DowDuPont: Meet the New Dow

Over the next few months, DowDuPont (DD 0.60%) will split into three companies, one focused on basic materials, one on finished products, and one on agriculture.

In this segment of Industry Focus: Energy, Motley Fool's Nick Sciple and Fool.com contributor Lou Whiteman profile the new Dow, the largest of the three new companies and the only one already trading as a stand-alone. Whiteman and Sciple discuss Dow's growth prospects and capital needs and also take a look at how Wall Street has reacted to the shares hitting the market.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on April 11, 2019.

Nick Sciple: Lou, I want to move on and talk about these new companies piece by piece. I mentioned off the top, the first one of these companies to emerge is new Dow, trading under ticker DOW. It's actually replaced DowDuPont in the Dow Jones Industrial Average. Again, as I mentioned earlier, management is hammering the table on this as a new, streamlined company. The older Dow had 15 companies. This new business has six.

Lou, what can you tell us about what we're going to get with this new Dow company and what investors should be thinking about it?

Lou Whiteman: Sure. This is going to be the largest of the three siblings. About $40 billion in annual sales. Most of that is from the old Dow. They've gotten rid of some of these businesses that we'll talk about in a second. They've added maybe $5 billion worth of revenue from DuPont.

This is the old-fashioned chemicals industry. This is the raw materials, the building blocks for coatings, for industrial products, for packaging. This is in some ways a commodity play. It's not the finished products, so it can be cyclical. The good news is, it doesn't necessarily have the forward R&D that you get with a finished product business.

Dow is everywhere. These chemicals, I think 7 in 10 cans of residential paint. You use this stuff all the time. These are the commodity products that go into so many of the plastic coatings of things. This is the stuff that you don't think of that you use. It's a very good business, but it is what it is. You don't necessarily innovate in the same scale that you can innovate in some of these other areas that we'll get to.

Sciple: Yeah, you're right, Lou. You mentioned, and I want to pull the thread on it, how this part of the business doesn't need as much incremental investment in R&D to develop the company. The new Dow has made a firm commitment to spend no more than depreciation and amortization over the next three years. They want to focus on cheaper products. They're really going to focus on returning capital to shareholders and not investing as much into new developments at the business. Going to realize some cost synergies.

When you look at this strategy for the new Dow, to keep as tight a lid on spending as you can and pump money back to shareholders through dividends and buybacks, what are your thoughts on that strategy as it fits into the context of the business they're going to be doing?

Whiteman: Part of this, this is the case for that original merger. Neither company was running at 100%. If you put Dow together with the DuPont assets, you have capacity to produce more product without the massive capital spending that you may normally need to expand. That's only going to last for so long, obviously. It depends on the cycle. But you can look out the next three years and say, "We have room to expand with the economy without massive capex projects." On the cost side, which you always talk about when a deal comes together, there seems to be a real potential for revenue growth, whether you call it revenue, synergies, whatever, as they use the combined capacity of the company. I think this is a pretty easy target for them to hit. I expect they should be able to run the business with growth without the capex to some extent for a while.

Sciple: Management says they're going to target 65% of net income returning to shareholders via dividends and buybacks, 45% of that being dividend, 20% at least in the near-term being buybacks. Wall Street has responded very positively to this stock. Its first day of trading, it popped 7%. It seems to be getting a lot of the love relative to the remaining parts of DowDuPont. As you look at Wall Street's initial reaction, what are your thoughts on how folks have reacted coming out of the gate?

Whiteman: For one thing, I think it's interesting to contrast that to how DowDuPont has been a real underperformer while all this was going on. I think this speaks to, again, the logic of the deal. There are different parts of the market, maybe, that'll be interested in these different companies. But there is demand for a Dow company profile type of stock without the other things. I think it speaks well to, hopefully, the bigger plan down the line.

There's a lot going on. You mentioned that Dow replaced DowDuPont in the Dow index. I would think that some of what we're seeing could be noise right now, where it's just people buying in because it's part of the index, things like that. But this is a good company. Again, I do believe that for a certain profile of investment, where you're looking for this stable, predictable company, without the baggage or upside, even, of some of these other businesses, that yes, there is a demand for it. And yes, this is to the point of what they were trying to accomplish. This is our first chance to see how it may look out in the wild. And so far, so good.