March1,2021 BARRON’S M3
age for stocks in the Dow Jones Industrial
Average, of which it is a component. Despite
their pessimism—and the stock’s recent
gains—it’s a good time to buy Dow.
Visiting a chemical plant is, frankly, a bit
of a letdown. There are miles of pipes. Ev-
erything is enclosed. Raw materials, which
are usually derivatives of oil and natural
gas, go in one end, and plastic products,
such as polyethylene beads, come out the
other end. There isn’t much to see. The
whole process feels like a black box.
That’s the way chemical stocks can feel
too. Chemical companies are, essentially,
spread businesses. They sell products, such
as plastic pellets, for pennies more than the
cost of the raw materials used to make
them. There are dozens of intermediate
products that are bought and sold. There is
more than one raw material too. Oil and gas
prices aren’t always equivalent for chemical
makers, and prices don’t always move in
lockstep with one another—just ask resi-
dents of Texas about recent natural-gas
pricing. The complexity makes commodity
chemicals a bit of a “trust me” business.
And 2020 wasn’t a trust-me year. As the
pandemic hammered the global economy,
Dow stock was moribund. It rose a measly
1.4%, excluding dividends, trailing the S&P
500’s 16% gain. That return wasn’t reflec-
tive of the company’s performance, however.
Dow generated a boatload of cash—roughly
$5 billion—even as its shares tumbled to
about $22 from north of $50.
“[We] are a cash-generating machine,”
Dow Chief Financial Officer Howard Un-
gerleider recently toldBarron’s. It’s a boast,
but one the company can back up.
What isn’t complicated is the dividend.
Dow stock yields about 4.7%, about three
times the S&P 500’s 1.5%. What’s more, the
dividend looks secure, thanks to all that
cash. Dow spent roughly 40% of its 2020
free cash flow covering the dividend. Dow’s
peers, includingLyondellBasell Indus-
tries(LYB) andEastman Chemical
(EMN), needed roughly 60% of 2020 cash
flow to cover their dividends. There is a
bigger margin of safety with Dow than
many other large, diversified commodity
chemical makers. That isn’t reflected in the
dividend yields, however. Many of Dow’s
commodity peers yield between 2% and
4%, while the chemical components of the
S&P 500 yield roughly 2.5%.
If Dow paid out 60% of its 2021 esti-
mated free cash flow and traded at a 4%
dividend yield, shares would be around
$75, up 26% from Friday’s close of $59.31.
That’s just one way to quantify the oppor-
tunity. Dow has cash, and the stock isn’t all
that pricey. Shares are trading at a free-
cash-flow yield of about 8% based on 2021
numbers, and the stock’s price/earnings
ratio is about 17. The S&P trades for about
22 times estimated 2021 earnings. It’s not a
bad setup for a stock that offers generous
quarterly dividend payments.
Wall Street hasn’t caught on yet, but a
few analysts are warming up to the com-
pany. BofA Securities analyst Steve Byrne,
for one, upgraded Dow shares to Hold from
Sell on Feb. 22, noting that product prices
for the U.S. chemical industry continue to
trend higher. His price target went to $64
from $53, though that isn’t exactly a ringing
endorsement. He joins 15 other analysts
who rate the stock Hold or an equivalent.
The number of Buy-rated analysts is
slowly increasing, however. They now
number six, up from four inNovember.
Fermium Research analyst Frank Mitsch,
for instance, cites Dow’s “impressive” free
cash flow, its “solid” management team,
and a “favorable” backdrop for chemical
companies as reasons to own Dow shares.
“The stock should work,” he says.
In fact, some might say that the stock
already is.—Al Root
Industry Action
Performance of the Dow Jones U.S. Industrials, ranked by weekly percent change.*
Oil & Gas 4.07%
–0.05 Financials
–1.78 Industrials
–2.07 Basic Materials
–2.12 Health Care
–2.50 Telecommunications
–2.63 Consumer Services
–4.62 Consumer Goods
–4.83 Technology
–5.19 Utilities
- For breakdown see page M32. Source: S&P Dow Jones Indices
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