The Urethane Blog

Dow Quarterly Earnings Call Highlights

Dow Inc. (DOW) Q4 2022 Earnings Call Transcript

Jan. 26, 2023 12:16 PM ETDow Inc. (DOW)

Q4: 2023-01-26 Earnings Summary

EPS of $0.46 misses by $0.11 | Revenue of $11.86B (-17.44% Y/Y) misses by $186.55M

Dow Inc. (NYSE:DOW) Q4 2022 Results Conference Call January 26, 2023 8:00 AM ET

Company Participants

Pankaj Gupta – Investor Relations, Vice President

Jim Fitterling – Chairman and Chief Executive Officer

Howard Ungerleider – President and Chief Financial Officer

Conference Call Participants

Vincent Andrews – Morgan Stanley

David Begleiter – Deutsche Bank

Hassan Ahmed – Alembic Global Advisors

P.J. Juvekar – Citi

Jeff Zekauskas – JPMorgan

John McNulty – BMO

Michal Sison – Wells Fargo

Kevin McCarthy – Vertical Research Partners

Matthew Skowronski – Credit Suisse

Christopher Parkinson – Mizuho Securities

Frank Mitch – Fermium Research

Jim Fitterling

Thank you, Pankaj. Beginning on Slide 3. In the fourth quarter, Team Dow continued to take proactive actions to navigate slower GDP growth, challenging energy markets and customer destocking. We proactively lowered our operating rates to effectively manage working capital, implemented operational mitigation plans and cost saving measures and prioritized higher-value products where demand remained resilient, including in functional polymers and performance silicones as well as in mobility, renewable energy and pharma end markets.

These actions, combined with our continued focus on cash enabled us to deliver cash flow from operations of $2.1 billion in the quarter. Cash flow conversion was 166%, and we returned $620 million to shareholders. Dow’s cash generation reflects our continued focus on operational and financial discipline, which was important as we navigated an extremely dynamic year in 2022, as you see on Slide 4.

In the first half of the year, we capitalized on strong demand across our diverse global portfolio while leveraging our derivative and feedstock flexibility and low-cost positions to mitigate higher raw material and energy costs. In the second half of the year, economic conditions deteriorated driven by record inflation, rising interest rates, ongoing pandemic lockdowns in China and continued geopolitical tensions.

In the face of these evolving market dynamics, Dow was resilient, generating cash flow from operations of $7.5 billion for the full year. While executing our disciplined and balanced approach to capital allocation. We delivered returns on invested capital of 15%, above our 13% across the economic cycle target, as we prioritized higher return, lower risk and faster payback investments.

We achieved credit rating and outlook upgrades as a result of our strengthened balance sheet, and we have no substantive debt maturities due until 2027. And we returned a total of $4.3 billion to shareholders, including $2.3 billion in share repurchases and $2 billion in dividends.

Moving to the Industrial Intermediates & Infrastructure segment. Net sales were $3.7 billion, down 20% from the year ago period. Volumes declined primarily due to lower demand in Europe for industrial, consumer durables and building and construction applications. Sequentially, net sales were down 10% as seasonal demand increases for deicing fluid were more than offset by declines in building and construction, consumer durables and industrial applications.

Operating EBIT for the segment was $164 million compared to $595 million in the year-ago period, driven by lower demand and increasing energy costs, particularly in Europe. Sequentially, operating EBIT margins expanded by 40 basis points as lower energy costs versus the prior quarter were partly offset by lower volumes.

Howard Ungerleider

Thank you, Jim, and good morning, everyone. We expect the market dynamics we experienced in late 2022 to continue into early ’23. While the pace of inflation has moderated, overall cost levels remain elevated, which has continued to trigger tighter monetary policy in most parts of the world and is weighing on both business investment and consumer sentiment.

The majority of economic forecasts are calling for slower GDP growth globally relative to 2022, although dynamics differ by region, with most regions except Europe still forecasting positive year-on-year growth. In the U.S., we see signs of moderating demand and the continuation of year-end destocking trends early in the quarter.

Building and construction end markets have been particularly impacted by inflation and rising interest rates with housing starts declining by more than 20% year-over-year in December.

Manufacturing PMI contracted for the third consecutive month of 48, while light vehicle sales in the U.S. were down for the full year by 8 percentage points. Easing inflation is leading to improving consumer confidence, albeit from depressed levels in late 2022, while consumer spending remains resilient. In Europe, we expect demand to remain constrained despite recent improvements in regional energy prices.

While the move to five-year highs in gas storage is a positive sign, changing weather forecasts are leading to volatility in the futures markets. High inflation and geopolitical tensions continue to weigh on consumer spending and industrial production. December manufacturing PMI has been contracting since July, and construction PMI reached its lowest level since May.

In China, while we’re very encouraged by recent ships in COVID policy to ease restrictions and open up orders, we expect these actions to take some time to improve economic activity. This is an area we’re closely monitoring as it has the potential to provide a source of significant demand recovery following the Lunar New Year.

And in Latin America, overall economic growth is expected to slow, driven by political tensions, high inflation and restrictive monetary policy. Given this dynamic backdrop, we will continue to take a region by region, business-by-business approach to managing our operations and adapting our businesses to the evolving market realities.

And the Industrial Intermediates & Infrastructure segment, demand remains stable for energy markets, and we’re monitoring demand for deicing fluids with a warmer than average winter. However, inflationary pressures in contracting PMIs continue to impact industrial demand, and we expect lower seasonal volumes in building construction end markets. We also anticipate an approximately $25 million headwind due to a third-party outage, which is causing a supply disruption on the U.S. Gulf Coast from winter storm Elliott.

And in the Performance Materials & Coatings segment, we expect demand recovery for performance silicones following year-end customer destocking as well as improved supply availability and lower costs. However, we also anticipate lower siloxane pricing in the quarter as we continue to see pressure from increased industry supply.

Jim Fitterling

In Industrial Intermediates & Infrastructure, our latest alkoxylates capacity investment in the United States was completed in the third quarter of 2022, and our next in Europe will be completed in the first quarter of this year. These projects will further serve high-value markets in home care and pharma and are just a start.

Our next wave of alkoxylates capacity investments remain on track. In fact, Dow has already successfully begun locking in supply contracts with several consumer and pharmaceutical customers to support the next wave of growth.

And in Performance Materials & Coatings, we completed 16 downstream silicone debottleneck projects in 2022 to meet demand for high performance, building and construction, personal care and mobility applications.

Additionally, we accelerated the delivery of our digitalization initiatives and now expect the full $300 million run rate EBITDA to fully materialize by the end of 2023, well ahead of our prior target of 2025. As a result, we anticipate our digital sales to comprise 50% of total revenue by 2025.

Looking forward, we expect to continue growth investments in our global operations, including key capital investments in higher-margin polyurethane systems and additional alkoxylate capacity, incremental projects to expand downstream, high-value ethylene derivative capacity and continued coatings and silicon debottlenecking projects. We will also continue progressing our operating investments to improve production capabilities and reliability as we shift our product mix toward higher growth and higher-value markets.

Vincent Andrews

Good morning everyone. Wondering if you could just unpack the outlook for Performance Materials & Coatings a little bit. And it sounds like there’s just a lot of moving parts right now with weak China in the fourth quarter but now reopening, some issues with new supply coming into the market. So obviously, uncertainty about how far and how fast China will reopen. But could you give us sort of the range of outcomes for how this segment might recover as we move through the year, representing that it could be a wide range?

Jim Fitterling

Sure. Good morning, Vince. Thanks for the question. First, I think it’s important to look back at the fourth quarter on PM&C and understand the fourth quarter. Coatings and Performance Monomers kind of got back to the normal fourth quarter seasonality that we would see, which a year ago was very different because we were still recovering from all the supply disruptions from winter storm URI and everything else that was associated with that. So I think you’ll see that they’ll come back to a more normal season in 2023.

And you also saw the impact of destocking. Destocking in the fourth quarter represented, and this is across the businesses, about 50% to 60% of the slowdown that we saw in the fourth quarter. So I think the destocking is going to work itself through in the first quarter. And then I think you’ll see us get back to normal seasonality there.

I do think positively on China for coatings and performance monomers. I do think we’re seeing China opening up. We’re not seeing issues with people coming to work. So I think we’re optimistic that the government will probably try to stimulate the construction economy there, and we’ll start to see that take off through the year.

On silicones and siloxanes, you had two impacts. One was the market impact of things slowing, which was the lower siloxane prices that hit hardest in China, obviously, at the end of the year. The other one was self-inflicted. We happen to have all three of the silicones pillar plants, the siloxanes pillar plant down at some point in the fourth quarter. And that lower operating rate really hurt us. They’re, all 3 back up and running. So I think that issue is behind us.

So I would expect you’ll start to see siloxanes demand pick back up. We saw destocking in all the downstream areas in silicones, personal care, home consumer goods, and we also saw it, obviously, in building and construction. I think that will start to rebound as the year progresses.

David Begleiter

Thank you. Good morning. Jim and Howard, given the recent decline in European natural gas prices, how are you thinking about the competitiveness of the European operations going forward?

Jim Fitterling

Good morning David. Very good question. Obviously, the European situation has been tough on all the European producers over this past year. In fact, if you think about the year-over-year performance for Dow for the full year, 60% of the decline in EBIT was related to Europe and that energy situation.

So this is very targeted. Incrementally, we saw a step change in the fourth quarter, obviously driven by the warmer winter and the inventory levels being back up. And they’ve done an admirable job, especially in Germany, of switching away from Russian natural gas over to other sources.

So that has helped. But we still have to take a look at long-term energy policies and work with the governments, both EU and the member states on energy policies because we’re a long way away from long-term competitiveness in Europe. I would say the decisions we announced today around restructuring, right now, we’ve looked at locations that are going to be challenged in any scenario long term, and we’ll take actions on those.

But on large sites, like our large cracker sites, we’re still able to run cash flow positive, and we’re working hard on that energy situation. We’ll continue to analyze that through this year and see what kind of work we can do with the governments there to make them more competitive long term.

John McNulty

Thanks for taking my question. So it seemed like the destocking was kind of at really accelerated levels in the fourth quarter. Can you give us a little bit of color as to which of the segments do you feel like you’re largely through that? And if anything, you may be — maybe we’re even at a balance side or even a restock phase? And I guess tied to that, — can you speak to the operating rates you saw in the fourth quarter and how you expect that to change as we look to 1Q?

Jim Fitterling

Sure. Good morning John. Good Question. I would say it accelerated in December. We made announcement in October that we were going to reduce some operating rates in ethylene, polyethylene because of some logistics constraints and other things that happen. We saw better logistics in December. December was our best export month of the year for marine pack cargo, so that’s positive. But at the same time, manufacturing activity in the last half of December really slowed. And so you could see that in the order pattern. And that stayed relatively slow the first half of January.

I do think we’re seeing manufacturing activity come back right now. We’re seeing that in the order book. I would not say that we’re at a restocking state yet. But I do think as the quarter progresses, we will get there because second and third quarter are typically our highest volume quarters. And there is not a lot of excess inventory anywhere in the change right now. So I do think it’s coming, but it isn’t here as we sit here right now today.

Michael Sison

Hey, good morning guys. What was the impact from the lower operating rates in the fourth quarter on EBITDA, meaning if you were at normal operating rates, what would that be? And then is that impact similar for the first quarter? And when do you think you can see your operating rates sort of improve back to normal rates in ’23?

Jim Fitterling

Yes. Just to give you an idea, I would say, probably you saw because of destocking, you probably saw a 10% lower operating rate due to destocking. Rough numbers, Howard, where do you think, [indiscernible] million.

Howard Ungerleider

Yes, I would say 10 percentage points. And that’s — I mean, when you think about every percentage point. Yes, look, I would say it this way, Mike. When you look at the sequential decline in probably two-thirds of that EBITDA drop was because of the destocking. And then the other balance was really the seasonal — just a seasonal sequential decline because we’re in more of a Northern Hemisphere business. And obviously, our coatings business typically is a seasonal low point in the fourth quarter.

Steve Byren

Yes, thank you. That 2,000-headcount reduction, how much of that is these assets in Europe that you’re planning to shutter? Or can you highlight what operations, is this commercial or back-office headcount? And then just one other quick one. Your partnership with Mura, when that’s at scale, you’re using the pyrolysis oil as cracker feedstock, how would you expect the profitability of that versus naphtha or ethane-based feedstock?

Jim Fitterling

Sure. Good morning Steve, good questions. 2,000 headcount reduction is not all specific to Europe, although Europe is a big part of the earnings decline that’s driving us to take these actions.

The site and asset decisions we’ve made so far are really smaller locations, smaller scale locations where we know they will be challenged through the year. We haven’t released a list of those we’re working through that with the European Works Councils, et cetera, but we will be doing that as we get toward the end of this quarter.

But — the $1 billion is really made up of two buckets: $500 million is structural cost reductions. That’s the headcount reductions, that’s productivity and end-to-end process improvement. So we’re really building off that digital work we’ve done, and that would work on improving processes and customer service and then the asset decisions. And then $500 million will just be reduced spending, turnaround spend, which Howard had mentioned, $300 million, leveraging our volume on lower purchased raw materials, logistics and utilities because we do see some supply/demand imbalances and the ability to do that and just tightening the belt to this environment.

So I would say I don’t — it’s not a haircut 5% of the workforce. It will be targeted, and we target around asset decisions. It will be targeted around businesses that need to tighten. It will be targeted around — it’s not just Dow headcount. We will have contractor reductions as well at the sites. And so we’ll look at it that way.

Matthew Skowronski

Good morning. This is Matt Skowronski on for John. Two commodities that Dow participates in, siloxanes and MDI, have had competitor capacity come online recently. You called out weaker pricing in siloxanes in your guide for the first quarter. But can you just talk about how long you expect it to take for pricing these commodities to recover?

Jim Fitterling

Yes, good morning. And thank you for the question. I think we’ll see a little bit of demand improvement. But siloxanes prices have fallen to their lowest levels in some time at the end of the year, and so we start the year at those levels. I don’t think we’re expecting any immediate improvement. The downstream demand still continues to be good. Building and construction will be the thing that I think will start to tip it to the positive. So if we see a good rebound in building and construction in China, that should start to pull things to the positive and lift things up.

North America has been fairly resilient. And North America and Europe are typically slightly higher than the Chinese prices, and that continues to be the same case today. So I — that’s my outlook on siloxanes on.

On MDI, I would say the biggest difference between what’s reported in the markets on MDI in our view, is just what you believe about the RTO timing of some of the Chinese competitions, new plants that are coming online. I think our view is that, that’s going to be stretched out over a longer period of time.

Most of what’s reported would have all that 4 world-scale MDI facilities coming on in 2023. I don’t think that’s our view of how that’s going to happen. That would be more spread over the 2023 to 2025-time period. And so I think that will take some of that pressure off of MDI.

Downstream demand for MDI and for systems and the application that it goes into is really good so I don’t feel worried about that. That’s purely what your assumptions are about — that our new demand coming — or new supply coming online and the time frame