Dow Braces for Economic Slowdown With Hopes to Maintain Dividend
Earlier this month, Dow issued third-quarter cash flow guidance which fell short of analyst estimates by 25%.
The commodity chemical producer cited a slew of macro challenges worldwide.
In Europe, surging energy and feedstock costs are pinching margins, and high inflation has slowed economic and industrial activity significantly.
The U.S. has remained on firmer ground, but high inflation and logistics constraints have weighed on manufacturing activity. And rising interest rates have cooled the housing market.
Meanwhile, China's economic recovery has yet to fully materialize due to the nation's Covid policies, resulting in slowing industrial production and retail sales growth.
Demand for Dow's plastics and chemicals is tied closely to the global economy since these critical inputs are used in many end markets, including packaging, infrastructure, appliances, electronics, automotive, and paint.
Source: Dow
When the economic tide goes out, Dow's profits usually plunge as chemical prices fall and industry operating rates contract to balance demand.
Dow has responded to current headwinds by reducing its polyethylene (i.e. plastics) production to better align output with slowing demand as well as supply chain and logistics constraints.
Analysts now expect Dow's earnings to fall 40% in the year ahead, and the stock's dividend yield has spiked above 6%, suggesting some investors worry about the payout's safety.
However, Dow is determined to prove it can maintain its dividend in a recession after slashing its payout during the 2008-09 financial crisis.
In recent years, Dow's free cash flow has averaged around $5 billion annually, comfortably covering Dow's $2 billion dividend commitment.
Management has taken advantage of this favorable operating environment by paying down debt. This earned Dow a one-notch credit rating upgrade from BBB- to BBB in June 2021.
The company's leverage ratio (i.e. net debt-to-EBITDA) now hovers near 2.0x, down significantly from the 4x to 6x range it sat in leading up to the financial crisis and the 2001 recession.
Coupled with over $2 billion of cash on hand and less than $1 billion of debt maturing until 2027, Dow expects to defend its dividend in a recession:
"You want to be able to support the dividend through the bottom of the cycle. So when we stress test our economics, we run a Monte Carlo simulation, which has proven to be uncandidly accurate, and it was through 2020. And we look at what our cash flow will be through the bottom of that cycle. Because we know investors have a long memory about having had the dividend cut in the bottom of the cycle. So I want to make sure that we can support that dividend in the bottom of the cycle...
We've looked at a slowdown scenario... And at the bottom in that scenario, we can support our CapEx investments. We can support our dividend. We can still be able to do share buybacks. Our debt, as I mentioned, is low. Our leverage ratios are good...
I can't predict any better than anybody else the uncertainties that are going to happen tomorrow. But I can tell you right now, this is the strongest the company has been in 125 years." – CEO James Fitterling, June 2022 Investor Conference
We have maintained a Borderline Safe Dividend Safety Score on Dow since the company separated from DowDuPont in 2019.
This reflects the firm's improved balance sheet but recognizes that profits generated from commodity chemicals are notoriously volatile over a full cycle.
Dow seems more likely than not to defend its dividend, but investors interested in the stock need to have a strong stomach for price swings when the economy contracts.
We will continue monitoring Dow's performance during this dynamic environment and provide updates as needed.
Investors can learn more about Dow's business drivers and competitive advantages in our Outlook.
