Dow Inc. (DOW) Q4 2011 Earnings Report, Transcript and Summary

Good day, and welcome to the Dow Chemical Company's Fourth Quarter 2011 Earnings Results Conference Call. [Operator Instructions] Also, today's call is being recorded. I would now like to turn the call over to Mr. Doug May, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Alicia. Good morning, everyone, and welcome. As usual we're 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 expressed 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 Dave Johnson, Director in Investor Relations. Around 7:00 a.m. this morning, February 2, our earnings release went out on Business Wire 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 expectations for the future. Those expectations involve risks and uncertainties. We can't guarantee the accuracy of any forecasts or estimates, and we don't plan to update any forward-looking statements during the quarter. If you'd like more information on the risks involved in forward-looking statements, please see our SEC filings, which are available on the Internet at dow.com. In addition, some of our comments reference non-GAAP financial measures. Presentation of and reconciliation to the most directly comparable GAAP financial measure and other associated disclosures are contained in our earnings release and the prepared slides and on our website. Unless otherwise, specified, all comparisons presented today will be on a year-over-year basis. Sales, price, volume comparisons exclude the impact of divestitures and EBITDA, EBITDA margins and earnings comparisons exclude certain items. The agenda for today's call is on Slide 3. I will now hand the call over to Andrew.

Thank you, Doug. Good morning, everyone, and thank you for joining us. If you turn to Slide 4, 2011 proved to be yet another successful and strategically important year for Dow. We reached new milestones and drove a focused agenda with clear priorities. As you know, the fourth quarter presented our industry with a challenging operating environment with new uncertainty driven mostly because of the sovereign debt issues in Western Europe, coupled with traditional seasonality, led to substantial destocking across supply chains, as customers reduced inventories prior to year end. We anticipate this volatility and we're prepared. Our company acted swiftly and purposefully, as we said we would. At our Investor Day last fall and during our third quarter earnings announcement, we discussed the levers we could pull and the interventions we would take if necessary. And that's exactly what we did. We cut discretionary spending. We took action to improve operating rates. We tightly managed working capital, and these actions generated cash from operations of $2 billion in the quarter. Over the last several months, we have been very focused on our interventions, which delivered results as follows: earnings per share excluding certain items were $0.25. Note that we had several certain items that impacted our reported EPS and resulted in an effective tax rate of more than 76% in the quarter. The largest of these was a noncash tax charge that reduced earnings by $0.23 per share. Bill will provide more details on this momentarily. Sales increased in all geographic areas. Importantly, we achieved a new quarterly sales record in the emerging geographies. In fact, this quarter our sales in emerging geographies reached 35% of total global sales, hitting our stated medium-term target. The benefits of our broad and growing global footprint were evident in our volume results,…

Thank you, Andrew. I'll be starting on Slide 10. Dow posted sales of $14.1 billion, up 5%, excluding divestitures. On a reported basis, we posted a loss of $0.02 per share. Earnings, excluding certain items, were $0.25 per share with EBITDA of $1.8 billion on the same basis. Certain items in the quarter included a tax charge for setting up a valuation allowance related to losses in Brazil of $264 million, which is equivalent to $0.23 per share. The valuation allowance will not impact our ability to utilize the Brazil tax loss carry forwards in the future for our cash tax rate. Our 2012 global estimated tax rate remained in the 20% to 25% range, as we previously communicated. Now turning to volume trends in the quarter on Slide 11. Overall, volume was flat year-over-year, as our emerging geographies delivered growth of 7%, fully offsetting weak demand in the developed regions. This was led by China, which was up an impressive 12%. Looking across our operating segments, Agricultural Sciences, Performance Plastics and Feedstock and Energy all reported volume growth. Coatings and Infrastructure Solution reported a decline in volume due to persistent headwinds in the construction industry. Electronic and Functional Materials saw a reduction in demanded due to recognized softness in electronics. Now moving to price on Slide 12. We achieved a 5% increase versus the fourth quarter of last year. Increases were broad based and led by Feedstock and Energy, which was up 11%. I'd like to provide some insight on the key drivers of our operating performance this quarter. As we've mentioned, broad-based price increases more than offset the rise in purchased hydrocarbon energy costs. However, our operating rate fell 9%, meaning we recovered less of our fixed costs due to lower demand, customer destocking and working capital management.…

Thank you, Bill. 2011 was a year in which Dow demonstrated its strong resolve, firm financial discipline and focus on operational efficiency. Moving forward, you can expect more of the same. Execution must and will be our #1 priority. Turning to Slide 18. Over the next few minutes, I'd like to provide some granularity on our expectations for 2012, how Dow is prepared to stay the course and deliver on our strategic priorities; leveraging our formidable feedstock advantage, something that will play into our strengths as the year progresses; pivoting integrated technology-rich portfolio and geographic reach to capture growth where it is happening most rapidly; advancing traction of our newly launch innovations with a focus on impact to the bottom line; and continuing to drive our operating and capital efficiency, pulling levers to mitigate risks and ensure we remain firmly on track to reach our near-term targets. So covering each in turn, on Slide 19, first, our unique ability to take advantage of attractive shale gas dynamics and the ethylene cycle. Today, 70% of our global ethylene assets are in cost-advantaged regions, with trapped gas in Canada and Argentina, as well as advantage feedstock positions in the Middle East and of course, the United States, giving Dow a huge advantage. Take for example the U.S. Gulf Coast, where ethane-based assets have fallen dramatically down the cost curve. Dow is at the epicenter of this trend. We invested more than $500 million between 2005 through 2008 to increase our feedstock flexibility, and these investments are driving bottom line results today, yielding margins that are better than the industry average. Now there has recently been a great deal of discussion regarding supply and demand dynamics for ethane in the United States. As a reminder, we were among the first to declare a…

Thank you, Andrew. Now as we move on to your questions, I'd like to remind you that my comments regarding forward-looking statements and non-GAAP financial measures apply both to our prepared remarks and the following Q&A. Alicia, will you please explain the Q&A procedure?

[Operator Instructions] We'll go first to John McNulty from Crédit Suisse.

A question on the cost-cutting and efficiency improvements, it looks like it should be a decent tailwind for you in 2012. I know originally when you had outlined, I guess, the -- all the potential cuts at your Investor Day, some of them were maybe more extreme for more extreme environments. They also might, at least in the near term, nick some of the growth. Have you started to implement those? Or are these more some of the moderate ones and you still have a lot more levers to pull?

The latter, John. Clearly, the latter. We have not cut into muscle. We still have lots of funds for growth. We're just being strict to portfolio and prioritization, especially against Western Europe lags. So some of the more commodity-oriented businesses in Western Europe, for example, are being de-resourced. And we will assess as the year goes by how much of that is a structural fix versus; just a temporary fix.

Great. And maybe just as a follow-up, you'd indicated your December operating rates jumped about 7% if I remember correctly. And I guess I'm wondering what actually drove that. Did you shut facilities down? Or I guess, how do you -- how do -- how should we think about that in terms of the sustainability of those operating rates?

With notable exception in Plastics where we actually pushed price in the quarter. We, in early November, as a team, put our heads together and pushed volume. We basically made the decision that this was a temporary restocking event, that this wasn't structural, that as a consequence of that, all of our low-cost positions around the world, notably the U.S., should be maximized in terms of operating rate. So we started pushing volume around the world where growth was -- is, and that absolutely, totally helped the operating rate.

We'll go next to Don Carson from Susquehanna International.

Andrew, how quickly can your -- will the ethane benefit flow through to your North American ethylene business. We've seen -- I think yesterday we you saw $0.52 ethane, down significantly. Is there an inventory lag there? And you talk about, on a more structural basis, ethane going long. I mean, where do you see ethane bottoming in terms of maybe not absolute price but percentage of its fuel value? And what kind of advantage does that provide for Dow?

Yes. So obviously, the margin recovery from the, let's call it, north of $0.90, the ethylene margins are starting to come back quite substantially here in the United States based on the ethane number. I think this morning, it was around $0.54, from memory. Look, Don, this is a little bit of hit and miss in the first half because it's still fairly tight based on demand. But of course with turnarounds, I mentioned in the script, turnarounds are coming in Q2, so we should expect to see some tailwinds on this current margin through the first half. I think the really positive margin expansion will come when structurally all the ethane comes on in the second half, late second half and for sure to 2013. The $6 billion, 2 new pipelines, lots of fractionation coming on. So we believe that this point you're making about where it will start to mimic fuel-value relationships, I think, will be for sure in 2013 but some tailwinds going into second half and some good, good margin expansion in the second half.

And just a follow-on on restocking. You thought you'd -- that restocking would soon occur. Are you -- We're seeing signs of that in North America. Are you seeing any signs in Asia of restocking in the polymer chain?

Yes, we are. And of course, they've got the extra issue of high naphtha. So they're really struggling in the price increases out there. So there's a price increase environment as well as good demand going on in the order book mostly because of post-Chinese New Year. As we said we would, it's really picking up. Actually, demand was going up going into the holidays this year.

We'll go next to Kevin McCarthy with Bank of America Merrill Lynch.

Maybe just a follow-up in a similar vein, Andrew. It sounds as though your outlook is more constructive on 2Q relative to 1Q. You got to bounce in December operating rate. It looks to us like polyethylene got $0.05 in December for the industry and if I look at your ethane sensitivity that you outlined, that should be about $0.5 billion or more on an annualized basis just in January. And so I wonder if you can elaborate. Are there kind of timing issues, lag effects or perhaps hedge positions that would cause a somewhat more delayed positive responses that flows through your financials?

Well, I think if you stay within the polyethylene envelope, I think is a very similar previous answer to Don. I think you're going to see price power plus good volume demand based on Asian dynamics as well as U.S. dynamics with exports. Probably mid-quarter, we'll see some good tailwind on margin expansion, but you won't see it annualize to usual numbers until Q2. So we -- there are, in fact, some headwinds going on. Clearly, we also, for Dow, we have turnarounds at the industry, so we won't have the full force of the operating rate until Q2, until those turnarounds are done. Q2 is the big spike in turnarounds by the way. But -- so we're cautious on Q1 but a little more bullish on Q2 and strong on back half of the year. Just to remind you, of course, outside of those envelopes, there's a C3 headwind that we're facing, and we're cautious on Electronic Materials recovery in Q1, so that's as a whole company as well as still a weak construction sector. But PE, polyethylene and Performance Plastics should get tailwind starting really probably like December. They'll have price increases in the first quarter, and we should see good tailwinds throughout the year.

And just as a follow-up, Andrew, what drove the double-digit increase in polyurethanes volume?

Well, the previous answer to my previous question, we had to make a structural decision. Do we bring down plants, take that cost? Or do we cover variable costs and move off low-cost positions? So our company went into strong volume year in November.

We'll go next to Hassan Ahmed from Alembic Global.

We've obviously chatted a bit about the ethane side of things. Just wanted your views on the propylene side of things. Obviously, propylene prices have come down a fair bit through the course of last year. Where do you see propylene prices going through the course of this year and next? And in terms of your margin expansion as a result of that, where do you see that?

Yes. So propylene in our view is starting to increase because of its alternative value, and gasoline has risen dramatically since January, effective price settlement for February. In fact, there's a propylene producer out there nominating a $0.22 per pound increase in February. CMAI estimates $0.12. We believe propylene will stay elevated because of these dynamics through the early summer. That adds a lot of emphasis in our Performance Materials group, particularly polyurethanes but beyond that to really get strong pricing increases out there, which is what our mode is. Epoxies will be challenged though because of operating rate and epoxies not supporting strong price increases, especially in allylics and phenolics. So that will be a headwind for us, but PU will be -- is pushing price increases as are all the other propylene derivatives. But it will be tough margin operating territory for the first half. Cost interventions will start taking hold to help margin expansion in the second half.

And Andrew, on the polyurethane side of things, which end market in particular are you seeing strength in? Is it auto? Is it -- I mean, obviously housing continues to be decently sluggish.

But polyols as a whole is doing very well, which is a very strong statement. So that means beyond just automotive. Yes, automotive, as we've seen with our auto companies. The automotive companies are coming off their bottoms and doing well. But we're seeing good use of polyurethanes in polyols in order -- in bedding, in furniture, so that implies good consumption at the consumer level in Asia in particular and the growth regions and some in the United States. In the U.S., we're seeing good use of polyurethanes in energy efficiency end use for our formulated systems.

We'll go next to Peter Butler with Glen Hill Investments.

If you look at the longer term beyond the really bad economic problems we're all facing, it sounds like maybe you're taking another look at the hand of cards that were dealt to you. And you sort of sound like you're liking the longer-term position of Dow a lot more than, say, a year ago, 6 months ago in regard to your raw material position and your emerging geographies. Do you think that is a good observation? And would you like to comment on possible adjustments of your 2015 targets?

Yes, Peter, that's a great question. Thank you. The 3-legged stool of the company, 2 legs have become very strong. The feedstock advantage position in the United States and Canada, with currently good old Canada, North America and our position in the emerging world, Argentina and soon Saudi Arabia 2015 and beyond gives us a very strong leg there. Second, the integration to downstream businesses whether it be polyurethanes or polyethylene and all the Plastics that will go into packaging, et cetera, very, very strong leg and then the third leg, which is the innovation agenda. But all of that has now given Dow 3 very strong legs. On top of that, our well-known operating efficiency. So this is a little bit of your mother and father's Dow combined with tomorrow's Dow. There was an article in Wall Street Journal today about whispering plastics in someone's ear. I think our type of plastics, high tech solution polyethylene going into high-end use markets and our integrated position down the chain in key markets, in emerging markets, gives Dow very strong 3-legged stool.

So if you had to make the predictions for 2015 today instead of last year, it sounds like those numbers would be going up.

Yes. So the $2 billion I referred to in just the feedstock advantage alone, we have $2 billion innovation agenda. So that's $4 billion of decline from '10 to '15. So what we're talking about here is we're on track for the '15. We're on track for the '10, and we certainly are on track to deliver, I guess, our commitments this year, resolute focus on that trajectory.

On a sort of separate subject. Why is the Kuwait decision delayed so much? It seems like from the outside that it's a simple legal question that you guys should win. Why is it taking the judges so long?

The enormity of the case. It's from a legal point of view -- I mean, you saw the Exxon case just recently. This is very much bigger than that case even. So I can't speak to the court system in -- the arbitration panel system in Britain or for that matter, the international court. It's -- this is just a very big case. So there's no speculation here because of any issue on outcome. It's all just the enormity of it. We don't control the time, but it's days and weeks, not months.

We'll go next to Andy Cash with UBS.

Just a couple of questions. First, on the ethane advantage, now this might be around for a few years, maybe longer. But given the horizontal drilling and frac-ing technology could be exported to other regions outside of North America, what is Dow doing? Or what can Dow do to lock in that advantage for the very long term and not just for the next few years?

Yes. So we talked about this a bit. We certainly aren't going to reveal our own hand, because there's a lot of guys out there in the business production and pipeline to have their views on things. And what we like about all of this, Andy, is that we're by far the largest consumer. So our U.S. Gulf Coast consumption of ethane, for example, is 115,000 barrels a day. So we're not going leave our sales market exposed in case the impossible happens, which in my view, you should never say it never can happen. And that is we get LNG global netback pricing into the United States. If that ever happens, the U.S. has done a very nice job of shooting itself in the foot, we can't rely on politics nor export terminals being built and for that matter, restraint supply. So we are working on ways to hedge and hedge so that we're not exposed to that dynamic.

Okay, my second question is it's not too long ago Dow was emphasizing -- I mean, you're still talking about your specialty businesses, but you used to emphasize them a lot more. And in sitting back then, the Dow was planning on topping its stock price with a specialty chemical multiple, and so now it seems like you guys are more emphasizing the commodity side of the business. You're really excited about that. So as you think about the stock in the next few years, is Dow thinking that the profit improvement over the commodity side will more than offset a lower valuation for the company's commodity business?

Well, I mean, you heard my 3-legged stool commentary earlier. And so clearly, one big leg of the stool is innovation and downstream and value add. Look, I think this whole commodity versus specialty thing is yesterday's conversation. I think today's conversation is who's got the scale to take the value add of low-cost feedstocks all the way to value add in the marketplace to be a diversified, integrated industrial in the space that takes material science, biological science and chemical science to value add based on low-cost positions and scale that can afford the R&D. In my view, that is new space in the, let's call it, the domain of value add, and the value add comes from 2 big bites: the bite of the feedstock end and the bite at the value-add customer end. That's the company we're creating. I'm not going to chase some multiple, Andy. I'm going to chase results. And we're going to, as I said on the call, deliver all this cash and reward our shareholders handsomely.

We'll go next to Bob Koort from Goldman Sachs.

Andrew, there seems to be some debate on ethane from the suppliers and the producers about the direction of future prices and I guess whether the last 18 months have been an aberration or a new normal. So I had 2 questions for you there. First, based on your experience when these pipelines are constructed or fractionation units built, is there a reasonably quick ramp of supply that comes from them so that you can have some confidence that ethane will show up in the Gulf Coast? And then secondly, obviously the only use for ethane is to make ethylene and the only value-added use. And it seems like there could be an awful lot of ethane swimming around before any greenfields are built. So given that you guys are one of the ones building a greenfield, what is the potential timing when you might actually start opening a valve and using ethane for a new global-scaled cracker?

Yes. So last question first. Just a little correction, we're not going to build a greenfield, we're going to build a brownfield. It will be a world-scale, ethane-based cracker. And we've announced that we're working on location, most likely Texas. And we are working to consume as much of that excess ethane that you've just talked about as we can. And your first question then, if you look at Alberta, if you look at Conway hub and if you look at what can be in the U.S. Gulf Coast, I think you've got yourself 2 analogs. I think the fractionation of the pipelines will create excess supply. We are by far the biggest demand. And we're going to participate in the distribution. We'll also buy and resell ethane to make your point. So yes, as it's only use, we will expand against -- that's the $4 billion program we announced. We will expand, and you can count on us putting a world-scale cracker in place to use that ethane for value-add uses for Dow. And our view is we can bring that on in the 2016, 2017 timeframe.

And Andrew, you signed an agreement with Range and they're going to pull some Marcellus ethane down in the Gulf Coast, but you've also got a lot of politicians chasing grassroots plants up in the Marcellus themselves. So is there any risk if Shell and somebody else builds a new cracker that there won't be enough Marcellus ethane to get down to the Gulf Coast?

Short answer is no.

We'll take the next question from David Begleiter from Deutsche Bank.

Andrew, on the same ethane issue, we've seen absolutely low net gas prices result in some shutdowns by drillers. Any concern that these low net gas prices do impact drilling activity and hence, liquids supply going forward?

Yes, we definitely believe that this new sub-$3 per million Btu natural gas number is not sustainable for that exact reason. So we see -- we still see natural gas in the United States climbing back to the $4 to $6 range through the decade to enable the cost of producing the shale, the natural gas from shale to obviously achieve breakeven and a return to the drillers. It doesn't affect the current stuff that's being put in place for NGLs. NGLs is still a very high return for everybody. In fact, you've got lots of producers who want to produce the gas just for the NGL. So it really comes back to the earlier question that Andy asked, which is how can we lock in the NGL advantage while there's excess NGLs over these next last couple of years. And you can really, really count on us to be working on that.

Andrew, just -- and also just your review on propane given that, I think, we're about to double export, propane export capacity this year and the potential for your on purpose propylene that's going forward and what feedstock they might use?

Yes. Clearly, clearly propane is a completely different dynamic. I -- you're exactly right, propane unlike ethane dynamic. So PDH, for us, is a no brainer. I mean, we have announced the 2 world scales. We are moving on the first one, and we'll move on the second one. We'll become 90% integrated as a result, and all value-add downstreams and propane will be exported from the United States for a long time.

We'll go next to P.J. Juvekar with Citi.

You were expanding most of your ethylene on the Gulf Coast. Can you review your Canada strategy, given your advantage ethylene and ethylene glycol capacity there?

Yes. So any global has the ethylene glycol capacity, as you know. We have our polyethylene plants up there, solution polyethylene as well as couple of swing trains. And we clearly, clearly have a advantaged position as I mentioned on an earlier question, the lowest cost, actually, in North America. We're working with MEGlobal on exactly your question. So they are keen on expanding. We are too and for the same reason, which is exports to Asia. And so we will have more to say on that in the next 6 to 12 months, but you can count on us having that same view on Canada as we do on the U.S. Gulf Coast.

Okay, and then...

Great. Operator -- sorry, go ahead P.J., one more follow-up?

Sorry. I would just have a quick question that, Andrew, you have a stated goal of reducing debt and no M&A. But there are other companies in the industry you were saying that rates are extremely low [indiscernible] , so it's not a bad time to do M&A. So how do you sort of balance that debt grade down losses any potential M&A?

I'll let Bill chime in here, give him a chance to say something. We look -- yes, I mean, we understand the dynamic around the financial -- the compelling reason from a financial point of view of doing M&A. But the cheapest M&A I have is in-house. We have so much organic growth opportunities. I don't need to go pay a premium for someone else's position. We have all the positions we need. So clearly, clearly we are very focused on growing organically and returning excess cash to our shareholders. And that's the march and the drumbeat from Dow. Bill?

I would just echo the same comment, P.J., is that we have significant amount of opportunities in-house, and so we don't need to go outside to get growth. So it's really different from that perspective.

Operator -- Andrew, would you like to make a few comments?

Yes, so look, I look forward to follow-up questions, and, of course, thank you for the ones that did get in. We had a very good year in 2011. And the drumbeat of Dow is to continue to grow earnings and to grow our EBITDA. We have some tailwinds with the line of questions on ethane and hydrocarbons in our U.S. Gulf Coast position, our Canadian position and of course our Argentinian position. But we also have a diversified portfolio that is growing in the emerging world. 35% of our revenues coming from the emerging world is something for you guys to pick as -- to take notice of. That's $19 billion of revenue and growing at double-digit rates. So we believe that 2012 will be yet another year in our march to $15 billion. And we thank you for your great interest and support, and we look forward to more conversations and of course, rewarding our shareholders.

Thank you, everyone, for your questions and for joining us this morning. We appreciate your interest in the Dow Chemical Company. For your reference, a copy of our prepared comments will be posted on Dow's website later today. This concludes our call today, and we look forward to speaking with you again. Thank you.

That does conclude today's conference. We thank you for your participation.