Why Dow the Materials Company is Outpacing the Dow

In the investment community, the word "Dow" calls to mind the Dow Jones Industrial Average rather than large cap materials company Dow (NYSE:DOW).
Why Dow the Materials Company is Outpacing the Dow
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In the investment community, the word "Dow" calls to mind the Dow Jones Industrial Average rather than large-cap materials company Dow (NYSE:DOW). But investors may want to start thinking more about this latter Dow given the stock's impressive run and diverse growth prospects in an improving global economy.

Since spinning off from DowDuPont two years ago, Dow shares are up a modest 14% but have more recently picked up the pace. The stock has nearly tripled since its March 2020 low—and up 13.3% year-to-date is outperforming Dow the benchmark which has advanced 10.7%.

Let's take a look at what is driving the Michigan-based company's recent performance and why it may continue to outrun the broader market.

 What Does Dow Chemical Do?

As the former material sciences division of DowDuPont, Dow sells a variety of products to the consumer, packaging, and infrastructure markets. It operates the world's largest ethylene plant mass-producing a gas that is a key input in the chemical industry.

Dow is best known for its polyolefin products. This is a fancy way to say polymers and plastics used by a wide range of customers in the food, consumer, and industrial packaging markets. About half of the company's revenue is derived from this business.

Its next largest segment makes polyurethane, another type of plastic that can be made flexible or rigid and has widespread industrial applications like building insulation, refrigerator insulation, and furniture cushions. The unit also provides various chemicals and solutions used by construction and infrastructure companies.

Dow's materials and coatings business is the last part of the three-headed materials monster. It too serves the infrastructure and consumer markets through a portfolio of architectural paints, industrial coatings, and even printer cartridge inks.

What are Dow Chemical's Growth Prospects?

For the remainder of this year, Dow's main growth catalyst is a more favorable commodity chemicals price environment. Last quarter it was able to top the consensus earnings forecast for the seventh straight time since trading on its own largely because of higher bulk chemical pricing. The price hike in the industrial and infrastructure business was particularly impressive. It increased 21% due to the combination of strong demand from construction and durable goods customers and global supply chain constraints. Price increases were similarly strong in the packaging and plastics business and pricing is expected to remain elevated.

Long-term, higher product demand from China as well as the domestic market is expected to be a primary source of revenue growth. All three business units are benefitting from increased demand during the economic recovery. This is likely to persist as vaccine progress supports a higher need for Dow's construction, packaging, and consumer durables offerings.

Dow's exposure to the global infrastructure market may be its biggest growth opportunity over the next few years. In the wake of the pandemic, the Biden administration as well as other world leaders are placing a major emphasis on infrastructure spending to upgrade aging or non-existent roads, waterways, communications, and other vital public resources.  

This is expected to present a tremendous opportunity for a company like Dow. Chemicals used in public works construction are likely to be in heavy demand especially if President Biden's infrastructure plan comes to fruition. Higher government and corporate spending to support the country's infrastructure ambitions along with Dow's low-cost operating model hold the potential for margin expansion and better than expected results.

Is Dow Chemical Stock a Buy?

Investors that like dividend income with a dash of growth have come to the right place in holding Dow. The stock comes with a 4.5% dividend yield and a solid growth outlook across its diverse consumer and industrial end markets.

Buybacks should also continue to be supportive of the share price. Although the company's $3 billion stock repurchase program has been put on hold since the onset of COVID-19, it wouldn't be surprising to see it resume given Dow's strengthening financial position and inexpensive shares.

After a dismal fiscal 2020 when earnings per share (EPS) fell 53%, Dow is forecast to return to profitability with a vengeance in 2021. The analyst consensus for this year's EPS is $6.00, a far cry from the $1.66 posted last year and a testament to the company's important role in providing the packaging, coatings, and chemicals for many parts of the economy.

Despite the stock's big run over the last year, it trades at a cheap multiple of forward earnings. The 10x multiple is near the low-end of its historical range and below its chemicals peer group average. An attractive valuation and prospects for a nice total return thanks to the generous dividend, is a winning formula for Dow the chemical maker—and reason to believe it will keep outperforming the Dow.

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