Dow Inc. 2019 Third-Quarter Form 10-Q Summary
Business context and reporting period
Dow Inc. and The Dow Chemical Company filed a combined unaudited Form 10-Q for the quarter and nine months ended September 30, 2019. Dow Inc. became an independent publicly traded company on April 1, 2019, following the separation of DowDuPont’s materials science business. Historical results are those of The Dow Chemical Company, the predecessor to Dow Inc. The agricultural sciences and specialty products businesses are presented as discontinued operations, while the ethylene and ethylene copolymers businesses received from Historical DuPont are reflected as a common-control transaction.
Dow operates through Packaging & Specialty Plastics, Industrial Intermediates & Infrastructure, and Performance Materials & Coatings. The filing’s comparisons are affected by the separation, changes in intercompany pricing, stranded-cost allocations, and pro forma adjustments.
Key financial metrics
| Dow Inc., in millions except per-share data | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $10,764 | $12,634 | $32,747 | $37,660 |
| Income from continuing operations | $347 | $714 | $593 | $2,449 |
| Net income available to common stockholders | $333 | $1,013 | $964 | $3,750 |
| EPS from continuing operations | $0.45 | $0.91 | $0.71 | $3.17 |
| Cash from operating activities | Not provided quarterly | Not provided quarterly | $3,980 total; $3,793 continuing | $2,524 total; $1,707 continuing |
- Sales: Q3 sales declined 15%; nine-month sales declined 13%. The Q3 decline reflected a 12% decrease in local price and product mix, a 2% volume decline, and a 1% unfavorable currency effect. Nine-month results reflected a 10% local-price decline, a 2% volume decline, and a 2% unfavorable currency effect.
- Profitability: Q3 net income attributable to common stockholders fell 67% year over year; nine-month income fell 74%. Approximate net margin attributable to common stockholders was 3.1% in Q3 2019 versus 8.0% in Q3 2018, and 2.9% for the first nine months versus 10.0% previously.
- Costs: Cost of sales was $9.4 billion in Q3 and $27.9 billion for nine months. Cost of sales as a percentage of sales increased to 87.1% from 82.8% in Q3 and to 85.3% from 82.3% for nine months, primarily reflecting environmental charges, lower pricing, and weaker operating conditions.
- Cash flow and capital spending: Continuing-operations operating cash flow was $3.793 billion, compared with $1.707 billion in the prior-year period. Management’s non-GAAP free cash flow was $2.409 billion, compared with $919 million, after $1.384 billion of capital expenditures. Full-year 2019 capital spending was expected to be approximately $2.0 billion.
- Liquidity: Cash and cash equivalents were $2.823 billion at September 30, 2019. Dow reported $7.617 billion of available committed credit facilities within $9.617 billion of total commitments. The current ratio was 1.69:1.
- Debt: Dow Inc. reported gross debt of $18.108 billion and net debt of $15.274 billion. Net debt was 45.9% of total capitalization, up from 33.7% at December 31, 2018, primarily because separation-related changes reduced equity. The filing states that debt covenants were satisfied.
- Shareholder returns: Dow paid $1.033 billion of dividends to common stockholders during the first nine months and repurchased $406 million of stock, including $101 million in Q3. Approximately $2.6 billion remained under the $3.0 billion repurchase authorization.
Material changes versus the prior comparable period
- All three operating segments reported lower Q3 sales and operating earnings. Q3 Operating EBIT was $798 million for Packaging & Specialty Plastics, $193 million for Industrial Intermediates & Infrastructure, and $200 million for Performance Materials & Coatings.
- Q3 pro forma Operating EBIT declined to $1.117 billion from $1.611 billion in the prior-year comparison. Nine-month pro forma Operating EBIT declined to $3.319 billion from $4.947 billion.
- Industrial Intermediates & Infrastructure was particularly weak: nine-month pro forma Operating EBIT fell 56%, primarily from margin compression, lower joint-venture earnings, and increased losses from Sadara.
- Performance Materials & Coatings nine-month pro forma Operating EBIT fell 34%, primarily because of siloxanes margin compression, weaker volumes, and higher maintenance costs.
- Equity earnings from nonconsolidated affiliates changed from earnings of $135 million in Q3 2018 to a $44 million loss in Q3 2019, and from earnings of $529 million to a $73 million loss for the first nine months.
- Integration and separation costs declined to $164 million in Q3 from $313 million, but increased to $964 million for the first nine months from $799 million. These costs were expected to be substantially complete by the end of Q2 2020.
- Operating lease right-of-use assets and lease liabilities of approximately $2.3 billion were recorded upon adoption of the new lease standard in 2019.
Guidance, outlook, risks, contingencies and unusual items
Management did not provide specific revenue or earnings guidance in the filing. It stated that Dow would focus on feedstock flexibility, lower-risk growth investments, stranded-cost removal, free-cash-flow improvement, debt reduction, and maintaining financial flexibility. Management expected sufficient liquidity to meet operating, capital, debt, pension, dividend, and other obligations.
- Unplanned outage: A countrywide power outage in Argentina shut down Dow’s ethylene operations for the entire quarter and generated repair, cleaning, and downtime costs.
- Environmental charge: Dow recorded a $399 million pretax environmental charge, net of indemnifications, in Q3. Environmental remediation liabilities totaled $1.193 billion at September 30, with ultimate costs potentially reaching approximately 1.5 times the accrued amount.
- Litigation items: Q3 included a $170 million gain related to the Nova ethylene asset matter and a $186 million pretax judgment gain overall. Nova subsequently paid approximately $1.08 billion Canadian dollars in October, while certain amounts remained subject to appeal. Dow also recorded a $98 million reduction in its breast-implant liability, partly offset by a $13 million related receivable charge, and a $50 million net charge for Dow Silicones commercial creditor settlements.
- Sadara: Sadara’s strategic review and impairment analysis were expected in Q4 2019. Dow’s $1.581 billion equity investment could be subject to an other-than-temporary impairment, potentially up to the carrying value.
- Restructuring and divestiture: Q3 restructuring and asset-related charges were $147 million, including a $75 million impairment associated with the planned sale of the acetone derivatives business. Additional Synergy Program cash expenditures of approximately $150 million were expected, primarily through year-end.
- Separation obligations: Dow recorded assets and liabilities related to indemnification, tax, and other agreements with DuPont and Corteva. Certain indemnification obligations are uncapped, subject to contractual conditions.
- Other contingencies: The company had $1.192 billion of asbestos-related liabilities, guarantees with maximum future payments of $4.116 billion, and a 35% share of Sadara project-financing guarantees of up to approximately $4.1 billion. Management considered payment under the guarantees remote, subject to project-completion conditions.
- Subsequent financing: Dow announced a make-whole call of $1.25 billion of notes due 2021 and later issued approximately $1.5 billion of commercial paper after quarter-end.
Most important facts for investors to verify
- Whether weaker pricing, volumes, and joint-venture results are cyclical or indicate sustained pressure on chemical margins.
- The outcome of Sadara’s Q4 impairment analysis and the potential effect on Dow’s equity investment and earnings.
- The cash and accounting impact of environmental remediation, asbestos matters, Dow Silicones liabilities, and separation-related indemnifications.
- Whether the reported improvement in operating cash flow and free cash flow is sustainable after working-capital changes, customer advance payments, and separation-related items.
- Progress toward the company’s capital-spending, restructuring, stranded-cost, dividend, debt-reduction, and share-repurchase objectives.
- The effect of the Argentina outage, the acetone derivatives divestiture, and other operational disruptions on future segment performance.
- Post-separation comparability, including pro forma adjustments, discontinued operations, related-party financing, and changes in segment allocation and transfer-pricing practices.