Dow Inc. (DOW) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Nan Li, the U.S. chemicals analyst at Bernstein. Thank you so much for being here today. We're thrilled to have Jim Fitterling, Chairman and CEO of Dow with us for today. And in the audience today, we also have Pankaj Gupta, the Head of IR from Dow. Jim was named CEO of Dow in 2018. Before that, Jim served Vice President and Chief Operating Officer. During his 39 years, at Dow, Jim has held leadership positions in many of the company's businesses and also in copper development and business operations. Jim has played a key role in transforming Dow from a lower-margin commodity businesses into one that is more focused on higher-growth consumer demand-driven markets that also value innovation. In addition, he has also served as a business lead in launching Dow's next-generation sustainability goals. So before we invite Jim to the stage, I'd like to cover a very quick housekeeping item. Throughout the fireside chat and feel free to submit your questions in the Pigeonhole app and also you can load up questions over there as well. So with that, please join me in welcoming Jim to the stage. Jim will have some opening remarks. And after that, we'll sit down further conversation.

And thank you, and good afternoon, everyone. Beginning here on Slide 2. Since we spun out from DowDuPont in 2019, we've created a more streamlined portfolio that serves some attractive market verticals growing faster than GDP. Our competitive advantages feature global scale, best-in-class feedstock and derivative flexibility and a strategically located footprint to supply demand in all major geographic areas. We have consistently operated the business with the best owner mindset as well as a disciplined and balanced approach to capital allocation. As a result of these actions at the end of 2022, we raised our underlying earnings above pre-pandemic levels, nearly tripled our 3-year cumulative free cash flow and have grown cash flow from operations every year since spin. We reduced our net debt and pension liabilities by more than $10 billion and have delivered around 80% of net income back to our shareholders since spin, well above our target of 65% across the economic cycle. All together, our actions have reduced our cash commitments by approximately $1 billion, driven by significantly lower debt and pension liabilities, no joint venture cash contributions and reduced share count. As a result, we've improved the company's ability to execute on our financial and capital allocation priorities versus prior cycles and across a variety of macroeconomic environments. In addition, we remain committed to our disciplined and balanced approach to capital allocation across the economic cycle. This includes keeping average CapEx within D&A and targeting greater than 13% return on invested capital. We will return 65% of net income to shareholders with our attractive dividend and share buybacks. All this, we have executed while maintaining our ratings agency adjusted debt to EBITDA of 2 to 2.5x. Our strong performance relative to peers is clear in our most recent annual benchmarking on Slide 3. A few key highlights. 3-year average EBITDA margins and return on invested capital above the peer median, best-in-class free cash flow yield on a 3-year average, which is nearly 2x the peer average and 3x the sector and market averages, best-in-class net debt reduction, resulting in improved credit ratings and lower interest costs and above peer median shareholder remuneration with a dividend yield above the peer sector and market averages. Consistent, disciplined and balanced capital allocation, coupled with execution of our long-term strategy to decarbonize and grow the business, continue to make Dow a compelling investment opportunity. Turning to Slide 4. We continue to see positive underlying demand trends and above GDP growth across our attractive market verticals of packaging, infrastructure, consumer and mobility. Our diverse global portfolio is well positioned to capture this demand, and we are executing our targeted suite of higher return, lower risk investments to deliver approximately $2 billion in earnings by mid-decade. These include incremental investments in Functional Polymers in the P&SP segment as well as targeted high-value investments in alkoxylates, downstream silicones, polyurethane systems and coatings. And I'm pleased to report that our FCDh unit in Plaquemine, Louisiana has started up and is now operational. The unit is feeding full capacity to the LA 3 separation system, and it's ramping up rates now and the team is working hard to learn as much as they can about yields and improve efficiency. Efforts like these will continue to provide cash flow generation building on our track record of cash flow growth every year since spin. In addition to operating earnings, we have up to $1 billion of unique to Dow cash levers. These include resolution of our current Nova litigation, structural working capital improvements and additional best owner infrastructure-related actions. Advancing these near-term growth investments positions Dow well to capture demand and raise our underlying earnings profile as market conditions begin to improve. On Slide 5, consumer and brand owner demand for more sustainable and circular solutions also continue to grow. It represents a significant opportunity for Dow as we plan to lead the transition to a more sustainable future. Our decarbonized and growth strategy positions us to drive long-term shareholder value creation. This includes phased-in investments to decarbonize our asset footprint and enhance our earnings profile as well as efforts to enable a more circular economy. For example, our Alberta path to Zero project will be the world's first net zero CO2 emissions, ethylene and derivatives complex. We recently announced Fluor as our partner for front-end engineering and design services; and Linde as our industrial gas partner to supply nitrogen and clean hydrogen for the site. The project remains on track to reach final investment decision this year, and we'll deliver another $1 billion in underlying earnings growth by 2030. We recently announced our Seadrift Texas manufacturing site was selected for our advanced nuclear project with X-energy. This will be the first grid scale advanced nuclear energy facility for an industrial site in North America. It represents an important step towards sustainable reliable and affordable clean energy in the United States. Additionally, we're taking a capital-efficient approach to scale and commercialize production for both advanced and mechanical recycling for plastics as well as for polyurethanes. This includes strategic partnerships with Mura Technology and Valoregen, among others. These actions will enable us to deliver our 2030 transformative waste target to commercialize 3 million metric tons per year of circular and renewable solutions. Taking a closer look at the near-term dynamics on Slide 6. While we see pockets of strength, we expect macro conditions to remain challenging in the near term. For example, European PMI contracted for the tenth consecutive month in April to [45.8%], the lowest level in almost 3 years. However, in the U.S., PMI has returned -- has remained relatively resilient and returned to expansionary levels in April. That said, U.S. consumer sentiment declined 7% month-over-month in May amid some renewed concerns about economic trajectory. In addition, retail sales growth remains tepid, increasing by only 0.4% month-over-month in April with furniture and electronics sales both declining. In China, the economic recovery continues, but it's very uneven. Month-over-month retail sales grew for the fourth straight month in April, reflecting significant increases in clothing, cosmetics, automotive and furniture end markets. However, there was a lower-than-expected demand for home appliances and building materials. In addition, industrial production continued to rise in April, however, at levels well below expectations and imports also decreased by almost 8% year-over-year. Our earnings outlook remains in line with the modeling inputs that we shared on our first quarter earnings call, primarily due to lower feedstock costs and the impact of our in-flight cost savings actions. Due to the slower macroeconomic activity and lower pricing levels, we now expect the second quarter revenue will be in the range of $11 billion to $11.5 billion. Our diverse portfolio enables us to capture volume in sectors where demand is more resilient, including energy, agriculture, personal care and household applications. We're also prioritizing returns -- prioritizing resources toward high-value products, including functional polymers, performance silicones and specialty solvents, where demand remains more resilient. Our advantaged cost position and industry-leading feedstock flexibility enables us to benefit from lower feedstock costs and healthy oil to gas spreads, and we're making progress on our previously announced actions to deliver $1 billion in cost savings in 2023, where we -- we expect to achieve 35% of that savings first half of the year and the remaining 65% in the second half of this year. Closing on Slide 7. In the near term, Dow will continue to respond quickly as macro conditions change, we expect the benefit of our operational and cost savings actions to build over the course of the year, our disciplined and balanced approach to capital allocation since spin allows us to fully execute on our financial priorities versus prior cycles, and we will maintain this disciplined and balanced approach as we advance our long-term decarbonize and growth strategy. Our growth investments are on track to raise our underlying earnings by an additional $3 billion by 2030. At the same time, we will reduce Scope 1 and 2 CO2 emissions by 30% compared to our 2005 levels and will further advance us towards achieving our net zero CO2 emissions target by 2050. With that, thank you, Nan, and I'll turn it over to you for some Q&A.

Thank you, Jim. Right. Just as a reminder to the audience at any given time, please feel free to see your questions in the Pigeonhole app. And Jim, maybe I'll just continue the topic on the macro part and cycle. I think that's something that is in people's mind right now. When it comes to the chemicals, it's impacted by a lot of different cycles. I think macro economy will impact the volume, the demand side. And also, we have the capacity expansion cycle that impacts the supply side, and we also have the oil and gas price that impacts the margin. So where do you think we are right now in the cycle?

Yes. So we're kind of in an unusual spot. I would say on -- when you think about the demand for durable goods, things are obviously in a down cycle right now, coming off of a very strong peak during post pandemic or middle of the pandemic people at home spending a lot of money on their homes, buying a lot of consumer electronics, appliances, and we all remember the shortages and how hard it was to get things at that time. Now we've shifted to more of a services economy. And what I would say is a fast-moving consumer goods kind of daily essentials economy. And what that has done is taken the steam out of the housing sector and also put -- inflation has put a lot of pressure on households for high-ticket item purchases. And so we see that in automotive. Mobility obviously is holding up well in electric vehicles where there's incentives to make that move towards the new technology. But internal combustion engine vehicles is still a little bit slow compared to what we would normally see. I'd say on oil and gas. I mean, oil has been -- oil and gas spreads, as I mentioned, are relatively positive for us. Today, they're in the neighborhood of about $66 a barrel equivalent, mainly because oil remains high, even in light of what I just talked about. There's not a lot of new supply coming in to the oil markets. I would say, personally, I think the fact that we're still in the spring, we're not into the heavy travel season yet. That usually tightens up oil price a little bit. And Russian oil, even though there are sanctions out there, Russian oil is still getting to the market. It's still getting to other countries being refined and making its way back to Europe. So Russian oil hasn't really left the market. But when you think about the next increment of supply, there's not much there. There hasn't been much investment going into oil. And so I think that's why you see the market believing that oil is posed to move up from here because it won't take much demand increase, demand signal to tighten up that remaining capacity. When you think about the markets and the way they work, if you're thinking about economic weakness, the first thing that comes out of the oil market is the short interest money. If they think things are potentially -- demand is going to be slow and things are moving down, it comes out first. And then we see where the market ends up balancing. Natural gas, on the other hand, production has been relatively strong. And so you see that here in the U.S. -- with natural gas prices down, you see the availability of LNG around the world. Europe's costs on LNG have come down dramatically. They're probably instantaneously around $13 a million Btu. I think they'll probably range if I look at electricity costs, electricity cost of $25 to $40 -- EUR 40 a megawatt hour gives you gas costs at somewhere between $8 to $10 a million Btu. So I think the near-term view on Europe energy costs as they've come down quite a bit from where they were in the first quarter of 2022. Having said that, I think the big concern on demand is housing market. If you're or looking at the housing market in China or the U.S., year-over-year comps are down considerably. We know construction in China has been off as much as 40%. We've seen similar data here in single-family homes. I'd say multi-unit residential has been a little bit more resilient and there's the concerns now about commercial property overhang in the market. What that means for housing is that the inventories are low of available homes, so the prices are high. And it doesn't seem -- I mean, it does seem that the cost to buy a house or have a mortgage would have gone up. But I think the spread between home owning and rents is a lot higher than people think, right? Rents are extremely high. yet the cost of owning is much, much higher than rents today, and both of those numbers have a big impact on the homeowners. So if you've got a mortgage that's going up because of interest rates or if you're renting and you got to pay those higher rents, you have less disposable income available. And today, it seems to be going towards day-to-day essentials and travel, if you think about where people are spending. We know electronics like PC sales are off 40%, you would probably argue that people bought a lot of that during the pandemic. Televisions are off. Anything that has memory device chips and it is off quite a bit. And most of the chip activity is in these more elaborate platform chips or things related to the AI sector today. And we see that in the demand for the goods that go into those equipment. Meanwhile, EVs are up in almost every geography. Battery production to support that is up, lots of new technology to go in there. And within our business, Packaging and Specialty Plastics is as it usually does through a cycle is holding up relatively well on volume and has really good cost positions, and it's a more durable goods part of the sector like in polyurethanes that is feeling more pressure. In II&I, Industrial Solutions is doing well. A lot of fast-moving consumer goods products energy, pharma, agricultural segments that they support. In Consumer Solutions, obviously, high end businesses like cosmetics, household items, everyday household items are good. We'll see a little pressure on volume and silicones for like big, what I would call, big urban high-rise projects where we saw a lot of the glass glazing that goes into those structures. Still good for this year. But as you look at the pipeline, the pipeline going forward may slow down a bit. And then when you get into architectural coatings, we sell into both do-it-yourself and the contractor business. I would say the contractor business is holding up a little bit better, maybe off single digits year-over-year or do it yourself is off maybe low double digits, around 10% or so year-over-year. So a long answer, but try to cover the whole range. It feels like -- and we've seen the bottom on ethylene margins, and we know where the cost positions are and where the high-cost and low-cost production is. And it feels like we've seen that, and we're starting to turn and see a little bit of margin improvements. I think we're at the bottom in polyurethanes, but we haven't seen the turn yet. And that turn will come when we start to see housing and durable goods trade-off.

Looks like you are more positive on the outlook from the macro part.

It's heavy lifting, I would say. I mean the reason we announced $1 billion in structural cost reduction as we looked at the year and, it was a year where if we wanted to deliver, we were going to have to have some additional help. We couldn't just count on tailwinds from the market. We had too many segments that had headwinds in front of them, and we have tough year-over-year comps, especially through the first half of the year, which was peak territory last year. And so, we said we've got to have some additional help as the year builds, and that's why we announced the $1 billion. But the teams are working hard. It does -- in Packaging & Specialty Plastics, they're working on mix and they're working on running the lowest cost assets as hard as they can and balancing the rest of the fleet. And then in polyurethanes business, they're working hard on understanding operating rates and how they can manage in a lower demand environment and making the good decisions, I think, to make the right trade-offs.

So with all the headwinds that you mentioned from the macro -- macroeconomic side, so just kind of playing the devil's advocate a little bit. So what if the economy will go south from here? So basically, what if we really go into even worse recession. So what will that do to Dow's earnings? And also out of other business, I think you touched on that a little bit. So which businesses are more resilient to the downturn and also more or -- like less cyclical?

Sure. Well, the more resilient businesses have always been Packaging & Speciality Plastics and the Consumer Solutions business. I would add within II&I, I would add Industrial Solutions to that compared to polyurethanes. Volume-wise, appliances, automotive, housing, all hit polyurethanes pretty hard. So as things slow down there, it's a little bit harder for them to rebound. I think -- if you think about it, from a recessionary standpoint, I mean, I can make the argument. We've been in this business for 125 years. And when you look through the cycles, typically, our industry leads into a recession. And if you look at where the market started to turn down last year, it was last July onward almost a steady monthly decay in the demand that got us into the first half of this year, and that was what was behind the decision to take action. And then our industry typically leads out of the cycle as well. So when demand comes back and inventories are low in the chain, there's a strong pull on that demand, and we feel it right away. It feels like we've gone through the downside, and we've stabilized on volumes. And now the question is, when will we start to see the signal improve and see the pull happen. Inflation is the wild card. Obviously, wage inflation is there and I think is baked in as everybody expected it would be. But I think the other thing that people have to factor in is there's going to be a shakeout of some sort that happens. One of the reasons we focused hard on our balance sheet during the pandemic is we wanted to come out of the pandemic with the strongest balance sheet in the sector. And I think we did that. We -- as I mentioned, we reduced our cash cost needs by $1 billion. We really got our net debt to -- we ratcheted down our net debt-to-EBITDA targets to that 2 to 2.5x range. So that gives us good stability. We moved our long-term debt maturity profile out till beyond 2027. So we have nothing really do until then. And our cost -- our borrowing is really bond-denominated fixed costs that are out there, and it was all done at below 5% rates, really, our average is -- blended average is just a little bit above 4%. So we're in very, very good financial shape. We continue to focus hard on cash flow and make sure that we're in a good spot there. That's what keeps the dividend safe and the dividend protected through this. And we'll continue to work on every lever to make sure that we keep that strength that we work so hard to get and are ready for the turn up in the economy, which will come I'm sure.

Glad to hear that. And also for the turn up from the economy, especially on the more durable side, consumer durables and also auto and housing. So you've been with Dow for like almost 4 decades. And during your experience, when those things happen, do you see a pent-up demand over there. So that means there is no demand that got lost. So all of the demand will come back later, stronger or sometimes the demand actually got lost, do you want to say.

It will. I mean things have to happen -- think about housing for a minute. Interest rates have gone up, and we still don't have 100% certainty that interest rates have reached their peak and are going to flatten out. So I think in order for people to want to step back into the housing market, whether you want to take the risk of building something speculative or whether you want to take the chance that you're going to go back into the market and buy. One of the first things you're going to look for is have rates reach their peak and flattened and maybe there's an improvement on the other side. So we haven't seen that yet. So it's a little bit early to tell. Urbanization has kept -- urbanization has kept the move on projects and big construction, what I would call mixed-use construction, we're already working on both, business as well as residential units. That business has been relatively good. but there's an overhang in office space in the big cities. And I think for that reason, you don't see much happening in commercial there. And of course, in this kind of environment, the lending tightens up right away. Those that need to get access -- that have access to money don't need it and those that want it don't have access to it. And so we're kind of managing through that. So I think we've got to see some stability on those rates first. and then we'll see if things can start to build from there.

Okay. And how about from the consumer durable and also the auto side?

Well, there's -- I think the restocking is out on consumer durables and autos. We see that sign the inventories through the chain are manageable. I would say there might be some sectors that have a little bit more finished goods, but I don't see it in -- chemical sector has been pretty well managed. I'd say, 2 levels downstream have been pretty good. So I feel like whenever we see the demand pull, we're going to see a step up right away. And I would say China and the U.S. markets are both looking kind of similar right now. I'd say the U.S. may be holding up a little bit better from an industrial standpoint but both consumer markets are looking pretty resilient.

Perfect. And also just kind of from a supply side. And can you also comment a little bit from a capacity expansion cycles along some of the bigger value chains that Dow participates in, kind of where in the cycle?

Yes. Most of the new capacity for the last decade in our industry has come on in China. And so we always watch China carefully to see what the timing is for new investments. If you look at polyurethanes, if you looked at siloxanes, which are the upstream monomers to make the silicone products, there's been big investments in both of those in China. So PO capacity propylene oxide capacity, siloxanes capacity has come on. But the market in siloxanes and silicones will pick that up and eat that up. And I would say on plastics, the same. There's been new capacity come on. We've seen some here in North America, and we have some more that comes on this year. But the growth in packaging, plastics has been so strong that it doesn't take long to eat that up. So a couple of world-scale crackers and derivative capacity along with that can be eaten up within a year pretty easily. When we look at 5-year outlook by China, U.S. capacity to rest of the world, things are pretty balanced. You can get some anomalies from quarter-to-quarter and year-to-year, but things are pretty balanced right now.

Okay. And also, I know that Dow has a pretty balanced sales when it comes to different -- contribution from different regions. And also maybe a follow-up question on China. So with what's happening in China for the past several years with all the economy slowing down, rising labor costs and also the geopolitical tension and also the more dynamic U.S.-China relationship. So with all of this happening, but China still accounts for about 1/3 to half of the chemical demand, depending on which value chain you're looking at, right? So with all of this happening at the same time? And does Dow have a new China strategy? Or how do you see this coming?

Our strategy has been pretty consistent. When we've looked at having a footprint in China for the Chinese market for a long time, really, really since the mid-90s when China opened up. China never had the cost position at the time to be the low-cost export market. I mean, that position was owned by the United States, Canada Middle East. We had some position in Argentina. So where we already had low-cost natural gas, those were advantaged locations. So China for China was always a strategy. And what you saw was a buildup of capacity, but still China being a net importer of chemicals, and that's still the case today. And in some specialized technologies like our functional polymers, which is about 25% of Packaging & Speciality Plastics. That part of the market is still served by imports from outside when it gets to basic commodity needs, China has the capability to do more of that domestically. So that's taken pressure off the rest of the world. So we're not looking, obviously, to make propylene oxide on the U.S. Gulf Coast and export it around the world. In fact, we'll probably reduce our footprint for a product like that on the Gulf Coast and balance it more on North American demand. It's very similar to Europe. I mean Europe has not been a major exporting geography for more than a decade. It's really been focused on Europe for the European market. And with these cost positions and energy, that's the way we're looking at it as well, is continuing to tighten that footprint and look at serving the European market and what policy decisions does Europe make going forward about energy that determine how much industrial capacity will be there because they've got the Middle East on their door, and they've also got China as well looking at them to see if they can take over some of that import position. But we remain focused on China for China, growing with our customers there. We continue to do application development in China with them. We're obviously concerned about tensions that are out there. we'd like to see better dialogue between the countries try to work out some of the differences. But I think we're balanced in our approach, and I think we've got a good long-term view.

Understand. And also, kind of the segue into Europe. So you mentioned Europe has become one of the highest cost regions around the world. I think during some of the earnings calls, you guys also mentioned that you have a plan on Europe. So can you maybe provide an update to us on where we are with regards to Europe plan?

Yes. We've looked hard at our European assets. I would say all of our cracker and plastics derivatives there are profitable and cash positive. So we haven't made any decisions to take anything out there. We've looked at derivatives because we got a good feedstock cost position, we've looked at the derivatives more. And we've got a slate of closures that we will announce through the year. More than half of them have been announced. So we got about the same number more to come. And that's part of that 2,000 head count restructuring and also the charge that we took in the first quarter to take those assets down. And we were looking at how challenged were they on a cost position? Do we think they could ever get to a position where they would be able to operate profitably. And we went through a pretty rigorous analysis of that and decided that now is the right time to make the move. So I still feel good about our cost position on crackers. We're watching energy costs in Germany pretty closely. That would say I would be -- so the area that's most exposed, and we're still trying to work through with the government where energy costs and policies are going to land. Some pressure has been taken off, obviously, because of what's going on in the energy market. But we also know that those things could change going into winter or another escalation of activities in Russia, Ukraine. We have to be eyes-wide-open about that and be prepared to make another move with that [indiscernible]

Okay. So basically, right now, it is still a self-sustaining region, which still generates a lot of cash and then we treat it as kind of stand-alone region and then we wait and see and see how the energy market where some of the policies will [ change ].

Right. We want to make sure we can still service the domestic market. We want to keep an eye toward demand. I think the real next question is, what's going to happen to demand? What kind of pressure is going to be on the industrial economy? How much of the industrial economy that we do business with will stay in Europe, how much might move? How will that affect? What we need today. But from an energy cost position and a monomer cost position, we're in a good shape on our cost position. So I feel good about that.