Why Shares of the Dow Chemical Company Could Drop This Week

Dow Chemical's first-quarter earnings may disappoint, but that could also mean an opportunity for you.

Neha Chamaria
Neha Chamaria
Apr 22, 2014 at 9:30AM
Energy, Materials, and Utilities

Having gained 11% year to date, will Dow Chemical (NYSE:DOW) stock maintain its momentum going forward? If you're a Dow investor looking for that answer, you may get it as early as this Wednesday when the chemical giant reports its first-quarter numbers and guides into 2014.

Plenty of restructuring news and strategy updates kept Dow investors excited during the first quarter. Citigroup even upgraded its price targets on Dow and peer LyondellBasell (NYSE:LYB) stocks last month as both companies take advantage of lower feedstock costs to expand their plastics businesses. Given the backdrop, tepid earnings from close competitor DuPont (NYSE:DD) released last week may have left Dow investors in doubt. Will Dow disappoint this week, pulling its share prices down?

Higher costs, lower profits
Half of Dow Chemical's total sales come from its performance plastics and performance materials divisions. Naturally, these businesses play a key role in deciding where Dow's earnings are headed. While the longer-term outlook remains positive, the first quarter could, unfortunately, turn out to be a tough one for the company.

Higher input cost could hurt Dow Chemical's plastics business in Q1. Source: Dow Chemical.

Extreme winters fueled demand for natural gas, pushing its prices up substantially. Prices nearly doubled year over year during the first quarter, even crossing $6 per MMBtu at one point in February. That should've rendered a substantial blow to Dow Chemical's margins, since it uses natural gas derivatives as primary feedstock for its plastics business.

Rising costs may also explain why analysts project Dow's Q1 earnings per share to improve just about 4% year over year on 3% higher revenue. Remember that the company repurchased shares during the quarter, which should have also boosted its EPS. In other words, don't expect to see much operational improvement in Dow's Q1 earnings.

Added pressure
The harsh winter could have also taken a toll on Dow Chemical's agricultural sciences business. DuPont reported 6% year-over-year drop in sales from its agriculture business during the last quarter on lower seed volumes from the U.S. Dow derives roughly 13% sales from agriculture, with seeds and traits making up nearly three-quarters of those sales. Furthermore, North America is Dow's largest end market for agricultural products. All that could add up hurting Dow's Q1 top line.

Dow's electronics business looks headed for better days.Source: Dow Chemical.

Diversity helps
On a brighter note, I'm expecting stronger numbers from Dow Chemical's other important businesses. While its coatings and infrastructure solutions business should benefit from greater construction activity in the U.S., firm global demand for mobile devices (smartphones and tablets) and improving prospects for semiconductors should propel Dow's electronic and functional materials division forward. The two businesses account for a little over 20% of Dow's sales.

In a nutshell, expect a muted quarter from Dow Chemical. That said, I'd also urge investors to focus more on Dow's strategies and plans for the year ahead, and not read much into its quarterly numbers. There's a lot going inside Dow, and investors can expect comprehensive updates in the company's upcoming earnings call.

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Fatter checks for you
Dow Chemical continues to shed unprofitable assets while deleveraging its balance sheet, which should help lower costs and debt burden going forward. That could also free up more cash, part of which could go to shareholders in the form of dividends and buybacks. In its upcoming earnings call, Dow will likely elaborate on projected cash flows for 2014, and how it plans to use them, so make sure you do not miss those details.

Likewise, keep an eye on updates about Dow's game-changing Sadara project, under which it is setting up the world's largest petrochemical facility at Saudi Arabia in collaboration with Saudi Aramco. Dow hopes to get the facility up and running by mid-next year, so the upcoming earnings call should provide key insight into the work progress. If on track, the facility should hit full production by 2016, which should also mark the beginning of a new journey for Dow Chemical.

This week could be an opportunity
Dow's earnings report may not excite investors much, but growth catalysts are aplenty. As LyondellBasell pointed out during its last earnings call, "industry conditions remain favorable for U.S. petrochemicals" if you look beyond the winter-related natural gas price volatility. That should encourage investors to remain bullish about Dow Chemical and even consider any drop in its stock price on weak earnings report an opportunity.