Dow Inc. 2019 Second-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 six months ended June 30, 2019. Dow Inc. became an independent public company on April 1, 2019, following the separation of DowDuPont’s materials science business. The Dow Chemical Company is Dow Inc.’s wholly owned subsidiary and predecessor for periods before April 1, 2019.
Dow’s continuing operations comprise Performance Materials & Coatings, Industrial Intermediates & Infrastructure, and Packaging & Specialty Plastics. Agricultural sciences and specialty products are presented as discontinued operations in prior-period comparisons.
Key financial metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $11.014 billion | $12.789 billion | $21.983 billion | $25.026 billion |
| Income from continuing operations | $90 million | $810 million | $246 million | $1.735 billion |
| Net income available to Dow Inc. common stockholders | $75 million | $1.333 billion | $631 million | $2.737 billion |
| EPS from continuing operations | $0.10 | $1.05 | $0.26 | $2.26 |
| Operating cash flow from continuing operations | Not separately provided for the quarter | Not separately provided for the quarter | $2.003 billion | $1.504 billion |
| Free cash flow, non-GAAP | Not separately provided for the quarter | Not separately provided for the quarter | $1.091 billion | $1.292 billion |
- Q2 net sales declined 14%, driven by a 9% decline in local price and product mix, a 4% volume decline, and a 2% unfavorable currency impact. All operating segments and geographic regions reported lower sales.
- Cost of sales was $9.420 billion, or 85.5% of sales, versus 82.4% in Q2 2018. Six-month cost of sales was 84.4% of sales versus 82.0% previously, indicating margin pressure despite lower feedstock costs and cost reductions.
- Q2 income from continuing operations before taxes was $215 million, compared with $1.059 billion in the prior-year quarter. Dow Inc.’s effective tax rate was 58.1% versus 23.5%; the increase reflected, among other items, separation-related and non-deductible restructuring effects.
- Integration and separation costs increased to $348 million for Dow Inc. in Q2 and $800 million for the first six months, compared with $262 million and $486 million, respectively, in the prior-year periods.
- Equity earnings from nonconsolidated affiliates declined to a $15 million loss in Q2 and a $29 million loss for the first six months, primarily because of increased Sadara losses and lower earnings from Kuwait and Thai joint ventures.
- Capital expenditures were $470 million in Q2 and $912 million year to date; depreciation was $538 million and $1.081 billion, respectively.
Liquidity, debt and capital allocation
- At June 30, 2019, Dow Inc. had $2.446 billion of cash, $20 million of marketable securities, $17.996 billion of gross debt, and $15.530 billion of net debt. Net debt was 45.6% of total capitalization, compared with 33.7% at December 31, 2018, primarily because separation-related adjustments reduced equity.
- Total committed credit facilities were $9.636 billion, including $7.636 billion available. The company reported compliance with its debt covenants; the principal revolving-credit covenant ratio was 0.49 to 1.00 versus a maximum of 0.65 to 1.00.
- Dow issued $2.0 billion of senior unsecured notes in May 2019 and redeemed $1.5 billion of 4.25% notes in June. Dow Silicones also repaid $2.5 billion under its term loan and intends to extend the remaining $2.0 billion for two years.
- Dow Inc. paid a quarterly dividend of $0.70 per share and repurchased $305 million of common stock. Approximately $2.7 billion remained under the $3.0 billion repurchase authorization at June 30.
Material changes versus the prior comparable period
- The separation from DowDuPont materially changed the company’s capital structure, ownership, reporting presentation, related-party relationships, and equity balances. Prior periods were retrospectively adjusted for discontinued operations and common-control transactions.
- Compared with Q2 2018, sales declined across all segments: Performance Materials & Coatings fell 10% as reported, Industrial Intermediates & Infrastructure fell 16%, and Packaging & Specialty Plastics fell 15%.
- Q2 Operating EBIT was $214 million for Performance Materials & Coatings, $154 million for Industrial Intermediates & Infrastructure, and $768 million for Packaging & Specialty Plastics. The latter two segments were pressured by lower prices, margin compression and weaker equity earnings.
- Cash flow from continuing operations increased year over year despite lower earnings, reflecting improved working-capital movements, customer advance payments, lower pension contributions, and higher dividends from affiliates.
- The company adopted the new lease standard in 2019, recording approximately $2.3 billion of operating lease right-of-use assets and lease liabilities at adoption. The adoption did not materially affect earnings or cash flow.
Guidance, outlook, risks and unusual items
Management stated that global growth continues but has slowed, with cautious buying patterns related to trade and geopolitical uncertainty. Dow plans to maintain cost and operating discipline, reduce planned 2019 capital expenditures from $2.5 billion to approximately $2.0 billion, continue cost-synergy and stranded-cost actions, and protect high-return growth projects. Management expects an additional $300 million to $400 million of cash expenditures for integration and separation activities through year-end and approximately $175 million of additional Synergy Program cash expenditures, primarily through the end of 2019.
- The company postponed construction of a planned 450 KTA European polyolefins facility after reviewing project returns and expected demand.
- Dow expects to loan up to $500 million to Sadara during the remainder of 2019; some or all of those loans could be converted to equity.
- Environmental remediation liabilities were $796 million, with potential costs for recorded matters estimated to be as high as approximately 2.5 times the accrued amount. Management also indicated that additional environmental charges could increase by up to $400 million as reviews continue.
- Asbestos-related liabilities were $1.218 billion at June 30, 2019. The company cannot estimate the full range of costs for pending and future asbestos claims.
- Dow Silicones’ recorded implant liability was $263 million, but the potential liability could reach $2.183 billion if the maximum capped funding obligation were required. Commercial creditor exposure was $84 million within an estimated range of $77 million to $260 million.
- Dow’s guarantees totaled $4.123 billion, principally relating to debt of nonconsolidated affiliates, including up to approximately $4.1 billion of guarantees for Sadara project financing. The guarantees were expected to be released after project-completion conditions were satisfied.
- Other key risks include raw-material and energy-price volatility, demand and pricing pressure, currency movements, supply disruptions, litigation and environmental matters, execution of the separation, indemnification obligations to DuPont and Corteva, access to financing, and risks associated with operating as a standalone company.
Most important facts for an investor to verify
- Whether lower pricing, volumes and equity earnings stabilize or continue to pressure segment margins.
- The pace and ultimate cash cost of separation, restructuring, stranded-cost removal and related indemnification obligations.
- Progress on reducing leverage and maintaining liquidity following the separation-related reduction in equity.
- Sadara’s operating performance, further funding requirements and potential conversion of loans to equity.
- The status and ultimate cost of environmental, asbestos, Dow Silicones Chapter 11, and other litigation contingencies.
- Whether the approximately $2.0 billion 2019 capital-spending plan and approximately $500 million full-year share-repurchase target remain achievable.