S&P Upgrades Dow Chemical - Analyst Blog

Credit rating agency, Standard & Poor has revised its outlook for The Dow Chemical Company (DOW) to Positive from Stable, as stated by the Associated Press (AP). The ratings agency attributed Dow’s Outlook upgrade to the solid second quarter results. According to AP, the agency has also reaffirmed its corporate credit ratings of “BBB-“on Dow and its subsidiaries including Rohm and Haas Co. and Union Carbide Corp. “BBB” is S&P's lowest level investment-grade rating

Although Dow’s second quarter results were below expectations, it outperformed on a year-over-year basis. Net earnings of 54 cents per share in the second quarter of 2010 fell short of the Zacks Consensus Estimate of 56 cents but were substantially higher than last year’s income of 5 cents. Including one-time charges related to temporary plant shut down, the company earned 50 cents against a loss of 47 cents in the year-ago quarter. Sequentially, earnings increased 22% from 41 cents per share.

Quarterly revenues climbed 26% year over year to $13.62 billion. Pricing (19%) and volume (7%) gains across all business segments and geographical regions, particularly in America and Europe, Middle East and Africa (EMEA) yielded healthy revenue growth. A stronger top line mitigated higher raw material and energy costs, translating into EBITDA of $1.9 billion, up 21% from the year-ago period.

Encouraged by the strong results and a positive guidance, the credit rating agency expects Dow to record meaningful growth going forward. We find that Dow has significantly offloaded debt, which soared after the Rohm and Hass acquisition. In 2009, Dow reduced $2.5 billion in debt. Dow’s net debt-to-capital declined to 46.5% from 49% in the first quarter.

Cash and cash equivalent of $3.1 billion as of June 30, 2010 were up 7.8% from $2.8 billion as of December 31, 2009. Reducing debt and improving cash flows should enhance Dow’s liquidity and financial position.

Our Take

Dow Chemical continues to make progress in delivering cost synergies from the Rohm and Haas acquisition, yielding higher margins in the specialty businesses while reducing volatility in earnings and cash flow. The company realized savings of $325 million in the quarter and a run rate of more than $2 billion.

Notably, Dow surpassed its Rohm and Haas cost synergy goal of $1.3 billion on a run-rate basis for the present quarter. Dow’s global operating rate was 86%, reflecting strength backed by the global economic recovery.

Dow is focusing on its core business and has been divesting non-strategic assets. In the reported quarter, the company divested its Styron business for $1.63 billion and plans to divest another $5 billion in non-core assets in the next two years. Last month, Dow announced plans to be a global sponsor for the Olympics.

The slow economic recovery in North America is a concern for Dow as it generates about 36% of its revenue from the region. Unplanned production outages are impacting many of Dow’s businesses and higher raw material and energy prices are further pressuring margins.

Currently, DOW has a short-term (1 to 3 months) Zacks #4 Rank but a long-term (6 months and higher) Outperform recommendation.