-- Buying 800 shares of Dow Chemical (DOW) at about $52.89.
After you have received this Alert, we are going to add a new position to the portfolio by buying 800 shares of Dow Chemical (DOW) at about $52.89.
One reason is that we want more late-cycle exposure. As the recovery of the U.S. economy continues, we expect inflation to creep higher, giving the commodity companies more pricing power. Another reason is that this is a restructuring story, as the company has several self-help actions under way to drive better earnings. In some ways, this reminds us of the DuPont (DD) story from a few years ago, as that company transitioned from a commodity-exposed chemical company into a specialty one. That resulted in higher growth, better earnings and a re-rating of the shares. We continue to like DuPont, but we see more upside to Dow Chemical.
Dow is the second-largest global chemical company. It provides chemical, plastic and agricultural products to a variety of end markets in food, transportation, health and medicine, personal and home care and construction. It has more 50,000 employees, more than 5,000 products and a presence in 36 countries. The North America region and the Europe, Middle East and Africa region each account for one- third of total sales, followed by Asia and Latin America.
The company is transitioning from commodity exposure toward more specialty-focused products, and it is selling assets and re-positioning its portfolio. Management has made a shift in its thought process and is focusing on earnings, EBITDA and enterprise value. As a result, it is evaluating all of its assets, especially those that don't justify reinvestment. It is focused on businesses that have strong market share, monetizing its pipeline and identifying value creation, being excellent at eight to 10 segments in which it can excel and where it has scale and can add value. And importantly, it is making the commitment to higher-growth end markets such as agriculture (where it has doubled in value over the past five years) and energy and shale exposure.
In addition, Dow is optimizing its portfolio and is divesting its chloralkali, chlor-vinyls, chlorinated organics and epoxy businesses. Those divestitures should garner $3 billion to $4 billion in proceeds and should be completed by year-end (we should get updates along the way throughout the second half). This will be a positive catalyst for shares, and it's a big reason we want to be involved ahead of time. But management has made it clear that all of its operations are under review, so we wouldn't be surprised to hear about more divestitures.
In addition to streamlining its business mix, it has an aggressive productivity program under way that it announced two years ago. The measures include cutting selling, general and administrative costs and research and development, focusing on margin (hedging better against feedstock costs) and better working capital efficiency.
The company has margin expansion targets for every segment. The electronics division currently has an adjusted EBITDA margin of 23%, and the company plans to get it to 25% by growing its technology capability and focusing on customer solutions. Coatings and infrastructure margins are currently at 13%, and the company plans to get that to 20%-25% via better cost controls, improving its product mix and higher utilization rates. Agriculture margins are 14%, and the company's goal is to get to 25% via product innovation. Performance materials margins are currently 11%, and the company wants to get to 15%-18% via cost-cutting and productivity efforts. Performance plastics margins of 18% should get to 20%-25% as the company expands its end markets and introduces new products. Feedstock and energy margins of 8% should get to 8%-12% as the company focuses on costs and improvement in hedging.
The message from the company is that it is making a big effort on returns and getting them higher, and it's encouraging that it has identified profitability targets for each segment. Management guided to $350 million in savings by 2015 from this program and $10 billion (plus) by 2015. Other initiatives under way are lowering its pension expense and improving operating leverage and productivity. We will hear more about these efforts at its analyst day, which is expected in the second half of 2014 -- that will be another positive catalyst.
The other opportunity we see is leveraging its balance sheet and creating more shareholder value in buybacks and dividends. Currently, the company's net debt to EBITDA is 1.6x and below its historical 2x threshold. It currently has a $4.5 billion buyback program underway ($3 billion remaining) -- we see this likely increased over time. In addition, the company will pay down some of its higher-cost debt, and that will also help earnings.
Much of these efforts have been under way over the last few years, but we believe that the involvement of Dan Loeb's Third Point in the shares has put additional pressure on the management to deliver the goods. Loeb added Dow Chemical to his $14.3 billion hedge fund in January, and he has publicly stated that he wants the company to split up and sell several of its segments -- namely selling its ethylene, propylene and other basic petrochemicals. We believe the company is undertaking these sorts of moves, and this will lead to better growth, higher earnings and stronger returns. Shares trade at a reasonable 14x forward estimates and carry an attractive dividend yield of 2.8%. Our 12-month target is $65.
After our trade, we will own 800 shares of DOW, or 1.52% of the portfolio.