Ever since the breakup of DowDuPont in 2019, specialty chemicals maker Dow Inc. (DOW 0.58%) has been a disappointment, generating a total return of less than 4% compared to the 24% gain by the Dow Jones Industrial Average and the better than 40% return of the S&P 500.
Yet this Dow 30 component represents a great deal for investors, not just because it is one of the cheapest stocks in the index across numerous metrics, but also due to its having fabulous long-term growth potential.
Image source: Getty Images.
One word: plastics
Dow is one of the world's largest chemical manufacturers, with annual sales north of $55 billion. Polyethylene, one of its biggest products, has applications across consumer and industrial markets. The company is looking to add 350 million kilotons of additional polyethylene over the next few years while also building a world-scale polyethylene facility on the Gulf Coast to meet consumer demand to meet consumer and industrial demand for specialty packaging, health and hygiene, and packaging applications.
Wall Street, though, is starting to get cold feet on Dow because it relies heavily on fossil fuels for inputs into its manufacturing processes, and the world, especially Europe, where it has significant exposure, is in a high energy cost environment.
Also, recessionary pressures could depress consumer demand. Dow did especially well during the pandemic with the increase of at-home delivery by consumers, as it tends to use more plastic packaging than bulk delivery of goods does. That may slow in the months to come, however.
Still consumer driven
That's been evident recently, with Amazon having to come to terms with slowing sales growth in its online retail business. It was recently reported Amazon was implementing a pause in hiring in its retail segment.
Still, Dow maintains that recessions actually don't impact business as much as you'd expect as it tends to only lose 2% to 3% of its normal volume in packaging and specialty plastics. President and CFO Howard Ungerleider said on the company's second-quarter earnings conference call that tough economic conditions actually drive consumers to those smaller-sized items, which pushes consumption of polymers higher.
Also, because Dow has a global footprint with facilities in dozens of countries around the world, it has flexibility when conditions in one market or another become unfavorable.
A solid business
This may be leading to a disconnect between expectations of what Dow will do in the quarters ahead and what's actually achievable, and may explain why the specialty chemicals manufacturer is so cheap. It trades at just five times trailing earnings and less than eight times next year's estimates, while also going for a fraction of its sales and only four times the free cash flow it produces.
It has generated $2.7 billion in free cash flow over the first six months of 2022, up from the $2.1 billion generated last year during the same period. Last year it generated almost $5.6 billion for the full year. Dow also has $2.4 billion in cash and equivalents and it lowered its long-term debt to by $1.3 billion from the year-ago period. In 2021, it shaved off some $2.4 billion from its debt load.
A reliable dividend
Of special interest is Dow's dividend, which at 6.1% is the second-highest yielding payout of the Dow 30 stocks. The company paid out $2.1 billion in dividends last year, but with a payout ratio of 49%, it is well covered and not in danger of being cut. While that does leave the company room to raise the dividend in the years to come, right now Dow seems more comfortable reducing its debt, which just may be a wiser use of its cash flows.
Dow has a strong balance sheet; a large, diversified business across numerous geographies and end markets; and a healthy, though admittedly cyclical business. With a fortified dividend and improving fundamentals, this blue chip stock's discounted value makes it an unstoppable deal today.
