Novice Investing - Good Chemistry at Dow Chemical

Date: Monday 13th 2008f October 2008 10:52:03 AM

Good Chemistry at Dow Chemical - 06/12/2006

By: Hari Wibowo

With oil price sky high, naturally, downstream chemicals such as polymers, plastics are squeezed due to high feed cost. When their raw material cost increases, the most common thing for companies to do is to resist raising price and cut cost instead. Efficiencies are improved and economies of scale are built. This is what is happening with Dow Chemicals Co. (DOW), the world heavy manufacturer of plastics and other derivatives.

Oil price currently is hovering near $ 70 per barrel, up from $ 20 per barrel several years ago. Yet, if you look at Dow's income statement, you won't believe that this is the plastic company that endure a $ 70 per barrel oil price. Net profits for the fiscal year ending on December 2003, 2004 and 2005 are $ 1.73 Billion, $ 2.797 Billion and $ 4.515 Billion respectively. Selling, General and Administrative expense rose a mere 10% despite the 41% increase in revenue. Now, that's what I call efficiency.

Some may say that Dow is at the peak of its cycle. That may be true. But look, the cyclicality of Dow is tied with the high feed cost. At this sky-high price, Dow reported a net profit of $ 4.515 Billion in 2005. If the economy slows and oil price fall down, what do you think the profit of Dow would be? Dow is big enough that its presence is everywhere around the world. If the world economy contracts (meaning = global recession) by say 3%, do you think oil price will fall less than 3 %. Less likely. Oil price may rise/drop more than 2% in a given day. Now, do the math if the demand for oil drops for 3% next year. Even a mere 5-10% drop in oil price can do wonder to Dow's gross profit.

When feedstock cost rises, producers are reluctant to raise price. When feedstock cost turn lower, will producers lower their price? Not a chance. That is why it doesn't matter if Dow is at the peak of its cycle. It is trading as if this is the peak of its cycle. Dow stock price reflects as if oil price will go to $ 100, which it may. But, higher oil price will eventually dampen demand, which will eventually causes oil price to drop. You may want to wait until oil price tops $ 100. But if it doesn't go that high, you are missing

a chance on Dow Chemicals. Do your research and you might pick up a good investment from here on. What? It is not as if Dow is trading at a P/E of 50. Hear me out. At the current price of $ 38.50, Dow is trading at 8 times earnings. 2006 is forecasted to be a good year for Dow, with earning per share (EPS) of $ 4.76.

You may feel that the company is paying me to tout Dow Chemical stocks. I am not. The truth is, I am just excited. This is quite an interesting company to watch and I could find no reason why its profits would be far lower than expected. Let's assume the worst case scenario with oil price at $ 120 or more by the end of 2007. Do you remember that oil price used to be in the $ 30 in 2004? Well, look here, two years of 100% + appreciation of oil price and Dow is making bigger enough profit to prosper. Maybe, Dow won't make as much money when oil price hits $ 120. Even if Dow is making $ 2.00 - $ 3.00 a share, it is good enough reason to research this company for long term investment at this share price.

Now, let's talk about the other scenarios; the brighter scenarios. Let's assume oil price stabilize at $ 50 per barrels (which is considered rather high) for the next two years. That is a 28.5% drop from current price. You see, when the price of your feedstock falls by 28.5%, companies do not drop their price by 28.5%! Sure, they might drop it a little bit, due to competition. Let's assume a 10% drop in revenue, versus a 28.5% drop in cost of revenue. Revenue for 2007 will drop to $ 41.676 Billion, while cost of revenue will drop to $ 27.367 Billion. Gross profit meanwhile, will rise to $ 14.308 Billion, a 6.27 billion increase from 2005 level!! If all else remains equal, Dow would have reported a $ 10.7 Billion of profit should oil price drop to $ 50. That is less than five times price of today's price.

As I said before, do your own research before you invest in any companies. I feel pretty positive about the stock. But then again, I might be wrong.

END

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding Dow Chemical Co. (DOW) or any other securities.

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