, you know, methodic, systemic, disciplined really paying a lot of attention to the criteria that matter for success. Creating a winning growth company. I’m really dedicated to putting down the earnings growth profile in a different place and doing it in a very methodical precise way. If I am blessed to have this job for as many years as I possibly could given my age I’ll see it through.
I’m not going to knee jerk around to people telling me to do short term things. That is easy to say when you’re on the outside. Trying to create long term earnings growth, that’s a different story and we’ll putting in place the discipline to do that.
Todd:
Yea, just from a personal standpoint I have not been able to understand the media’s infatuation with you having to do something. I’d rather do nothing than something stupid.
Andrew:
(Laughing) Unbelievable how the English language causes the media to go to strange places. If I could put your headline on every analyst report, I would.
Todd:
Recently you said that EPS in 2015 would be $10. I believe that presentation was before your recent comments on energy prices and price increases. Now 2015 obviously seven years away. The current situation (oil), does that have any bearing on that estimate?
Andrew:
No, you know, we’ve estimated margins based on the commodity cycle and on global demand and supply . We take into account higher equity earnings from the joint ventures which will come online between 2011 and 2015, we add a portion of what we expect to get from our R&D programs, plus better quality earnings from our performance business and our continued cost controls. There are no assumptions around the use of the proceeds. The only assumption in there is, 3% average volume growth seven years, 3% is incredibly conservative – but okay.
We will just leave that as an assumption. I think the point that people miss is, yeah, there are recessions to worry about and term issues to worry about but we’ve positioned the company to get that number, the $3.50 number, and the $10.00 number, we’ve positioned it already. I don’t have to announce anything else – nothing more than we’ve already announced, that’s the bonus to this whole conversation … and that’s the part of the story that people don’t get.
And I will tell you this, I’m saying it over and over, I’ve had over 200 investor meeting in the last three months, you know many of them one on one, in one office with two or three people and what I keep telling them is you stand the risk of missing out the inflection point. You’re trying to call bottom on me and yeah, there are lots of things to worry about, the cost of surging oil, but I’m recognizing that case by a 20% increase … now we are not going to stand here and take surging oil, we’re going to pass it on and we are going to take advantage of surging oil, not to be victimized by it . You’re going miss the inflection point, you’re thinking “this company is going crater like it did in 01-02” and you’re waiting for that point, and what we are showing you two mile posts that are saying that between now and 2011-2012 we will reach an inflection point, and if I have anything to do with it, sooner rather than later, 2009 / 2010 right? So answering the earlier question , it will be independent of where oil tracks and it will be somewhat immune to the U.S. economy because of the global economy.
Todd:
When I first saw the $10.00 a share, to me it seemed far below what I would of anticipated, based on the things I see going on, and I assumed I was missing something, “something is just not right” I said. The question that maybe your anticipating oil going to $175 by then or something like that. Now obviously you have the cash coming in, it doesn’t seem to me that M&A is imminent. It seems to me like probably it’s a couple years off. The little tiny ones are what’s most likely, but anything significant based on the direction your going with AG and current valuation there. It would seem a wiser use of the cash is either more of the petrochemical joint ventures, share repurchase or increasing dividend, accurate?
Andrew:
Yes
Todd:
Ok, now, any breakdown between what you anticipate going between dividends or repurchases?
Andrew:
No, we haven’t, we’ve got target values but we haven’t declared them . I get asked that question a lot AS you can imagine.
Todd:
Yeah, I’m sure you do.
Andrew:
What I keep saying over and over is capital structure matters, dividend consistency matters. Dow has never had dividend consistency. You can rest assured that as we get confident about our extremes, we just went through a whole discussion on that, the dividend increase is definitely something the demand is paying out ratios of 40% or more and then additional repurchases. We’ve bought 6% already of outstanding shares over the last two years. We have the opportunity with the Kuwait cash, depending on what share price you want to use of buying 20-25% of the company back if we want to. That might limit our planning and it might limit our opportunity so we probably wouldn’t do all that. But even half that number, if it happens, it surely a big number. You know I will tell you that most likely we are going to address that as the next quarter goes by and give some answers. Also we’ll return some cash to R&D to do what we have to do and some on the M&A side. As I’ve said to the world, I do think that share repurchases and dividend increase in some construct is very likely in the next six months.
Todd:
I mean, to me, I don’t see a problem sitting there with $3 or $4 billion in cash waiting for the perfect deal to come down the road in a couple years.
Andrew:
Yeah, many people say that to me and I agree with them. One more time, that tells me why I have enjoyed reading your stuff, it’s very logical and you know people they’re trying to intervene. I don’t play games with my language, I actually say it.
Todd:
No, I think people try to interpret what you say instead of just listening.
Andrew:
Thank you for saying that, I really appreciate that. You know it is logical what you just said, and that’s exactly the way we are thinking. We don’t have to make this a mystery and I think keeping the cash makes sense and frankly the company’s earned the right to grow in as many ways it can, organically and through M&A – and of course organic can also mean investing in share purchases in itself.
Todd:
If you were to pick what area of the company that just, you just can’t talk enough about because your so excited about it, which one would it be?
Andrew:
Well you know, that’s a great question and I don’t think I’ve been asked that, so you get originality, and you know I’m not going to cop out on you, that would be out of my character. I would have to say the whole AG Bio space, not just AG space.
Todd:
Me too.
Andrew:
We are under promising and over delivering there and we’ve got some neat stuff going on in the world of bio technology, alternative energy, alternative feed stocks and I can’t wait until to investors day because we will be making a lot more noise about this. You may have noticed, even today I think, AG made some additional announcements.
Todd:
I saw that, I saw that.
Andrew:
We have whole slue of things that we are literally just dropping out there. And just calling it Dow Ag is actually limited, we are leveraging over into polyurethanes, epoxy resins, polyestyrene, etc, there is a bunch of other uses that we are putting IT into. Some of the neat stuff we are doing in new technology developments around energy efficiency comes n a very close #2. For example, the new diesel filter that’s launching and also the Building Integrated Photovoltaics program we are working on for our Dow Building Solutions. So energy efficiency as a whole. I’ve launched these four mega trends to give everyone a sense of where we are focusing our efforts and you may have noticed all the examples I’ve given are in two of the four, health and nutrition and energy, those two.
Disclosure (“none” means no position):Long Dow
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