Dow Inc. (DOW) Earnings Call Transcript & Summary

Good morning, everybody. This is Bob Koort at Goldman Sachs. I run the U.S. equity research effort on the chemicals space and pleased this morning to be joined by Howard Ungerleider, who's the President and CFO at Dow. As protocol for this conference, we're going to be doing this as a chat, where myself and Dylan Campbell, who covers Dow with me here at Goldman are going to ask Howard questions. We would strongly encourage that you could ask your own questions. If you look on the web portal there, there is a place to submit questions via a box, a text box. You lob those in, and then we'd be happy to ask those on your behalf of Howard. So without further ado, let me turn it over to Howard Ungerleider for some initial remarks, and then we'll get into the Q&A. Howard?

Thanks for having us, Bob. And good morning to you, good morning, Dylan, good morning to everybody out there who has joined us. First of all, let me just say on behalf of the Dow team that I hope everyone listening in and your families are all safe and healthy. We continue to be inspired by how the global community, certainly our essential industry, first responders and those on the front lines at Dow have all stepped up through this unique time that we're all experiencing. And for any of those of you who are on the front lines and listening in, I just want to say thank you from the bottom of my heart for what you're doing. I would say, turning to our topic today, I'd like to just begin with a brief summary of our first quarter. Our results exceeded Wall Street expectations. We did clearly see divergent demand patterns in the quarter. Consumer staples, things like food packaging, health and hygiene and cleaning materials showed strong demand, while anything really touching durable goods, particularly automotive and appliances were soft. We delivered strong cash flow again this quarter with cash flow from operations and free cash flow both up year-over-year despite the lower earnings. Our extensive liquidity and our improved liability profile were also highlights. At the end of the quarter, our total cash and available committed liquidity was approximately $12 billion, including $3.6 billion of cash on hand. And as a result of the liability actions we accomplished since spin, we have no significant long-term debt maturities due for more than 3 years. On the call, we also shared the proactive measures we're taking, totaling more than $1 billion of interventions: reducing CapEx by $750 million year-on-year, further trimming our operating expenses by another $350 million, releasing $500 million from working capital and idling a few of our assets to balance production with demand. Those actions will further enhance our financial position through the current market conditions that we're experiencing and certainly will turn into tailwinds as we run through the rest of the year. In the second quarter, as we highlighted, we anticipate clearly global demand softness from lower economic activity, and that will impact our results. The modeling guidance we provided offered our best estimates for the quarter in light of prevalent market uncertainty, and certainly, the low visibility that we're still dealing with. We know it's going to take some time for consumers to reengage. But already this month, we're seeing economies make plans to reopen with industries like automotive and construction beginning that process even this week. As this trend of a gradual and sustainable reopening of economies continues through the second half of this quarter, we expect recovery will begin to take hold as the year progresses. And Bob, with that, I'll throw it back over to you, and let's jump into the Q&A.

Terrific. You guys have a pretty sizable effort in Asia, Howard. I'm wondering how do you -- what have you seen in China as they started to reopen again? And how do you think about applying those SKUs to the Western markets?

Yes. I mean look, what we've seen is in line with the modeling guidance we provided for the quarter, Bob. And what I would say is this, that certainly, Q1 was a big headwind for us in China. So China demand, if you think about a typical Q1, inclusive of a Lunar New Year, our demand might sequentially drop by about 10% from Q4 to Q1 on a typical year. We saw a 25% sequential reduction in China from Q4 to Q1. So 15% worse demand from a volume standpoint, and it's still early in the second quarter. We're not quite halfway through May. What we saw coming out late in the quarter, late in Q1 and early in Q1 is a significant rebound in China for about 2 or 3 weeks, followed by about 2 weeks of softer demand. And now what we've been seeing for the last couple of weeks is demand improving again. So I think there was a little bit of pent-up demand as a result of the big lockdown and the shut-ins that everybody was experiencing in China. That pent-up demand kind of came back in a hurry; a couple of week, petered out a little bit; but now we're on an upward trajectory. And if you look at -- look, if you look at our demand or you look at any of the industrial statistics of electricity, even traffic in the urban areas, retail sales, things are looking up. I mean I would say in China, the only things that you still really see that are still below 80% or so in terms of what it used to be, were really anything touching travel and leisure and mass transit. So whether it's airplane travel, whether it's mass transit, bus or train, movie theaters, anything where people are needing to congregate are still probably in the 60% range or lower. But everything else, even in the durable good area in China is really starting to move up. Clearly, the consumer staples are moving up at a faster rate than consumer durables.

Howard, this is Dylan. I'm Bob's team. I've got a question here from an investor just asking about how you would characterize, I guess, the inventory situation in China on the back of that demand commentary?

We've seen -- is that question specific to China or around the world?

Yes, China, China, sorry.

Yes. Look, I think inventories are starting to come off. And we've seen that really every week. And you can see -- you've got some -- now you've got, especially on the ethylene chain, you've got a cost push happening now. We really never saw a big demand drop, for example, in polyethylene. It was on the margin. But really, overall, it was more flat versus a year ago, which is certainly down versus a typical China, which is usually growing at 2 to 3x their GDP. But now that we've come off of that, demand continues to return and costs are higher. And so you're starting to see continued pull, and actually price is moving up as a result.

Howard, it's clearly rough times when Dow is yielding almost 9% on its dividend. And it does seem a lot of clients have questions around sustainability, commitment to the dividend, ability to pay it in these kind of environments. Would you just walk through the -- your approach towards the dividend commitment to that dividend and maybe the puts and takes around cash this year and into next year to cover that dividend?

Yes. I mean I think under periods of economic distress, whether it's what we're dealing with now or '08, '09 or '01, '02, clearly, cash is king or cash is queen, depending on your perspective. And I'm very proud of the Dow team for the amount of focus on cash. This was a key difference of, I would say, the old Dow into the new Dow as we spun out. It's something that we've been talking about really since 2018. We now have every single business leader around the world who has a P&L, also has a balance sheet and has a cash flow statement that adds up to the enterprise statement that Jim and I manage together. And so ever since spin, so beginning with the second quarter of last year, every quarter, so far, inclusive of the first quarter, we've delivered higher cash from ops and higher free cash flow versus the same quarter a year ago, despite the macroeconomic environment, the margin compression that we saw last year and certainly, even in the first quarter, where we saw the big pandemic demand and the beginning of the oil price compression that we saw in the month of March. And so when I think about the dividend, look, the dividend from a management standpoint as well as our Board, it is our top, it is our #1 financial priority. So the commitment could not be higher. When we look at the cash flows, and let's just look this year at the bearish -- the most bearish case that's out there on the Street right now. In terms of the sell side, I think the lowest number is around $5.1 billion or $5.2 billion on an EBITDA basis. If you subtract out interest and taxes, you're looking at about $4 billion net. We lowered our CapEx spending to $1.25 billion. We've got a $500 million commitment on Sadara, and we got a $2.1 billion dividend. So even at that -- the most bearish sell-side estimate for this year, you've got more than enough cash from operations to cover the dividend. But you've got other things and other levers that we are pulling, and we will continue to pull on the nonoperational side. So in the first quarter, we received a $250 million tax refund from the Canadian government as a result of the first Nova judgment that we had. So that's a nonoperational cash flow that's on top of those numbers. If you really are in that $5 billion EBITDA range, you should see a significant release of cash from working capital. We are and have been working on structural improvements on working capital to the tune of about $300 million a year. But if you're really at the $5 billion level, and if you believe that hydrocarbon values are going to stay low -- that's not necessarily my base case. But if you have that point of view and you're that bearish, then you will release between $500 million of cash from working capital and as much as $1.5 billion. And if you go back and model our portfolio over the last many economic cycles that typically coincide with a petrochemical down cycle, that's the kind of release of cash you got from working capital. On top of that, we've got the second Nova judgment that we're seeking to get in the court. I don't know whether that happens this year or next year, but that's several hundred million dollars that we expect to receive from the second judgment on the top-up on the first judgment from 2012 to 2018. And then we've got the Olin payment that is expected to come due at the very end of this year. So -- and there are other things that we're working on that we haven't talked publicly about yet. And as we get them more concrete, we will certainly share. But there are hundreds of millions of dollars of additional nonoperating cash flows that the Dow team is focused on to weather this storm.

Howard, this is Dylan again. I guess following up on that, 2 areas that investors question in regards to the cash flows is your pension and the risk with Sadara. Can you talk a little bit about kind of the risk in terms of your cash flow specifically? And how you're kind of managing those risks with the pension in terms of when you actually expect a potential true-up in this lower interest rate environment? And then on Sadara, how your -- how negotiations are going currently with both the lenders and the partners?

Yes. So thanks, Dylan. And look, on the pension first, I mean, we're in a very good position on the pension. We do have our pension underfunding right now. It's about $8 billion because of the lower discount rate environment that you mentioned in the question. But because we've been putting so much voluntary payments into our pension in the last 5 years as we were setting up the capital structure for spin, look, our mandatory requirements this year is about $250 million to $300 million of cash. That's about flat with last year. And obviously, we mark the pension to market at the end of every year. But I would say if it was marked today, our cash need next year and most likely in 2022 would be in that $300 million range. So for the next 3 years, 2020, '21 and '22, most likely, it's not going to be a significant cash drain. That number can step up by $400 million or $500 million in 2023 and 2024 potentially, but we're actively engaged in -- with many other companies and trade associations and looking to get the pension corridor smoothing that was put in place during the financial crisis in '08, '09. Those corridors are set to expire. But obviously, with a very low discount rate that we've all experienced, I think there is some -- certainly, desire and political will in Washington to help all companies through that process and just continue with some of those corridors. If that happens, that will reduce our cash need in those out-years pretty significantly. So we're in a good position on the pension. And obviously, I mean, the discount rate -- lower discount rate hurts, but the spreads widened, and don't underestimate that the widening of the spreads definitely will be a tailwind to offset most, if not potentially all of the headwinds depending on where the discount rate and the spreads are at the end of the year. Look, on Sadara, I would say, Sadara continues to operate very well, right? So it's 26-unit operations. They're world-scale assets. Before the pandemic, they were sold out. There was good demand. And I can circle back to the demand comment in a minute. But fundamentally, it's got a capitalization problem. So it's got too much leverage, and we're working -- Dow and Saudi Aramco and Sadara are working together with the lenders to reprofile that debt. In March, we did achieve the last substantive step to achieve project completion, and that was the rail agreement, the final logistics agreement that Sadara had to sign with the Saudi rail authority, so that's done. So we have now passed that last substantive step. We're working on the administrative steps. In a normal environment, that would probably take a month. And I would say, based on where we are with the pandemic and a lot of government offices closed or working reduced hours, we're probably looking at getting that done by the end of the second quarter, all the remaining administrative steps to achieve PCD. But we're not waiting. We've begun the process with the lenders. Once we finalized that rail agreement, we've now begun the process. So we've reviewed presentations. We've sent the draft term sheet out to the lending syndicate. We expect initial feedback before our -- before our second quarter earnings call. So on the second quarter earnings call, I'll have more to say based on the feedback that we've got. And I would say, most likely, certainly, our target is to get that negotiation done by the end of the year. And that's why I say, look, for modeling purposes, I think it's reasonable for you to assume no change in the cash outflow for Dow in 2020 versus 2019, which was a $500 million use of cash, which is really just to pay the -- majority is to pay the principal drawdown. Because remember, it was project financed, and so what we need to do with this reprofiling is reprofile the debt, work on looking at the tenors and/or looking at the amortization tables, but really turn it from project debt to company long-term debt. And so that's the goal and I would say we're on track to get that done by the end of the year. And I would say that Jim and I are working on that together actually with the CEO and the CFO of Saudi Aramco. We're talking about once a month, the 4 of us on a regular drumbeat just to keep the teams focused and delivering on that goal.

And Howard, on the Sadara, the range of outcomes then into 2021, is the worst case having to pay down that principal again for another $0.5 billion? And the best case is no cash leakage? Can you give us some guardrails on what outcomes might occur for next year there?

Yes. I mean I think -- yes, I think if you want to be a real bear and say there's no way they can get the reprofiling done, which is not my view, Bob, but if you want to take that, then I think just assuming a $500 million use of cash from Dow into Sadara to pay off -- continue to pay off the project financing principal, which basically all comes due over the course of the next 10 years. It's pretty -- it varies a little bit year-to-year. But basically, it would be about a $500 million draw every year until we could get that reprofiling done. But Bob, that is not my base case.

And so if it does get reprofiled, then that $500 million goes away, but there's other interest payment? Or how do we think about the net of it, if you resolve things favorably?

Look, our -- look, it's a negotiation. I certainly don't want to negotiate with the lenders on this webcast. But what I would say is, look, our goal and what we put forward in the term sheet is to make sure that Sadara is cash flow self-sufficient and can weather the next several years without any cash from Dow or Saudi Aramco.

Got you. Turning to the businesses and maybe start in the polyolefins world, polyethylene, particularly for you guys. Clearly, the COVID crisis has created some demand pressures and some opportunities, I guess, but it was amplified by the oil crash. Can you talk a little bit -- you guys have a very broad view, obviously. You've got ethane crackers in South America, Canada, U.S., but you've got naphtha-based cracking, not only here, but abroad as well. Talk about the dynamics and how the competitive environment has shifted. What you guys have done in light of this correction in oil prices and compression and maybe that...

Look, I think -- I would say this, Bob. Certainly, nobody likes the state of the economy around the world and what we're all dealing with related to the pandemic. But I would say this kind of an environment actually plays to Dow's strength, Dow's portfolio, our feedstock flexibility, our geographic presence. So yes, we have a significant amount of capacity in the U.S. Gulf Coast, but we also have capacity in Alberta. We have a capacity -- which is gas-based, as you know. We have capacity in Argentina, which is gas-based with shale in the Vaca Muerta. We have a significant feedstock flex in the U.S. Gulf Coast. We can crack 2 to 3x the amount of naphtha or propane than the industry without us. In Europe, we've invested significantly over the last couple of decades on our ability to either crack naphtha or crack as much as 65% LPGs. Obviously, if you believe that we're going to be in this low oil environment and the cost curve is flat, then we're going to make a lot more money in Europe. We're going to make a lot more money in Thailand with the assets, which are naphtha-based. And then back to the Sadara point, it's a mixed feed cracker. So there's a big naphtha component there. And if you really believe that naphtha is going to be advantaged over ethane for a long period of time, then we'll make more money in Sadara as well. I also think the applications that we're in tend to be a lot more tilted to the consumable area. Whether it's packaging, food packaging, whether it's hygiene and medical applications, they're consumable applications for a big chunk of our demand. And then you think about our catalyst technology, our process technology, our unique comonomer capability to utilize octene. We put out a benchmark in 2018. And then we updated that benchmark again. I think we put the slides in the first quarter earnings deck, which everybody should have access to. So margins, certainly in '19, are lower than they were in '18, but we actually widened our relative advantage versus the next 2 players on the cost curve. So I think it plays to our strength.

And can you talk about -- I mean you do have flexibility. Are these, the shifting feedstocks, something that you can take advantage of and optimize for? Or does -- as everyone shifts one way or the other, does it remove that opportunity? Are there storage and logistics issues if you crack heavier and finding places to put those byproducts? Can you just talk about the -- sort of the ability to flex quickly or not by yourselves and the industry?

Yes. I would say we're not immune to the issues that you read about. You certainly, I'm sure, heard some of our other peers deal with. But certainly, we've been investing in feedstock flexibility for a long time. And when some people talk about feedstock flexibility, they say they've got 2 furnaces that can crack naphtha, they've got 3 furnaces that could crack ethane. When we talk about feedstock flexibility, it is in-furnace feedstock flexibility. Where we run the model -- look, we can run the model daily. We typically only make the changes about once a week, unless there's a big dislocation that encourages and is economically beneficial. But relative -- when you look at the cost curve right now, you would say you want to crack as much naphtha as you can. But to your point, a lot of the -- when you crack naphtha, as you know, a lot of the byproducts or coal products, depending on your perspective, go into durable goods. The C4s and things like that will go into tires, will go into other automotive and transportation infrastructure applications. And the demand there, because of the pandemic is so low, that on -- in a theoretical basis, naphtha looks like the cheapest crack. But in reality, ethane and propane are kind of battling for lead position still. As the demand comes back, that probably improves. And if oil stays low, naphtha probably gets a little bit better. Although, look, you look at demand right now, gasoline demand has jumped -- is starting to jump up. Oil, this morning, touched $30 at Brent. It hasn't touched $30 for about 30 days. It's up about 25% or 30% just in the last couple of 5, 10 days, something like that. So you're starting to see the world come back. And I do think jet fuel demand will lag, but it appears that gasoline demand is going to strengthen. And look, if people in the large metro areas have an opportunity to fly from Boston to New York or DC, will they fly? Or will they get in the car and drive? And my gut says, at least for the first few months, you're going to see a lot more gasoline demand relative to jet fuel demand. But back to your C4 question, we've got a lot of flexibility, I would say, more than most and the ability to actually handle the C4s on our own. And that's something that we purpose built.

And looking at the U.S. specifically, I think last year, consultants are pointing towards about 40% of the U.S. polyethylene was exported into the global market. Following the decline in oil prices and a flattening of the global cost curve, how has that changed the global trading dynamic? And then I guess a related investor question here is, how has the competitive response from Chinese chem producers changed due to the lower oil price environment?

Yes. I mean look, I think certainly, what we saw is a reduction of exports to China in the first quarter as an industry. But that was really because of the China demand and their lockdown. What we've seen since they have restarted their economy is actually demand, they've been pulling even more on export. And export shipments are -- they're running up against the logistics bottleneck versus anything other than a demand issue or anything like that. So I'm probably more bullish that as long as we see economic activity continue to strengthen in China and then the rest -- around the rest of the world as we come out of the kind of stay-at-home orders and/or the lockdowns, depending on what country you're in around the world, that really shouldn't be a big issue. I would say from a Dow perspective, look, we did not build our Gulf Coast assets for export outside of the Americas. So really, for us, the long term -- if your view is the shale gas advantage is gone, which, by the way, is not our view. I mean I think when you look at past oil shocks, about 80% of the time, when you've had an oil shock like we've had, within 12 months, the oil price is up about 40% from the shock. And so that -- we're already up 30%. And I would say you're looking at -- you look out the forward curve right now, it's -- you got to go out 2 or 3 years on the forward curve, but you're in the mid-40s already. And so -- and if you think about where different oil producers need the oil price from a budget standpoint, that is probably in that kind of a range. So there's going to be demand growth that will draw price up. And then there's going to be budgetary pressure that will also draw -- either if demand doesn't grow, you're likely to see supply go down. And so I just fundamentally don't believe today that the shale gas advantage is gone and gone forever. Certainly, the cost curve is flatter today than it's been. But look, if you just look at the oil-to-gas ratio, you're back towards 16 or 17, maybe even 18 as of this morning. So I mean, they talk about -- traditionally, if you're at 6 or below, you're at parity. So you're not at parity, you're still advantaged. The relative advantage is lower than it's been. But I would also say that if you're in a low-demand environment, if you believe that the pandemic is going to be a much slower return, which certainly some folks believe, then I would point you to -- look, you got to look at what capacities around the world are vulnerable, either because they're CTO- or MTO-based or they're small or they're old or they're not connected to the feedstock and they're in an import situation. Because what we saw after the '08-'09 crisis is about 4 million metric tons of capacity came out of the supply. Two million came out permanently, meaning were not mothballed, but were actually demolished. Two million metric ton was mothballed or idled and then came back between 2010 and 2011. When we do that same analysis on the vulnerable assets today, our list is about a little bit north of 20 million metric tons, a little bit above 10% of the global capacity, and CTO and MTO alone is that -- is about 6.5 million tons. And that's -- if your oil price is not above $50 a barrel, it gets very hard for those CTO and MTO assets to run. So if you don't shut anything else down, if you believe in a low oil environment, the likelihood that those CTO and MTO assets either don't run or run at reduced rates is really high.

Howard, do you think -- one anxiety point for clients on the polyethylene markets have been a wave of capacity outside the U.S. that was sort of gotten past the first wave here. But maybe in China, in particular, there was another wave coming. Do you think some of those expansions are vulnerable as well? Have you guys adjusted what you see on the supply side? Is that getting stretched out?

Yes. I mean look, there's a typical rule of thumb that on capacity additions or announcements, half the stuff that gets announced gets built, and the half that gets built takes longer. And we've seen that in the Middle East wave, we've seen that in the U.S. Gulf Coast wave that we're just going through. I believe we will see that in the China wave. So yes, some of the capacity will get built, no doubt, but I do think it will take longer. I mean certainly, even the announcements that you've seen with some of the capacity that's got an incentive to get finished just because of the pandemic and getting contractors on-site, you've seen many peers announce their inability either to get contractors or to make sure that everybody is doing the work safely, you've really had to slow down the construction and/or pay more. So I mean, I think you're going to continue to see that. So yes, there will be a next wave of capacity that gets built. But I actually think, in some ways, a macroeconomic pause is typically good from the cycle perspective because what happens is, look, when everything is good, people start announcing and building. When things turn south, everybody is going to pull from the same playbook, which is significant reduction of CapEx. I mean we've certainly done our fair share. The oil majors, each one of the oil majors has announced their fair share. So you're seeing that happen. And what that does -- and Bob, you're no stranger to this. You know you've experienced this as well as I have. That basically creates the next macroeconomic and demand up cycle.

Yes. We only have a couple of minutes, but maybe just real quickly, in polyurethanes and acrylics, what are you guys seeing there in terms of margin pressures and the path forward? And what are you seeing in terms of any market response in those segments, given the tough conditions out there at the moment?

Yes. I think -- look, I would say, if you look at monomeric MDI, which has the additional distillation step, and that generally has been commanding a premium over PMDI, I would say all polyurethane chemistry really is exposed in a significant way, certainly, from our portfolio, to the more consumer durables, automotive, furniture and bedding, appliances. And this has really been hit the hardest from a Dow perspective on demand related to the pandemic. As the economy starts to improve, I mean, we're -- I'm sitting here in Michigan. The automotive companies, the big 3 have started a return to work as of Monday. And then the target is starting next week, they'll start to ramp production again. So we should start to see as the quarter progresses and then certainly into the back half of the year, we'll start to see some demand pull. But certainly, isocyanates are at trough or maybe even below normal or typical trough margins. So there's not much lower they can possibly go. You're at the cash break-even point. On acrylics, it's kind of a tale of 2 worlds. You've got a DIY segment, which actually through the pandemic as long as countries were not limiting the sales because of the essential designation, we actually saw good DIY demand in those places where they were not deemed essential. Obviously, you couldn't buy the paint. And then in the infrastructure segment, that you've seen in the contractor professional segment where work was not allowed, you've seen that drop off. And my guess is as we reopen, we'll start to see that improve as well.

Terrific. Unfortunately, we're out of time there, but really appreciate the help, Howard. And everybody, have a great day.

All right. Thanks, Bob. Thanks, Dylan. Take care.