Dow Inc. (DOW) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Day 2 of the Morgan Stanley 14th Annual Laguna Conference. It's my pleasure today to have with me Jeff Tate, CFO of Dow. Before we dive into things, just a couple of things I need to remind everyone of. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. Jeff has a few prepared remarks to kick things off. And along with those remarks, there are slides that are posted at the Dow website that anybody online is welcome to follow along with. Jeff?

Great. Thank you, [ Mark. ] And good morning, everyone, and thank you for having me today. Before we get into your questions, I'd like to begin with just a few remarks to paint a picture of how the third quarter has evolved. I'll share Dow's views on the external factors and market conditions that have the greatest impact on our business as well as an overview of our self-help actions, continued financial discipline and our near-term priorities. Now I'll start on Slide 2, with the current environment. The macro backdrop remains dynamic and largely unchanged from what we outlined in July at our earnings. Specific to Dow, our strategically advantaged global footprint and local supply chains in every region continue to be differentiators for us. The oil-to-gas spread remains elevated as geopolitical tensions in the Middle East continue, supported by recent material escalation of crude pricing, while gas remains largely unaffected. This reinforces the competitive advantage of Dow's purpose-built asset base and feedstock position that we've developed over decades. And while the tariff landscape has become more complex, Dow's direct exposure remains minimal. That said, continued volatility and uncertainty in the early part of the third quarter have created some headwinds that we're working to offset. Several market developments are working in our favor, which we expect to at least partially offset some of the impacts, but we've got more work to do. More specifically, July polyethylene prices in the Americas settled down $0.10 per pound. This reflected declining feedstock prices and margins in the early part of the month when initial expectations for a durable solution to the Middle East conflict began to surface. In August, however, widespread reporting indicated those expectations were not realistic in the immediate term. In the month, we saw some improvement in the global operating environment along with higher oil prices. This ultimately led to polyethylene prices selling flat month-over-month. So far in September, we are seeing a strengthening order book, including in Asia. Along with the recent sharp escalation in global feedstock costs, this supports our announced global price increases globally, including $0.10 to $0.12 per pound for polyethylene in the Americas. With a rapidly rising cost environment, we are implementing these price increases with urgency. So looking at some of the key markets that Dow serves across our portfolio, consumers remain selective with spending trends favoring essential items. Additionally, the building and construction and automotive markets continue to face challenges amid a cautious monetary policy environment. Shipping through the Strait of Hormuz and other regional water was also remains constrained, tightening global supply further. And low water levels in Europe, including the Rhine, are constraining competitor supply across several products, which is leading to higher market prices across our Industrial Intermediates & Infrastructure segment. So to summarize, the geopolitical and macro backdrops remain volatile and demand signals are mixed. While polyethylene price declines early in the quarter represent a headwind, Dow continues to lead with deliberate actions, and we remain focused on controlling what we can control. Our self-help actions and the breadth of our portfolio are helping to partially offset this impact, and we now expect to deliver EBITDA of $1.5 billion to $1.6 billion for the third quarter. This represents our best estimate based on what we see today, recognizing that a continued volatile environment this month could ultimately influence the outcome. Next, I'll share some examples on Slide 3 that outline the ways in which we are taking decisive actions to improve our financial strength. First and foremost, we continue to enhance Dow's balance sheet and near-term financial performance. To start, our major planned maintenance for the year is now complete at several of our largest assets, which should provide a tailwind in the fourth quarter. In addition, we received the remaining tax withholding related to the NOVA litigation settlement earlier this quarter. We are also actively prioritizing deleveraging with excess cash, and we expect to release more than $500 million of net working capital in the second half of this year. Looking longer term, we have no substantive debt maturities until 2029. And importantly, we continue to deliver our self-help actions, including our recently upsized in-year target for Transform to Outperform. With this, we now expect to deliver $1.3 billion in total benefits from self-help in 2026. Our intentional actions continue to strengthen Dow's credit profile as improved earnings, balanced capital allocation and self-help actions drive higher cash generation and lower leverage. This was evident by a recent rating agency outlook upgrade. Next on Slide 4. I'll unpack some additional details on how Transform to Outperform is delivering value as a significant contributor to our self-help improvements. We expect Transform to Outperform will deliver an upsized benefit of approximately $700 million this year, clearly demonstrating the early value we are capturing. Importantly, we remain confident in the more than $2 billion total opportunity that our transformation will deliver, and we're seeing significant early results from every work stream. A broad range of actions will contribute to the benefits we expect in the second half of this year. And let me highlight just a few examples. We already implemented approximately 70%, 7-0, of the total Dow role reductions, and we expect to implement nearly all of them before the end of this year. This is expected to contribute more than $200 million of EBITDA uplift in the second half. We're also leveraging advanced technology, which has identified more than 50 opportunities to streamline and strengthen our end-to-end processes, leading to improved decision quality, discipline and profitability. Additionally, we have completed our site transformation playbook at 6 of our largest sites, with 3 additional sites started this quarter. In total, this is expected to deliver approximately $50 million in the second half of this year. The actions we're taking include improving production yields, driving maintenance productivity and energy inefficiency and optimizing third-party spending. Our strategic sourcing and contract renegotiation initiatives are also delivering structural cost savings of more than $70 million in the second half of this year. This includes implementation of targeted RFPs across consumables, labor, corporate services and raw material purchasing contract renegotiations. And in our logistics and network optimization initiatives, we're reducing costs while also improving network efficiency and strengthening utilization of our logistics fleet, all of which we expect will deliver more than $30 million in benefit by the end of 2026. On the growth side, we are seeing initial results from accelerated market-focused strategies. Our commercial teams are delivering increased profitability, supported by strong execution and business models that enable us to access markets that Dow has historically deprioritized. We're also evolving to serve fast-growing segments with one Dow approach and sharpening our focus to win even greater share with existing customers in markets we know well. We remain encouraged by these early wins and the value they're generating. These examples give us great confidence in the magnitude of the opportunities and our ability to deliver against them. So closing on Slide 5. Given the external factors I described, we are staying focused on the areas that we can control. Self-help, like our transformation, will continue to underpin how we work, and our sites remain firmly set on the 3 priorities that we outlined in July. We will continue to hold ourselves accountable to deliver on our commitments and demonstrate tangible examples of our progress, all to ensure we're consistently creating value and that is grounded in that principle. First, we will drive focused growth and innovation in the high-value markets where Dow can win and create differentiated value with our customers. We will prioritize targeted innovation, technology and commercial excellence to strengthen our competitive position, deepen customer relationships and accelerate growth where we have the greatest opportunity to lead. Second, we're enhancing our portfolio competitiveness. This means operating with the best owner mindset. We're investing in our businesses and our technologies where we can grow and create value, and where we can't, we will continue to take actions like the noncore divestitures and asset shutdowns we've recently completed. And third, we will continue to hold ourselves accountable for taking a balanced approach to capital allocation. This includes using consistent principles to strengthen our balance sheet, driving a focus on cash flow and ensuring maximum financial flexibility. So the key takeaway is this. Team Dow is executing with discipline. We're doing so in an uncertain environment and taking bold actions within our control to deliver lasting competitiveness. We have a strong portfolio, a world-scale global asset base, deep customer relationships and exceptional talent. And we have a clear path to creating long-term value with greater earnings durability and stronger cash flow throughout the cycle. Thank you for listening. And [ Mark, ] I'll be happy to take your questions.

Great. Thank you, Jeff. A lot to unpack there. I guess let's dig in first a little bit more on the Transform to Outperform program, right? I mean of the $2 billion target that's out there, how much of that do you think is truly structural and permanent, right? I mean, meaning it can survive a return to even tougher macro environment versus just variable cost savings that could reverse should volumes or activities decline further?

Well, I'll tell you this, [ Mark, ] this is one of the unique things about our Transform to Outperform initiative, which we announced back in January. This is not a typical restructuring program. And so our expectations and the way that we are executing is that all of this will be structural. All of this will stick, all of this will be sustainable. 2/3 of that value generation will come from productivity and the other 1/3 will come from growth. And we're really focused on simplifying our operating model. We're focused on eliminating work, automating work as we move forward and ensuring that as we make the reductions in the workforce that I mentioned, that it's not a smaller number of colleagues that are doing the same amount of work and doing it the same way, but really effectively looking at how can we modify and enhance the way we do that work in a more efficient manner.

So what tools are you utilizing then to simplify that workflow? Is that more automation, more adoption of AI technology? Or is it just simply streamlining operations as you see it?

It's interesting. Some of this is fundamental looking at end-to-end processes. Across the company, we have identified those end-to-end processes that touch all elements of the company from an operations perspective, [ Mark. ] And then looking at the fundamentals of that, there are typically going to be some handoffs and some trade-offs that you make from one end to the next. And so we're going through a very detailed evaluation of each one of those processes and looking at ways to more effectively do that, some will come from automation, some will come from AI, some will come from elimination and standardization of those efforts around the globe.

Got you. That makes sense. Let's pivot over -- you touched on the portfolio competitiveness, right? And as I think about the optimization of the portfolio, in your Performance Materials & Coatings business, you've engaged in a multiyear strategy to shift the mix towards higher-value downstream products, while rightsizing higher cost upstream capacity. Where are you today in terms of the percentage of PM&C silicone revenues in higher value downstream applications versus more commodity upstream? And what's the target mix, you think, by '28?

Sure. No, this is an exciting one. And obviously, I spent a lot of time in my prepared remarks talking about Packaging and Specialty Plastics because that's typically one of the areas people like to engage in conversation when it comes to Dow. But we have so many other parts of our enhanced diversified portfolio such as PM&C and Silicones. One of the things that is really interesting about our Silicones business, it is the world's largest, most integrated Silicones business globally, first and foremost. And what we have done is we've continued to shift further downstream to higher value, higher growth markets associated with silicon. So you think about automotive, you think about health care, you think about different parts of data center, data centers and electronics. So for example, we just announced recently a $100 million investment around our Silicones business that will be focused on the U.S., China and Japan, with a lot of that going into end market applications such as the sensors, the radar sensors that go into autonomous vehicles. You think about the advanced chips from a semiconductor perspective and ensuring that our Silicones products are part of that. When you think about how do you be successful in the silicones market, there are a couple of things that customers expect. They expect differentiated technology, they expect supply reliability, and they expect technical support. And our Silicones business is able to provide each one of those on a consistent basis.

Maybe let's double click on that a little bit more, right? You've talked about expecting 20% or higher returns on downstream silicone volumes, driven by double-digit growth in EVs, consumer electronics, data centers, as you just mentioned. But what's the capital intensity of the downstream silicon expansion investment in the U.S. and Asia? And then what do you foresee as the expected payback period relative to that 20% return target?

Well, that's one of the interesting things because in some of your more commoditized assets, you would expect a longer payback period and perhaps a smaller return. In silicones, first and foremost, our GDP growth is 1.5 to 2x on average, right? So significant growth, again, at much higher margins. The payback that we've seen on our project from a silicones perspective are typically in the 2- to 3-year time frame. And if I look at the $100 million investment that we just recently made that I mentioned, a significant portion of that will be here in the U.S. at our facility, but we also have facilities in China and Japan as well where we're really diversifying that investment across the globe.

Got you. Maybe let's just wrap it up on PM&C. Operating EBIT was around $133 million in Q2, down year-over-year despite the 11% net sales growth, largely because of plant maintenance, sorry, at the Barry shutdown. When do you expect PM&C EBIT margins to recover to and/or above prior year levels? And what do you think are some of the most important factors to kind of drive us there in that recovery?

Yes. One is the silicones growth that we just discussed, [ Mark. ] That will be a significant catalyst for that. The other is our Coatings business. Our Coatings business is one that continues to take market share. We are growing with the customers that are winning in the market. So you think about architectural coatings and the success that we're having there. Those will be 2 of the significant drivers. And silicones on the Barry U.K. shutdown, that will have an immediate EBITDA uplift. We completed that shutdown in the second quarter of this year. And that will deliver, by the second half of this year, about $60 million of EBITDA uplift improvement. And we will see significantly higher amount going into 2027. So we've got a number of self-help actions that are driving that, but also the way we're going to market with silicones as well as with coatings that will drive continuous year-over-year growth in PM&C.

Got you. On the comment you made there with coatings taking share, I guess what's driving that share gain? What differentiates your products versus the peer class?

A lot of it is the reliability that our products can offer. We -- from a supply chain perspective, a manufacturing standpoint, our customers want to know that when they need our products that are, again, differentiated that they can get them anywhere that they need them. And that has been one of the operational excellence, competitive advantages that Dow has continued to have. So one is the differentiated technology. The other is the supply reliability that we can offer.

Interesting. Let's shift gears maybe over to Industrial Intermediates & Infrastructure. You touched on some of the softness we're seeing in some of these markets, housing, obviously, being one of them. But you're expecting a normal seasonal decline in building and construction in Q3 with some margin pressures in Europe. We've all been waiting for this recovery now in the housing market for some time, and yet housing starts and existing home sales are still well below historic averages. What are you seeing thus far this quarter in building and construction? And how are you managing the business through the current higher-for-longer rate environment?

Sure. I mean when you look at building and construction for us and specifically in the II&I segment, there are a couple of dynamics that I think are worth mentioning. One, yes, building and construction is a significant portion of the portfolio, but it's a mixed bag from a demand perspective because data centers also do provide some level of a tailwind within that segment for us. The other thing that I would also mention, [ Mark, ] is we have our Dow Industrial Solutions business as well, that is an II&I segment. That's the alkoxylation investments that we've made over the past couple of years. So again, you think about home care, personal care, pharma, electronics as well, those are areas that are growing higher margin, faster than GDP, which will continue to provide that tailwind for us as we think about year-over-year growth.