Second Quarter 2012 Earnings
The Dow Chemical Company
July 26, 2012
Quarterly Earnings Conference Call/Webcast With
Investors, Financial Analysts and the Media
Andrew N. Liveris, Chairman and CEO
William H. Weideman, Executive Vice President and CFO
Doug May, Vice President, Investor Relations
Good morning everyone, and welcome.
As usual, we are making this call available to investors and the media via webcast. This call is the property of The Dow Chemical Company. Any redistribution, retransmission or rebroadcast of this call in any form without Dow's express written consent is strictly prohibited.
On the call with me today are Andrew Liveris, Dow's Chairman and Chief Executive Officer; Bill Weideman, Executive Vice President and Chief Financial Officer; and David Johnson, Director in Investor Relations.
Around 7:00am this morning, July 26th, our earnings release went out on BusinessWire and was posted on the Internet on Dow.com. We have prepared slides to supplement our comments in this conference call. These slides are posted on our website on the Presentations page of the Investor Relations section, and through the link to our webcast.
Some of our comments today include statements about our expectations for the future. Those expectations involve risks and uncertainties. We can't guarantee the accuracy of any forecasts or estimates, and we do not plan to update any forward-looking statements during the quarter. If you would like more information on the risks involved in forward-looking statements, please see our SEC filings.
Additionally, some of our comments reference non-GAAP financial measures. A reconciliation to the most directly comparable GAAP financial measure and other associated disclosures are contained in our earnings release and on our website.
Unless otherwise specified, all comparisons presented today will be on a year-over-year basis. Sales, volume and price comparisons will exclude divestitures. EBITDA, EBITDA margins and earnings comparisons exclude certain items.
The agenda for today's call is on Slide 3. I will now hand it over to Andrew.
Thank you, Doug.
Good morning everyone and thank you for joining us.
As we stated during the quarter, the second quarter of 2012 presented a challenging market and operating environment. However, despite these extremely volatile conditions, we continued to tightly manage operations – driving and accelerating a full array of efficiency and cost reduction measures…and delivering cash flow improvements.
Global economies have been not only volatile, but conditions clearly deteriorated as the quarter progressed. This led to weakening demand and extremely cautious buying sentiment….which in turn impacted pricing and volume dynamics…as we indicated throughout the quarter.
In addition, the fragile European environment placed significant downward pressure on currency for businesses operating in that region, and Dow was no exception – given our large footprint in the EU.
Finally, Dow faced additional headwinds in the quarter, as we experienced an unusually high impact from planned turnaround costs – both within our businesses, as well as at our joint venture partners.
This all resulted in the following:
- Earnings per share were $0.55.
- Sales declined by 6 percent, led by Western Europe. Currency accounted for more than $400 million of the decline…. nearly half of the overall company sales decline on an adjusted basis.
- Volume declined 1 percent with price decreasing 5 percent.
- On the better news side, we saw continued strength in Agricultural Sciences – which grew volume 10 percent and delivered record second quarter sales…
- And we captured volume gains in Performance Plastics, as well as in China.
- However, on the whole volume decreased across most operating segments and geographies due to a synchronized economic slowdown, coupled with cautious buying sentiment seen across most value chains.
- This global volatility and weakness drove rapidly changing hydrocarbon and commodity costs, which led to declining prices.
- While feedstock and energy costs decreased by nearly $1 billion versus the second quarter last year, our pre-turnaround inventory build muted that benefit.
- EBITDA was nearly $2 billion, reflecting margin compression due to the dynamics I just outlined. This was coupled with reduced equity earnings, which were down due to planned turnarounds at MEGlobal and ongoing silicon value chain weakness at Dow Corning.
- As a result, our operating rate was 78 percent for the quarter, including turnarounds, which impacted the quarterly average by 3 percentage points.
- In the midst of this difficult operating environment, we responded by intervening, and pulling multiple levers that we have available – just as we said we would.
- We delivered an increase of nearly $700 million in cash from operations in the quarter…
- And brought our net debt to capital down to 40.4 percent – remaining firmly on track to reach our year-end target.
The key takeaway is this: In the face of significant headwinds, Dow maintained its focus on execution and controlling what we could control – driving cost reductions and delivering cash flow improvements.
We have taken – and we will continue to take – action to help mitigate the current dynamics. We are a strong company and are moving forward in continued pursuit of our long-term strategy.
I'll have more to share on this in a moment. But first, let me turn it over to Bill for more detail on our financial and operating results.
Thank you, Andrew.
Turning to Slide 6, adjusted sales decreased 6 percent to $14.5 billion, and EBITDA was nearly $2 billion in the quarter.
On a reported basis, earnings were 55 cents per share. This compares with earnings of $0.84 per share in the same quarter last year, or adjusted earnings of $0.85 per share.
On Slide 7, I want to take a moment to give you additional insight on the key drivers of our operating performance this quarter.
Declining feedstock costs were a headline. However, the benefit of falling hydrocarbon prices was largely offset by declining prices and currency headwinds.
In addition, as Andrew mentioned, we had a large number of planned turnarounds in the quarter…both within Dow as well as in our joint ventures.
Our operating rate declined 6 percentage points, due to lower demand and customer destocking.
The good news is that, looking forward…the peak turnaround season is behind us…so we are well-positioned to capture the benefit of continuing favorable feedstock costs going forward.
Now let me turn to volume trends on Slide 8.
Overall, volume declined 5 percent year-over-year, or 1 percent on an adjusted basis, due to weak economic conditions and cautious buying sentiment, which occurred throughout most of our value chains.
We did see bright spots in Agricultural Sciences, which benefited from very strong industry fundamentals, as well as Performance Plastics and Asia Pacific, where new capacity from our joint venture in Thailand continues to support growing demand in that region.
Now let me turn to price trends on Slide 9.
Price declined 5 percent in the quarter…with currency accounting for more than half – or approximately 3 percent of the decline.
We saw decreases in all geographic areas and most operating segments.
Now turning to our operating segments…starting with Electronic and Functional Materials on Slide 10…
Electronic Materials volume declined slightly due to continued softness in the industry. However demand gains were reported in Semiconductor Technologies due to improving foundry utilization rates and significant revenue growth in OLED materials for Display Technologies.
Functional Materials revenue declined overall, as higher costs associated with turnarounds dampened bottom-line results.
Looking forward, we expect to see some sequential improvement in this segment, and should start seeing year-over-year earnings growth in the fourth quarter and moving into 2013.
Turning to Coatings and Infrastructure Solutions...
Dow Water and Process Solutions reported record quarterly sales with strong demand in reverse osmosis membranes for industrial water applications.
Sales declines in Dow Building and Construction were primarily driven by ongoing volume contraction in Europe. Recall last quarter you saw us take action here – adjusting our footprint and reducing structural costs in Europe.
Within Dow Coating Materials, the bright spot was North America, where the business achieved double digit volume gains in both architectural and industrial coatings. However price was down, driven by weak demand in Asia, leading to an oversupply of less differentiated epoxy-based products.
As you think about this segment going forward…while we have seen modest improvements in the construction sector, we do not expect to see marked improvement in Dow Corning equity earnings…leading to lower year-over-year earnings for the remainder of 2012.
Moving to Agricultural Sciences, which delivered record second quarter sales with gains across most crops and geographies…driven by new solutions, healthy market fundamentals in crop protection…as well as strong gains in seeds and healthy oils. Double-digit gains in corn and soybeans also fueled portfolio growth.
Looking ahead, we anticipate a typical seasonal decline in this segment…coupled with increased pressure on mid- to late-season crop protection demand due to U.S. drought conditions.
In Performance Materials…volume declined in all geographic areas, reflecting soft demand and high turnaround activity versus the year-ago period.
- Polyurethanes posted demand growth in Asia Pacific driven by the new HPPO plant in Thailand. However, overall Polyurethanes sales were down, primarily due to the shutdown of our TDI asset in Brazil, as well as an MDI outage early in the quarter.
- Epoxy sales contracted due to continued softness in allylics and phenolics.
- This more than offset strong performance in Polyglycols, Surfactants and Fluids, as well as Dow Oil and Gas.
We anticipate improvements in this segment sequentially. However ongoing weakness in Thermosets will dampen year-over-year profitability in the second half of the year.
Moving now to Performance Plastics on Slide 12…
Sales in this operating segment were down versus the same period a year ago.
- Broad-based volume gains in Performance Packaging and Dow Hygiene and Medical were offset by pricing headwinds in all geographies.
- However, sales in Dow Electrical and Telecommunications grew versus the year-ago period, with double-digit revenue and volume gains in Asia Pacific.
- And Dow Elastomers posted new first-half records for both sales and EBITDA.
Looking forward, we expect ongoing weak demand and margin compression in Europe…coupled with depressed margins in Asia Pacific….will result in lower year-over-year performance in the back half.
Despite these current headwinds, we expect the continuing favorable oil-to-gas ratio and a steady rise in operating rates – even in a slow growth environment – will generate strong results in Performance Plastics next year and beyond.
Finally, Feedstocks and Energy reported a decline in volume, due to lower sales of propylene in Asia as we started up our HPPO facility, as well as lower VCM sales due to an asset shutdown in the second quarter of 2011.
Looking forward, we expect sequential improvement due to lower turnaround costs at MEGlobal… partially offset by soft chlorine derivative demand in both Europe and the United States.
Now I'd like to cover a few additional financial highlights on Slide 13.
Our focused efforts on working capital and discretionary spending improved cash flow from operations by nearly $700 million versus the same quarter last year.
And net debt to total capitalization dropped to 40.4 percent.
Now, looking to the third quarter, I would like to provide a few comments for modeling purposes:
- Equity earnings are expected to remain flat, as the benefit from lower turnaround costs in MEGlobal will be offset by continued weakness in Dow Corning and ongoing naphtha margin compression in our JV's in Thailand;
- Turnaround costs will decline approximately $100 million sequentially, but still be up nearly $50 million on a year-over-year basis;
- We expect currency headwinds will continue due to the weak euro;
- While ethylene margins in Europe recovered early in the second quarter, we expect margins will contract in the third quarter;
- And lastly, our tax rate going forward will be similar to what you saw this quarter.
And now I'd like to turn it back over to Andrew.
Thank you, Bill.
I would now like to turn outward, and take a look at the world we are operating in today…to give you a sense of how our company is responding to these increasingly volatile times and delivering even in the face of these current headwinds.
As you know, Dow's vast presence in end-markets and geographies gives us unique and early insight into what is happening around the world.
At the end of 2011 and moving into the first quarter of 2012, we said that…while we did not see any material improvements in the first quarter… demand growth was expected to gain momentum in the second quarter….with improvements in the back half of 2012.
However, moving through the first and second quarter, we saw an accelerated slowdown in most global economies – a slowdown that has weighed heavily on a variety of regions and sectors.
In fact our heat map illustrates our view of the downward shifts in growth expectations…with movements downward outweighing the positive by a ratio of 10:1.
Therefore, looking forward, we believe it is unlikely that there will be broad positive developments in the global economy through the second half of 2012.
Europe continues to be an area of major concern, as ongoing recessionary conditions now appear to have broader implications across the rest of the world…and this has instilled increased caution among investors and consumers.
China's economy has continued to decelerate as European exports suffered…and we will likely linger around the current level until broader measures taken by the government to inspire domestic growth in investment and consumption take hold.
And in the United States, improvements in consumer confidence have moderated due to soft employment data and uncertainty in Europe, and slowdown in exports due to the weaker global economy.
Dow is facing this new reality head-on – recognizing that under these conditions, the timeframe for when we reach our near-term earnings targets will be extended.
However, let me be absolutely clear – our near-term targets remain intact. We simply recognize that current realities can obviously impact the pace at which we will achieve them.
We remain extremely confident in Dow's ability to successfully reach our stated targets.
As you have seen us talk about, the breadth and scale of our enterprise provides us with four unique value drivers…
Drivers that enable us to deliver higher and more sustainable growth over the long-term…with differentiated solutions that customers want and need….as well as drivers that give us the ability to mitigate economic uncertainty – leveraging an industry-leading low-cost position.
We have a portfolio that is "fit to fight"…and we are in execution mode.
This begins, first and foremost, with managing our capital and cost structure to drive efficiencies and reduce costs.
Recall that during our Investor Day last fall we outlined cost and cash levers totaling $2.5 billion….levers we were prepared to pull should economic conditions warrant.
Earlier this year, we confirmed $1 billion of interventions were in motion.
In fact, these programs are not only well underway…but are actually delivering ahead of schedule…and gaining momentum.
Year-to-date we have delivered nearly $600 million of interventions, and in April we announced additional actions to adjust our footprint in response to new macroeconomic realities – primarily in Europe.
Today we are announcing that, due to the current dynamic operating environment, we will further accelerate our focus and expand our targets yet again…moving from $1 billion to a total of $1.5 billion of interventions.
This begins with taking additional actions to drive efficiencies and tailor capex and growth spending to match the current realities.
And you should expect to hear more from us this quarter regarding additional interventions we will take to reduce costs, and adjust our structural footprint to titrate longer-term growth needs with the current realities.
As a result, Dow's financial discipline and foundation is indeed strong...
This is demonstrated in our balance sheet…where significant debt reduction actions we have driven over the past two years have us firmly on track to deliver against our net debt goals.
In addition, our cash flow targets remain squarely in place, and we are on track to deliver $8 billion in cash from operations in 2011 and 2012.
And in terms of how we plan to use this cash, we've been very clear: Our priority is to increasingly reward shareholders, pay down debt and invest prudently in organic growth.
In addition, as you know, earlier this quarter we received a $2.16 billion award in the K-Dow arbitration. This award does not include interest and costs owed to Dow. We anticipate the final award covering interest and costs later this fall.
We are very pleased with the outcome of this significant arbitration.
The award has not been factored into any of our financial or business modeling, and an award of this significance will serve to accelerate our priorities for uses of cash.
Turning now to the second driver for Dow's competitiveness …our world-leading feedstock advantage.
As the largest, most flexible and most experienced ethylene producer, we hold a unique advantage. Our tremendous scale and reach…our integration and infrastructure advantage…and our feedstock flexibility differentiate us from our competitors within every region of the world.
- 70 percent of our ethylene assets are located in advantaged positions in the U.S., Canada, Argentina and the Middle East;
- Our global infrastructure and integration gives us a comprehensive network of mining, storage, pipeline and global production capabilities… allowing for quick adaptation to market realities;
- And, of course, there's our unique feedstock flexibility.
For example, in both Europe and the Americas our industry-leading flexibility allows us to tailor our feed slate in response to price conditions, providing additional advantage.
Let's take a look…
Now, as you know, ethane fundamentals are very strong on the U.S. Gulf Coast as we move into the second half of 2012 and beyond.
And we have already highlighted the "naphtha-to-ethane" arbitrage that provides tremendous margin expansion opportunities for ethane-based producers like Dow.
But additional, more recent industry dynamics illuminate what differentiates Dow from its competitors – and that is the unique advantage Dow gains from the powerful combination of current ethane and propane advantages on the U.S. Gulf Coast…
This is where Dow's current flexibility options – and our forward-looking flexibility investments – really come into play.
Remember that Dow alone has one-third of the propane cracking potential among U.S. Gulf Coast chemical players. When propane prices decline so that they become the preferred crack for ethylene – as they did during the second quarter – our flexi-crackers can immediately turn to propane to take advantage of the arbitrage vis-à-vis ethane.
Going forward we see structurally long propane often creating a ceiling on ethane pricing – and you can be sure Dow's flexibility will allow us a uniquely advantaged feed slate.
Our European assets are also advantaged, due to our best-in-industry propane and condensate flexibility.
On the whole, we estimate that our feedstock flexibility alone provides additional value of up to $250 million per year, depending on market conditions.
So as you can see, the powerful combination of our operating and capital efficiency….coupled with our world-leading feedstock advantage…differentiates Dow from its peers – making us best-in-class when it comes to cost and scale.
Creating that strong cost advantage is the foundation that allows us to compete in tough industry conditions…and we are also investing to deliver higher growth and higher margins through our unique solutions.
This brings me to Dow's integrated portfolio…a portfolio that is designed to mitigate risk and capture value on multiple fronts.
We use our deep value chain integration to opportunistically take advantage of attractive dynamics in the markets and regions where growth is happening most.
Take, for example, our geographic diversity and broad reach.
Over the last several years we have purposefully invested in emerging regions…building assets and developing on-the-ground know-how that give us the unique capability to deliver high-tech solutions across a wide-range of industries and end-markets…
For example, our exposure to diverse end markets was on display in China in the second quarter…
Here we saw overall sentiment and market confidence deteriorate in the quarter…and yet we were able to post record sales and double-digit volume growth in China versus the year-ago period.
This is because of our exposure to resilient and varied growth sectors such as packaging, water, automotive, agriculture and electronics.
- In Dow Water & Process Solutions, we are benefitting from steady demand across all segments, with emphasis on systems for industrial and waste water;
- Dow Automotive has positioned itself well with local customers to serve the fastest growing segments of the Chinese automotive industry;
- And finally, our Agricultural Sciences business has invested in additional sales resources in the region…enabling us to increase sales of differentiated crop protection products.
So, turning to Slide 24 and our next key driver….our robust technology pipeline.
The value of our innovation programs is clearly tilted toward implementation…and we continue to make steady progress in monetizing this pipeline across our businesses.
The impact is already reaching our bottom line, with sales from new products having delivered about $400 million of EBITDA since 2009.
And we are commercializing new solutions every day…
Take Dow Automotive – the market leader for crash durable adhesives. This quarter we commercialized the next generation of our BETAMATE™ structural adhesives with a Chinese OEM.
This is an attractive segment, as crash durable adhesives enjoy high growth rates due to superior strength…as well as the potential for light weighting…. allowing our customers to increase fuel efficiency.
Dow Electrical and Telecommunications recently launched the latest advancement in its ENDURANCE™ family – a new insulation technology that leverages our unique combination of polymer and electrical material science with application expertise to bring utility companies high reliability and low-cost ownership for underground cables.
And then there's Dow AgroSciences…where convenience and resistance management are driving customers to our new Refuge Advanced single bag solution for corn…bringing farmers insect protection advantages that competitive products cannot match…and making it simple to achieve higher whole-farm yield.
Also this quarter we commercially launched POWERCORE™, which extends our SmartStax technology into Latin America. POWERCORE provides corn growers with the broadest above-ground insect protection available. The net result is that we have the superior option to increase productivity and yield in this key growing region.
Our R&D investments…and differentiated solutions like these…are powering our Seeds, Traits and Oils portfolio…which is now a full $1 billion strong with an impressive five-year growth trajectory.
So as you can see, the powerful combination of our integrated and well-balanced portfolio….coupled with our rich technology pipeline…allows Dow to drive share and margin gains through unique offerings and solutions to our customers.
Before we wrap up, I want to revisit our priorities for the remainder of this year and moving into 2013…
The new reality is that the world is not in normal growth mode, and it does not appear that we will see this for at least 12 – 24 months. As a result, we are adjusting these priorities so that we accelerate our short-term interventions as follows:
- Driving – and accelerating – cost reduction and efficiency actions to meet these challenging conditions head on;
- Implementing these disciplined price and volume actions;
- Managing margins by leveraging our feedstock advantage, integrated portfolio and global reach;
- Continuing to de-leverage our balance sheet, and generating solid cash flow, which underpins our strong dividend…a dividend that is among the top of its peer group in terms of yield and payout ratios... and signals confidence in our ability to deliver higher and sustainable earnings growth over the long term.
In short, we are focused on execution…concentrating on the things we can control…and taking further steps to fortify our foundation in this highly uncertain environment.
You will hear more on this as we move through the quarter…which brings me to our upcoming Investor Forum – which will be held October 3rd in New York.
During this business meeting we will share our priorities for 2013 – and provide you with the granularity that underpins both the near-term interventions we are taking, as well as our growth trajectory moving forward.
The bottom line is this: Our management team is fully aligned and accountable, and we remain committed to delivering on our earnings trajectory and EBITDA targets.
We have the right strategy in place to deliver over the long term…and we will continue to return value to our shareholders.
It will be an exciting event, and I really look forward to seeing you all there.
With that, Doug – let's turn to Q&A.
Thank you, Andrew.
Now we will move on to your questions.
First, however, I would like to remind you that my comments regarding forward-looking statements and non-GAAP financial measures apply to both our prepared remarks and the following Q&A.
Karen, would you please explain the Q&A procedure?
Thank you everyone for your questions and for joining us this morning. We appreciate your interest in Dow.
For your reference, a copy of our prepared comments will be posted on Dow's website later today.
This concludes our call for today. We look forward to speaking with you again through the quarter.