Dow Inc. (DOW) Earnings Call Transcript & Summary

Hi, good morning. I am joined here by Jim Fitterling, CEO of Dow Chemical. We will be allowing him to make some comments today, and then we'll move into Q&A. And I just want to remind everyone that we use a platform called Pigeonhole, where you can submit your own questions and then vote on questions to make it more interactive. As a friendly reminder, this event is open to the public. Please refer to the cautionary and forward-looking statements and the materials Dow will post. And with that, I will turn it over to Jim.

Good morning, Jean Ann. We appreciate the opportunity to be with you today. And before we jump into the discussion, let me begin with a brief update on the quarter. In our first quarter earnings call, we outlined our expectation for continued economic recovery and demand strength across many of the end markets that we serve, including packaging, electronics, mobility, architectural coatings and consumer durables, and industry trends have been supportive. In April, U.S. vehicle sales reached their highest level since July 2005. Housing starts continue to be strong and were 60% higher than a year ago, still tracking at their highest level in over a decade. U.S. manufacturing PMI indicated overall economic expansion for the 11th consecutive month. And while recovery has begun in many sectors, most are far from reaching pre-pandemic levels. There continues to be a significant opportunity for additional upside, most notably in the service, travel and industrial sectors. And as their recovery accelerates, oil demand will take another leg up to at least pre-pandemic levels. A release of COVID lockdowns in the coming months will be a catalyst to unleash service sector spend. And while travel recovery is beginning to improve, total domestic travel spend in March was still 30% below March 2019 levels according to the U.S. Travel Association. Business travel and international travel will begin to return, and that will provide yet another catalyst for demand. Despite significant improvement from the pandemic lows, the U.S. industrial production index and industrial capacity utilization both remain below pre-pandemic levels. As these sectors continue to rally in the coming months, we anticipate additional sustainable upside in the global economy. All in all, strong demand, low inventories and elevated raw material costs continue to support margin momentum across our value chains, and we're still projecting top and bottom line growth sequentially in all operating segments in the second quarter. In fact, today, we see additional EBITDA upside of approximately $400 million to $500 million versus the current First Call consensus for the second quarter. Looking into the second half of the year, we continue to see demand strength coupled with constrained inventory levels as the industry manages the backlog of customer orders and supply pressures from the impact of Winter Storm Uri. Despite U.S. polyethylene industry supply increasing significantly since 2017 to support growth in the growing export market, the latest ACC report shows the 2021 year-to-date industry average days demand of inventory remains below the 2017 average. Currently, both ethylene and polyethylene margins have expanded and robust packaging demand strengthened by positive outlooks in retail and e-commerce end markets, combined with unplanned industry outages, continues to support pricing strength despite some less bullish consultant views. The recent oil price increase driven by continued global reopening incentivizes more drilling and provides more associated gas, further supporting the integrated margins. We expect polyethylene margins to remain strong given it's 1.3 to 1.5x GDP demand growth that is projected to outpace supply additions in the near term after accounting for typical project delays and cancellations. Across the board, economic indicators remain positive, pointing to continued global economic growth, strong supply-demand fundamentals and robust chain margins in our key end markets. Driven in part by government stimulus, globally, consumers have accumulated more than $5 trillion in savings. And U.S. retail sales remain elevated, up more than 50% over April a year ago, with rapidly improved consumer sentiment and consumption and a sharp increase in spending is expected in the coming months. Business investment is also up, with CapEx spending of the S&P 500 expected to rise 7% this year. And IMF is projecting the strongest global GDP growth in 4 decades at 6%. Against this positive backdrop, Dow is well positioned to continue creating value for our owners and stakeholders by focusing our resources and investing in assets and capabilities to address faster-growing markets with differentiated and sustainable solutions. We were early in the cycle to bring up more than 3 billion pounds of polyethylene and 4 billion pounds of ethylene, which allowed us to maintain our leading market position and continue satisfying robust packaging demand with low capital intensity expansions in the near term. Next up is more than $1.5 billion in near-term earnings catalysts that will accelerate this value creation. During our earnings call in April, we outlined our additional incremental expansions in key value chains that are expected to generate approximately $1 billion of accretive earnings. These lower-risk, higher-return and faster payback CapEx projects include our Canada and Thailand expansions, debottlenecking projects in all 3 operating segments as well as incremental investments across the U.S. Gulf Coast, Europe and China. Many of these projects convert captive merchant monomer and intermediate products into higher-margin formulated solutions. Our investments in digitalization will also accelerate growth and expand our competitive advantage, providing a benefit of greater than $300 million accretive annual EBITDA. And our previously announced restructuring initiatives will deliver additional run rate savings of approximately $300 million. The completion of Sadara's debt reprofiling and improved cost position also enables increased equity earnings potential for Dow and enhanced financial flexibility, including a $350 million cash tailwind in 2021 year-over-year. And we continue to enhance our competitiveness by reducing our carbon footprint, developing circular solutions and delivering value creation with our recent best-owner mindset actions. Our key to deliver further earnings upside is Dow's differentiated portfolio that enables us to capture demand growth and higher margins across the broad set of end markets, value chains and geographies. For example, our higher-margin functional polymers and polyurethane systems businesses serve high-growth downstream markets such as mobility, infrastructure, construction and durable goods. We have an expanded portfolio of sustainable surfactants plus new investment in additional alkoxylation capacity targeting fast-growing pharma and crop defense sectors. And while only 1/3 of our Consumer Solutions business is tied to upstream merchant siloxanes where near-term supply and demand dynamics are constructive, 2/3 of our siloxanes are captive to downstream silicones where our debottleneck investments are unlocking additional capacity, enabling us to capture higher margin growth in high-end personal care, commercial building, electronics and mobility end markets. Dow's innovative solutions also address some critical megatrends. In the mobility sector, electric vehicles use more Dow content than internal combustion engines, approximately 50% more elastomers, acrylics and polyurethanes and 3 to 4x more silicones. Our high-value adhesives and packaging solutions support the rapidly growing e-commerce sector, and Dow is widely recognized in our industry as an innovation leader. We were recently recognized as the first company to receive 5 Gold Edison Awards in a single year for our products and applications such as electronics, 5G, foldable smartphone and tablet displays, barrier coatings and battery materials for electric vehicles. And we've won more Edison Gold awards cumulatively over the past decade than any other company. Across our portfolio, we provide more sustainable offerings to our customers and enable conversion to renewable energy such as lower carbon energy solutions in gas treating, carbon capture and concentrated solar power, a full suite of elastomers for longer life and higher efficiency protective films for photovoltaic solar applications, building and infrastructure offerings that enable reduced energy consumption and increase the viability of renewable energy options. And through value chain collaboration, we enabled the transition to increase post-consumer recycled content in our products as well as the design of fully recyclable packaging. Our partnerships with companies like Fuenix, Mura Technology and Lucro Plastecycle are just a few recent examples that highlight the growing demand for these circular solutions. Supporting our downstream portfolio, our extensive geographic reach, along with our advantaged feedstock positions around the world, coupled with our industry-leading feedstock flexibility enables structurally lower costs and a relative competitive advantage versus our peers. Finally, the financial discipline and best-owner mindset actions we have taken since spin have established a strong foundation for Dow. Our annual benchmarking highlighted that over the past 2 years, we achieved top quartile cost structure and cash conversion, best-in-class net debt reduction and a top quartile dividend yield. Moving forward, we will continue to apply a disciplined and balanced approach to capital deployment. We'll keep CapEx within depreciation and amortization and continue to prioritize downstream higher margin, faster payback growth investments with upstream investments to expand Dow's leading ESG profile while reducing costs. Our actions this year to deleverage gross debt by approximately $1 billion and reduce pension obligation by more than $2 billion are supporting our progress toward our economic cycle target of 2.5 to 3x on a ratings agency basis of debt-to-EBITDA. And we will continue to return approximately 65% of net income back to shareholders, with approximately 45% primarily from our industry-leading dividend and the remainder from share buybacks. Altogether, considering Dow's near-term earnings catalyst, differentiated portfolio, financial discipline, competitive cost structure and our balanced approach to capital allocation, Dow is uniquely advantaged to continue delivering value for our owners for the foreseeable future. And with that, Jean, I'll hand it back over to you to open up the question-and-answer session.

Great. Thank you, Jim. So I am Jean Ann Salisbury. I am the natural gas and midstream analyst at Bernstein. So I think as a result, many of my prepared questions will be generalist in nature. I think that's okay because it's a generalist conference. [Operator Instructions] I see we've already gotten a few. Great. So if I could just start on a few about the polyethylene cycle. So first question, kind of coming from my world a little bit, U.S. E&Ps are maintaining capital discipline and crude production has been flat since the downturn. Many believe that this may limit ethane and propane production going forward. Do you see a risk that your feedstock costs could move up to naphtha parity if this continues?

I don't think that's a real risk, Jean Ann. There are a lot of drilled but uncompleted wells in the U.S. And as the demand comes back, which I think the next leg up on demand is really going to be driven by jet fuel and the return to travel, that will quickly cover the supply needed. And of course, there will be associated gas with that. And as you see right now, frac spreads on ethane are about $1 and that's really a good margin in that part of the business, and that's not surprising. I think we see ethane between $0.22 and $0.28 in the near term.

Great. Can you share your view on the current global supply-demand picture for polyethylene here?

Yes. The demand, I think, is the real story. Demand has been strong. And in fact, you have to remember that demand volumes really stayed with us right through COVID. And I think that speaks to something that we've seen over several economic cycles back in 2001 and '02, which was a big trough 2007, '08, '09 period. We saw that polyethylene held up the best of anything in our portfolio, and I think that surprises people on the demand side. And then on the supply side, really projects have been delayed and have not come on at the pace that everybody thought. So we've absorbed all this capacity that's come on since 2017, and we're really not completely out of the pandemic around the world yet. I'd say the other thing is that the United States inventories are very, very low. And one of the things that you see right now is that the amount being export is even off. So the inventories are low with exports being down. And as exports continue to increase, that will tighten things up even more.

Makes sense. And then some specific questions about supply and demand. There have been some COVID-boosted plastic areas such as food packaging, PPE, et cetera. Do you see this staying when the pandemic is over? Or do you think you'll drop that or maybe gain some other places?

I think it will stay. There could be some trade-off in business. I mean when you think about travel and institutional use of packaging like big institutional food process, reopening of hotels, these kind of things, we haven't seen that demand pull through. We saw everything shift over to more consumer-oriented sales. So we'll probably see institutional sales come back, and maybe you'll see a little bit of consumer trend down. But I think as travel begins, you're also going to be -- see a step-up in packaging related to people traveling around, and that's been low. The other thing that I think will continue to help packaging is the amount of post-consumer recycle we're putting into products. There's a strong demand from users for that. And secondarily, just safety and security of the food supply and the medical needs that we're going to have going forward.

Yes. That makes sense. And then just building on that, are there areas that COVID plastics demand fell off over the past year, such as like personal care or industrial that might rebound in the second half?

The biggest area where they fell off was in functional polymers. Functional polymers are going into things like products for tires and automobiles, which is starting to come back; membranes for roofing, for like large commercial buildings or for home buildings; membranes for applications like in water treatment ponds and things like this. That's all slowed down. We're starting to see the construction part of that come back now. I think one of the things that's happening in construction markets is there's been a very hot property market for available homes and very low inventory, so it's really driven home pricing up dramatically. And now as the -- as kind of the spike in wood prices and construction materials prices comes off of that very peak values that you saw, some people who want to have a home are thinking about construction and you're seeing a big increase in single-family home starts. So I think you're going to see another wave of construction in the back half of the year as people start building new homes.

That's interesting. Do the ethylene capacity additions coming out from Asia worry you?

No. Asia is the fastest-growing market for polyethylene demand. And so I think they will still be an import region even without those capacity additions. And obviously, it just takes time to bring on those new big assets. Not everybody can bring them on and get them up to capacity like we were able to during the shale gas wave that came through here. So I'm not super concerned about that. I think we're going to continue to see strong demand for the downstream derivatives. And there will be times where things get tight from time to time. The high-cost producers, obviously, are going to be the naphtha-based producers. And I think oil is continuing to be constructive. We're at oil consumption now of about 95 million barrels. Pre-pandemic, we were just over 100 million. If you add back aviation fuel and travel, you probably add about 5 million barrels a day back to that. You're within striking distance of pre-pandemic levels. And then I think you've still got pent-up consumer savings and you've got pent-up industrial demand growth.

So I've gotten a few on Pigeonhole. Where do you think plastics chain operating rates are?

Plastics derivative capacity operating rates are well into the 90s right now. We haven't seen these kind of levels since the first quarter of '19, and I'd say back into the peak, which was really around the 2017 time frame. So I think they're going to stay there. Typically, there's more derivative capacity than ethylene capacity. But in this case, with plastics, you've really got more ethylene capacity right now than polyethylene. And so things are going to continue to be tight in that part.

And then another one from Pigeonhole. Can you give any color into pricing for the second half of 2021 after a strong first quarter?

Yes. Hard to read. May was up $0.05 in North America. I think we see relatively stable pricing in Asia right now. May was a holiday month in China. You had the first week of May out for holidays, so that had some impact. And I think the strong pricing here has really reduced the amount of exports out of the U.S. So I imagine some will start to close, both Asia will move up and probably Europe will move up and the U.S. will move down a little bit. But I think they'll start to gravitate into a more normal phase. One of the biggest challenges right now within polyethylene is depending on the grades of product that you make. There's some tightness in additives and raw materials like comonomers that go into that, and so that also has a big impact. So you'll see certain products that are really tight within that overall broad category polyethylene.

Given the strong demand in packaging and consumer durables in 2020, how is the company addressing the risk of any potential pullbacks today if we were to start to see a slowdown?

Well, we focus mainly on getting our cost structure right. So we did a lot of restructuring. We've always been paring back uncompetitive assets. You see the work that we've done on our debt profile to get our balance sheet in order. I think if we continue at these rates, we'll be well within our net debt-to-EBITDA targets, maybe even below our target range by the end of the year. That's a very positive sign. We weathered a really tough situation in second quarter last year and we're able to support the dividend, and we've made cost improvements since then to really lower our breakeven costs. So I feel good about our flexibility. We have good visibility to the market demand on a weekly basis. We have a good feel for the order book. And as you can see, the team has been really good at making quick actions and doing the things we need to do to stay competitive.

Great. So switching gears a bit, most people think of Dow and think of polyethylene. What other segments do you think should get more attention from investors? And where do you see as having the most opportunity for Dow outside of polyethylene?

We're the world leader in silicones production. Silicones are a very strong and sustainable product line that goes into a lot of high-value applications, more ubiquitous than polyethylene even. They're in more things that you touch every day than plastics are, and they provide a really strong functionality for everything. Everything from building and construction to consumer products that you use every day, laundry detergents, et cetera. So I think that's a strong growth area that's growing faster than plastics, and it's a lot of formulated solutions. Our Industrial Solutions business, we're a leader in alkoxylation technologies and they've made some huge breakthroughs in sustainable solvents, low VOC solvents and also sustainable chemistry for applications like the textile industry. You see the recent launch with Ralph Lauren of a product called ECOFAST Pure, some big partnerships that we've got in the pharma and home care space. So I think you're going to see continued growth there. We just brought up a new plant in January of this year. We've got another project under construction right now. So our ability to execute and build world-class assets during COVID is something that I'm very proud of the team for. Polyurethanes and the growth in our systems business downstream, whether it's in construction materials or whether it's in insulation materials or whether it's in automotive applications, that business continues to have double-digit growth in its high value-add. And I mentioned before, in electric vehicles, we're seeing 40% to 50% more use of our traditional materials versus internal combustion engine vehicles and 4 to 5x more use in silicones. And that's because they appear in more parts of the automobile. There are more electronics on an EV, noise vibration and harshness is a different sensitivity than it is with an internal combustion engine. You've got a lot more communications, you've got heat transfer issues you've got to deal with batteries and you've also got to protect all of that from the elements, and silicones does the absolute best job of all of that. So high-growth area for us in that space.

This is a real generalist question follow-on on the electric vehicle type of silicone to plastics, but are they more complex to produce and you would have fewer competitors that would be able to kind of be in that market?

It's a different value chain, obviously, because you've got -- the powertrain in an EV is really the battery and the delivery system to the axles. And it's different than it is with an internal combustion engine. So you'll see GM, for example, making the coinvestment in batteries because powertrain is critical to making that car move. So I think you're seeing that shape out, whether it's in China or whether that's here. But the tier OEMs, they're dealing with the body of the car, the internals of the car, et cetera. They're the same. You'll see different battery producers. You'll see maybe some different technology into braking systems and other things, but you'll see more electronics, and that will start to look a little bit different than what the traditional car looks like.

Makes sense. Cool. Moving on to some general Dow business questions. Now that Sadara refinancing is done, what are the next steps on the project?

Well, Sadara is doing well. There -- it's running well. And obviously, it's also benefiting from improvements in the economy and the Asian growth. And so that's the reason we built it in the first place. In addition to just the refinancing, we improved the cost position of Sadara with bringing some additional feedstocks. And so we've got an additional 10-year supply for more ethane allocation in there and 5 years extension to the liquid feedstocks that come in as well. So it's really improved Sadara's feedstock flexibility by about 30%, 35%, and it's going to continue to reduce its breakeven cost position, and it's benefiting from higher prices in the market as well.

Okay. Where do you hear from investors that they want you to invest your marginal dollar? Projects, debt, dividend, et cetera? Or would you say that there's no consistent message and every investor wants something different? And what are your priorities for the marginal dollar, I guess, outside of necessarily what investors want?