Novice Investing - Time to Buy Dow ?

Date: Friday 29th 2008f August 2008 02:07:13 AM

Time to Buy Dow ? - 01/12/2007

By: Hari Wibowo

I have covered Dow Chemicals (DOW) and why I was intrigued at it on the first place back in June 2006. At the time, oil price was hovering at $ 70 per barrel, which is a killer for plastics companies like Dow. Yet, if you look at Dow Chemical's income statement, it does not look like a company that experiences a 400% increase in raw material cost. Profit for the year ending in December 2005 was $ 4.515 Billion, or $ 4.70 per share. For all of fiscal year 2006, Dow is expected to earn $ 4. 19 per share.

At current stock price, Dow Chemicals is trading at a P/E of 10, which implies the peak of its cyclicality. Has earnings reached its peak at Dow Chemicals? Hardly. In fact, if you look at the high oil price, it implies a possible bottom for Dow Chemical's earning. And all that, Dow is trading at a mere P/E of 10. Wow!

Want to hear some more good news? Six months ago, oil price was hovering at around $ 70 per barrel, en route to all time high of $ 78.00 per barrel in the summer. As of late, oil price trades at $ 55 per barrel or less, which is 21% below its summer nadir.

What happened with Dow when the cost of its raw material decrease by 20%? Now, we are making assumption that oil price will stay at that level for the remainder of the year, which is a pretty tough prediction. When your cost of raw material decreases by 20%, your average selling price would probably not drop as steep, perhaps, dropping by as much as 10%. Thus, you still get the 10% increment in gross margin. Depending on the ratio of your gross margin with your fixed cost, the final impact for your net income is more than 10%. In Dow's case, using 2005 income statement, it will add as much as $ 3 Billion in additional profit. This implies a 65% increase in net profit. While Dow's profit will not increase 65% year after year, with a P/E of 10, everyone is expecting Dow to record lower profits ahead. But, the above exercise implies otherwise. It implies that Dow stock is currently undervalued. For the past year, Dow had tumbled to as low as $ 33.00, during which, it snaps back and rise higher. While buying at $ 33.00 is a better deal, the fact of the matter is that, Dow Chemical stock price may not reach that point anytime soon.

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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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