Marcial: Pros See Catalysts for Improvement at Dow Chemical

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BW's Gene Marcial

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2010 Earnings Jump?

One reason why some bullish pros regard Dow as a contrarian play: They see a big jump in earnings in 2010. McNulty, for one, forecasts Dow will earn just 7¢ a share in 2009, down from $1.80 in 2008. But for 2010 he expects earnings to leap to $1.21. That jump reflects what he anticipates will be a "modest improvement" in the company's cost-savings targets and better fundamentals behind a number of Dow's end-market businesses, including products for the electronics and auto industries.

McNulty points out that the stock has yet to reflect "the dramatic improvement" in Dow's capital structure and the likelihood that Dow will be able to succeed in its cost-savings program.

Dow has also been busy selling assets to beef up its balance sheet. Prior to the acquisition of Rohm, almost 50% of Dow's annual revenues came from highly cyclical commodity businesses. Dow is the world's largest producer of polyethylene and polystyrene resins, which are used in a broad variety of applications. Its plastics products account for 23% of sales and 33% of profits.

Analysts estimate that asset sales should total $23 billion to $26 billion, which would include the commodity plastics, latex/rubber, and calcium chloride units. Dow sold its Morton Salt operations this year for an estimated $1.6 billion.

"With the credit markets having improved and the global economy stabilizing," Dow will no longer be a distressed seller of assets, says analyst David Begleiter of Deutsche Bank (DB), which has done banking for Dow. He believes the company will be moving fast on asset sales, which he says will include Dow AgroSciences, a global maker of herbicides that accounts for 8% of total sales and 26% of earnings.

Low Market Cap

For a company whose sales in 2008 totaled $57 billion, some investors believe its market capitalization of $17.6 billion reflects a misapprehension of Dow's growth prospects. They note that the low market cap stands at a mere third of sales. During its good years, Dow's market cap was about 75% of sales.

This hasn't been lost on some of Dow's large institutional investors, such as Fidelity Management, Brandes Investment Partners, Barclays Global Investors (BCS), and BlackRock (BLK), which have increased their holdings of the stock as of Mar. 31.

Dow's stock may still be near the bottom reaches of the chart, but even a modest upturn in growth could provide the reaction the bulls are hoping for.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.

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