Dow Inc. (DOW) Earnings Call Transcript & Summary

Hi. Good morning. This is Jeff Zekauskas, the chemicals analyst at JPMorgan. And this morning, it's my pleasure to welcome you to the JPMorgan Virtual Industrials Conference. The format of our conference is virtual in the interest of health and safety, and we very much appreciate your attendance. For today's fireside chat, you can submit questions by e-mailing me at jeffrey.zekauskas@jpmorgan.com, whereby using the conference website through the Ask a Question feature. It's my pleasure this morning to introduce Howard Ungerleider, who's the President and Chief Operating -- and Chief Financial Officer of Dow Chemical. Howard has been a long-time Dow veteran, both on the financial side and on the business side. And joining Howard is Colleen Kay and Pankaj Gupta of Investor Relations. As a reminder, this event is open to the public, and please refer to the cautionary and forward-looking statements in the materials that Dow will post. With that, I'll turn it over to Howard, who will make some opening statements, and then we'll proceed with our fireside chat. Howard?

Well, thanks for having us, Jeff, and good morning to you, and good morning to everyone. And Jeff, I answer to any name and any title. So you just feel free to call me whatever you want. But look, I really appreciate the opportunity to provide an update on the quarter, including the impact of winter storm Uri. Perhaps you want to talk a little bit about changes we recently announced to our U.S. pension plans, and of course, our continued focus on driving long-term growth and our enterprise value. Now as we shared on our fourth quarter earnings call, we exited 2020 with increasing momentum. And underlying market fundamentals, frankly, have only continued to improve in the first quarter despite the unexpected disruption from winter storm Uri in February, which was significant. Demand for packaging applications continues to remain resilient. And what we've seen is really construction, automotive and manufacturing production really continue to trend positively. Just a little bit of a stat, new U.S. housing starts and existing home sales are up double digits over last year. And frankly, they've reached now levels that we haven't seen since the economic upcycle of 2005, just to put those statistics in perspective. The Dow team continues to proactively capture these favorable market dynamics, managing through the winter storm impact as well as several planned turnarounds. In polyethylene, we achieved price increases in January and February and March, and we also have nominations in place for April, really as a result of the continued solid demand momentum, the disrupted supply conditions and the very, very tight chain inventory levels that we see. Strengthening demand in industrial and consumer durable good end markets, combined with industry tight supply and low inventory levels, have also supported margin strength in MDI and polyurethane applications. And in our silicone business, it's beginning to really benefit from industry demand improvements in consumer end markets, such as electronics, home care and mobility. And really, what we're seeing now is a particularly strong in our higher-margin offerings, which was lagging when you think about the last half of last year. And then in our coatings business, the do-it-yourself coatings demand continues to remain high as consumer home improvement trends continue. In addition, I would say our previous and our ongoing investments in lower-risk, faster-payback expansion debottleneck projects in silicones and industrial solutions continues to enable Dow to capture the strengthening demand we see in automotive and electronics, in pharmaceutical markets as the global economy continues to recover. Now in terms of winter storm Uri, first, let me just say how proud and thankful we are that team Dow remained safe as our team took swift action to operate -- to activate, I should say, our preparedness plans and moved really rapidly to respond. Winter storm Uri had a broad impact on the U.S. Gulf Coast, in particular, across the entire state of Texas and really resulted in widespread utility and raw material supply disruptions. This was a very significant event for the entire industry and I would say, much more significant than a typical hurricane, as it covered the entire state, and it impacted really almost all the gas fields plus the entire electrical grid in the state. And while Dow, like many others in the industry, experienced production outages predominantly across Texas, I'm really proud of the fact that our team successfully began to bring our impacted assets back online as early as 1 to 2 weeks from the storm's peak. As of today, I'm pleased to report that all of our crackers on Dow's U.S. Gulf Coast are operational with the one exception being Sabine River, and Sabine will restart later this month. And we expect all of the assets impacted by the winter storm to continue to ramp through the end of March and into April as we still are dealing, like many others are, with a few raw material constraints, and we are continuing to do some freeze damage repairs. In general, I would say we expect our Texas assets to be at 80% rates by the end of the month and full rates at some point before the end of April. And that will really enable us to begin to fulfill the backlog of demand, which is pretty significant. Now Dow's ability to rapidly respond and restart, I would say, is a true testament to team Dow's dedication and our pride of ownership. And once all the units are back at full production rates, as we do with all significant operational events, we'll be taking a look at additional maintenance and improvements and incorporating all of our learnings into our future plans. And while many of our businesses declared force majeure on products and the aftermath of the storm, our teams are certainly working hard to mitigate the operational and customer impact as much as possible, and we continue to stay as close to our customers as possible as these product and supply chain impacts across the industry have clearly created extremely tight supply balances. Now as all units come up, we'll continue to work through the backlog of orders and the pent-up demand in each of our value chains. Assessment of the financial impact due to the storm is still underway. But despite the impact from the shutdown, the repair, the ramp-up cost, we actually, today, expect net upside for the quarter from the tight dynamics we're experiencing across both durable and consumer end markets, resulting in first quarter results that should be $50 million to $100 million higher than the current first call EBITDA consensus estimate. Moving forward, into the second quarter, we expect these strong supply-demand fundamentals to continue in light of the order backlogs that I mentioned, the pent-up demand and the low inventories in most of the value chains that we see. As of right now, I would call the upside of at least $300 million to $400 million versus the current second quarter first call consensus EBITDA. And when combined with the continued recovery that we see from the pandemic driven by increased vaccinations, further economic stimulus out of Washington, rising demand as the service sector reopens and frankly, an expected increase in industrial capital spending, we expect these tailwinds to continue into the second half of the year as well. Of course, we'll share more detailed guidance, Jeff, for the second quarter during our earnings call in April. A couple of other things before we turn into Q&A. I would say earlier this month, we announced updates to our compensation and benefit programs. We followed a comprehensive review, a benchmark relative to our peers as well as a survey of our organization really in order to better align with the market as well as the needs and preferences of Dow's globally diverse workforce, while also continuing our focus on financial flexibility, and of course, continuing to strengthen our balance sheet. This included the decision to freeze our U.S. pension plans as of December 31, 2023, which is really a shift in line with the industry trends and market practice today. We also made a $1 billion voluntary plan contribution to our U.S. defined benefit plans this month as a result, and these actions will enhance the strength of our balance sheet by reducing our pension plan obligations by approximately $350 million. It will decrease our pension expense related to the U.S. plans by more than $160 million this year. It will also improve the funded status by almost $1.4 billion, and it will eliminate required pension contributions for the U.S. plans until 2024. Beginning next year, the annual benefit cost reduction will be partially offset by a higher company match of employee contributions to the U.S. defined contribution plan. We'll have more details on this, along with an updated view of our full year model and guidance to share on our earnings call when the pension remeasurement is complete. Finally, Jeff, what I would say is looking ahead, we continue to be very well positioned to capture additional value-creating growth. We expect new consumer behaviors that have emerged during the pandemic to continue to benefiting our consumer-led portfolio as the global economy continues to recover. And in spite of the weather-related events that we talked about already, market indicators continue to show above-GDP growth across many of the sectors where we compete. And we see the new orders to inventory ratio from the manufacturing PMIs remaining above 50, which also reinforces continued expectations of market expansion. And so against that backdrop, we expect to see the recovery broadening across our portfolio, including our higher-margin consumer solutions, our PU systems and our functional polymers business, which all serve mobility, infrastructure and construction end markets. And really, as an example of this momentum, this month, we signed an MoU to build a specialties hub in China to provide customers in this high-growth region local access to Dow's portfolio of high-value products and PU systems as well as EO and PO derivatives in applications like automotive, pharmaceutical, lubricants and adhesives segments, to just name a few. And we also recently started up a new PEG unit on the U.S. Gulf Coast, which positions us for further growth in the pharmaceutical and consumer product applications, which, as you know, grow at a rate of between 2 and 3x GDP. We also continue to advance our ESG-focused ambition. Our proxy statement and our annual report were released earlier this month, and they highlight our ESG actions across the company. This year, we plan to expand our accountability for our inclusion, diversity and our equity performance award targets to all of our people leaders, really increasing the shared ownership of these critical performance metrics. And as part of our Board's succession planning and refreshment actions, we've nominated 2 new directors for election at our upcoming annual meeting, which further will bolster the strength and the diversity of our Board. And we also launched a new ESG Resources section on our investor website, really to just continue our path of increasing our transparency and ease of access to all of our metrics, including our ESG metrics, which we encourage everyone listening to please visit that website. And contributing to progress on our sustainability targets, our packaging business recently launched AFFINITY RE. It's a new sustainable hot-melt adhesive polyolefin elastomer. It's made using 100% bio-based feedstock. It delivers a 45% lower carbon footprint, and it really capitalizes on the strong growth in consumer packaging and e-commerce without compromising on adhesion performance. Our commitment to sustainable innovations like AFFINITY RE in collaboration with our customers, combined with our digital acceleration investments, our global scale, our low-cost structure, our industry-leading feedstock flexibility, combined with our significantly improving financial flexibility will all continue to drive long-term growth in our enterprise value. And Jeff, with that, I'll hand it back over to you to open Q&A.

Thanks very much for the summation, Howard, and the slides. I don't have a first call monitor in front of me. But my memory is maybe the second quarter first call estimate for Dow in EBITDA terms was about $2 billion. And so if you add $400 million to that, that's $2.4 billion. But if you annualize it, it's $9.6 billion. So is that order of magnitude, what we're talking about, if it turns out you were able to maintain your second quarter level of profitability through the course of the next 12 months?

I mean, look, Jeff, first, you don't have a first call monitor, but you're very close. I think first call is just shy of $2 billion. And you're right. If you add $400 million, you're at $2.4 billion. So look, your math is correct. I would say this, let's deal with it one quarter at a time. So as we see the first quarter, as I mentioned in the prepared remarks, we've entered -- we entered the year with momentum. That momentum has continued. And despite Uri, we're able to offset all the headwinds of Uri based on that momentum in terms of volume and overall margin. And we've been keeping costs under control. So that's why we say, "Look, we see $50 million to $100 million upside versus the consensus estimate in Q1." And it's still early. We'll have more to say on the April Q1 earnings call about the second quarter. But I wanted to take this opportunity to at least share with you what our thinking is. And that's $400 million to $500 million of tailwinds or upside versus the current consensus for the first quarter, which is just above $2 billion, yes, today.

So that's a pretty good quarter, Howard. So is the second quarter of 2021, the peak as a base case? Now I understand oil can go up and what that can do is that can alter things. But just conceptually, as you look at the flows of commodities, and it may be that it comes off by just a little, but should the second quarter have a peak like characteristic?

Yes. Look, I think it's very dangerous for anybody to call a peak or a trough in advance. But my short answer to your question, Jeff, is no. We are far from an earnings peak. I mean when you think about -- look, if we were able to deliver a $2.4 billion second quarter, that certainly feels a lot better than the second quarter a year ago or even what we did in the fourth quarter, but it's still far away from peak kind of numbers. If you go back to when we spun out the new Dow and we look at the portfolio, at that point in time, we were looking at an earnings peak of $12 billion to $13 billion of EBITDA. And I would say, since then, we've continued to invest in additional growth capacity, and we've continued to take cost out. So essentially, we've lowered the breakeven point of the company. So you're looking at -- I mean, I would say, today, peak numbers are $13 billion-plus from an EBITDA perspective. So even if you take your $2.4 billion and annualize it, you're still far away. And then you look at the economy. And certainly, packaging has continued to be resilient. I think it surprised most players that through the economic depths of the pandemic, polyethylene demand actually rose 2% last year. And I think a big part of that is everybody was consuming but consuming more in their homes and less in restaurants and hotels and travel and stadiums and theaters, et cetera. And so your amount of packaging per square inch of food consumed, as an example, went up, and that's what allowed the market to continue to grow even though overall GDP reduced. But there are many value chains that, even sitting here today in March of 2021, are well below normalized. I mean, if you think about travel, you think about commercial construction, you think about industrial CapEx, you think about the entire service sector, which does drive demand for a lot of the products that we serve as well, all of that is in very early innings of return. And so there -- I think there's a lot of potential upside in front of us over the next several years.

So what we had was a freeze in Texas. And maybe we lost, I don't know, 3 weeks of polyethylene production. And so maybe that's 6% of an annual amount. And Braskem Idesa has been out or off and on because of their negotiations and trying to get feedstock. And so maybe the market is, I don't know, 10% short in polyethylene. And then the challenge for the industry is going to be to boost production to try to balance the markets more. Do you think that, that's a reasonable assessment? And how long do you think it might take before the market can be more in balance in the United States in polyethylene?

Look, I mean, I would say a couple of things. When you look over the last 10 years, I would say that certainly, our P&SP business has been a very good earnings contributor, a very good return on capital and cash flow generator. And it's been -- while it certainly has been up and down, I would say it's been an earnings ridge really since probably 2013 time frame, maybe with the exception of a little bit of the margin destruction that we saw as a result of the pandemic and hydrocarbon prices because of oil dropping this time last year. You look on a go-forward basis, there is good demand growth. And yes, there is supply growth. But I would say it's in the margin of what the expected demand growth is. And certainly, there are bulls out there and there are bears out there. Personally, my view is, look, we've been in an earnings ridge for the last 7 years, plus or minus, and it's likely the next 3 to 5 years is also to see a similar activity. And I think what we saw with the freeze is we're one issue, one weather event away from supply/demand tightening operating rates. And so it doesn't take much to tilt the market. The reality is every year, the grid, even with the new capacity that's been coming on since 2015 and is forecasted to come out in the next 3 years, every year, the grid on average does get a year older. And so whether it's unplanned events because of mechanic -- asset mechanical reliability, whether it's a weather event or whether it's just aging assets that get taken out or unplanned events. This year, the other thing that is certainly, I think, going to be true even before the winter storm Uri is there was a significantly higher percentage of planned maintenance turnarounds in 2021 than in 2020. And so Dow, just as an example, last year, we had 1 cracker for planned maintenance. This year, we've got, depending on how you do your math, 3 or maybe 3.5 because we have to take a pit stop for our assets down in Argentina. So we've got 3.5. And I don't think we're an anomaly. I think we're representative of the trend. So there's going to be significant planned maintenance that needs to happen to these assets in the grid as well. So I mean, we'll see what the next several years are. And obviously, it will depend on your point of view on the reopening of the economy and how much demand growth we get. But depending on your point of view, GDP globally this year between 5% to 6%, I think, is in line with most of the economists, if you look on the Bloomberg terminal. And if you think about ethylene derivative demand growing at conservatively 1x and optimistically 1.5x, you're talking about significant demand growth this year and into next year as well.

I do notice that polyethylene prices in the United States are maybe, I don't know, a few hundred dollars a ton higher than where they are in China. And normally, from my point of view, the U.S. price is at a little bit of a discount to the Asian price. And what I had thought was that our prices were more elevated, and we were such an expensive market that we really weren't exporting at anything like these kinds of prices. And so that's why I thought that there might be some moderation in the short term. Do you think that's reasonable? Or it's too hard to predict?

Well, I think I would say it this way, Jeff. I think in many ways, it's not really a global market. It's pretty much 4 -- 4 or 5, depending on how you do your math, 4 to 5 regional markets that are all connected with physical arbitrage. And so it is not surprising that given the winter storm that the U.S. price has moved up faster than some of the rest of the world. But the reality is the markets are interconnected. And I think what you will see, and you're already starting to see prices in Asia, prices in Europe moving up because of that interconnectedness. So there are traders out there that will try to bridge that arbitrage and close those arbitrage gaps. And it typically takes, I would say, 3 months, plus or minus, for the global market prices to calibrate. A bear might say the U.S. price will come down. I would say my view is actually Asia prices and European prices and Latin American prices are moving up. And I think that's more likely to happen based on where I see the demand picture and the supply. I mean, when you look at the European market right now, you've got at least a couple of players in Europe on force majeure having nothing to do with winter storm Uri but because of some mechanical issues that they're experiencing in Europe. And obviously, Asia is still a net importer of polyolefins, and so they are going to have to deal with lower imports, which is certainly going to drive pricing up in Asia. My best guess today, Jeff, is that's how things calibrate. But it's going to take some time. I mean, I would say when you think about a typical hurricane or a typical typhoon in Asia, it's typically 3 months before you see things calibrate. Given the extent of the damage and the capacity that was taken offline with Uri, I think it's a 6-plus-month event before we start to see things calibrate back to just fundamental underlying demand.

Okay. Sadara had all of these struggles over the past several years, but wasn't that built for sort of a higher oil price environment? Shouldn't that have a better contribution in 2021?

Yes, it should. I mean, I would -- I probably would reject the struggles comment, but I would say that, look, we're very proud of the Sadara team. The assets have been running extremely well since really day 1. The assets were sold out very quickly. Remember, it passed the lender reliability test on the first go when it had really 3 years to pass it, but it passed on the first try, even surprising ourselves because we figured we'd have to do it twice to solve some of the punch list items. You're right. Look, it has been improving. It's been improving because of lower cost. We've taken cost out. Sadara team has taken cost out. They've continued to creep the assets, and they've continued to sell up the value of those assets. I mean, the fourth quarter, Sadara improved their results by over $130 million versus Q4 a year ago. It was the first quarter where it actually had a profit. It was a positive contributor to Dow's equity earnings on an EBITDA basis. And I would say, look, their portfolio definitely mirrors our portfolio. So as our earnings have improved, I would expect Sadara to be a much bigger positive contributor to both Saudi Aramco and Dow in 2021 relative to 2020.

What about the MDI markets, Howard? Those have been pretty tight. How is your production? And are your prices moving up? How's profitability in MDI?

Yes. I mean, look, we -- if you think about the pandemic and you think about isocyanates, they go into -- a large portion of isocyanates go into durable goods. And if you think about the pandemic and what that did, the automotive and construction, in the second quarter of a year ago, that was the value chain in Dow that was the hardest hit. You're talking about operating rates that went down to -- we matched production to demand. You're talking about operating rates that went down in the mid-50s in order to keep pace with the demand. And I would say, since the third quarter of last year, the durable demand has continued to increase, frankly, at a pace faster than we had originally expected. And we went from polyurethanes essentially being breakeven cash margin to having some reasonable profitability in the fourth quarter, but still way below normalized, maybe slightly above trough-type economics. So I do expect in the first quarter and again in the second quarter for that to continue to improve. When you think about isocyanates, there's not a lot of new capacity slated to come on until at least, I think, mid-2023. And if you believe in continued economic expansion, which we do, it should be a good few years for the polyurethane franchise in Dow to continue to drive higher earnings.

And in your opening comments, you mentioned some recovery in your silicones and siloxane business. Can you expand on that a little bit?

Yes. I mean, certainly, and I would say that there was -- certainly, last year and the year before, some additional siloxane capacity came into the marketplace. And that really drove siloxane pricing down. And then when you think about the downstream market, so a reasonable chunk of our performance silicones goes into personal care applications. And so when people were in quarantine or lockdown or weren't going out and wearing face coverings, they just weren't buying the higher-end cosmetics, the higher-end lotions and potions that drive a lot of our margin growth. Plus commercial buildings, high-rise buildings, that's another big area where we participate. And so what we started to see -- it lagged. When you think about our P&SP business really led out of the pandemic. Polyurethanes and acrylics were next. And really, silicones lagged, I think, because of the combination of too much supply of siloxane and then not enough demand because of the pandemic. We started to see that improve in the fourth quarter. And I think as this year progresses, we'll see continued demand growth with the reopening on some of the higher-margin applications like personal care, like commercial buildings, industrial CapEx plus automotive. When you think about the expanded mobility, whether it's EV, we sell a lot more pounds of silicone in an EV car than in a traditional industrial combustion car. So as the market continues to go EV, as the world continues to implement 5G technology from a telecommunication standpoint, I think those are all going to be key drivers of earnings growth for our silicones franchise over time. And we'll continue to drive higher earnings from siloxanes upstream as both the supply-demand balance improves and as we continue to take more siloxanes out of the merchant market and grow our downstream formulated silicones business faster, which has certainly been the strategy and will continue to be the strategy.