Plastics. It may not be your career choice, but it could still make you a lot of money -- in the stock market.
Demand for plastics has all but shriveled up over the past year. In fact, this economic downturn has been particularly hard on plastics producers; higher oil and natural gas prices in early 2001 caused raw material costs to spike just as demand dried up. But what seems like the worst time for profits is actually the best time to be looking at stocks of big plastics makers such as
No other material is as ubiquitously consumed and as sensitive to economic growth as plastic. From cars to computers, trash bags to seat cushions, plastic is everywhere.
And while it's too soon to call a bottom in the economy, the worst could very well be behind us. According to Merrill Lynch's major chemical analyst Michael Judd (who recently upgraded Dow to strong buy), if you had bought Dow's stock in September 1990 -- six months before a trough in industrial production -- your 12-month return would have been 34%. (Merrill Lynch has done investment banking business with Dow.)
Given that the latest reading of the Institute for Supply Management jumped to a better-than-expected 48.2 (still a recession level, but the highest reading since September 2000), there's probably more risk of being too late in buying Dow's shares than in being too early.
Dow is the world's largest and (arguably) lowest-cost chemical producer. More than 50% of the company's sales are derived from plastics and plastics' building blocks, with the rest coming mainly from other chemicals such as chlorine and caustic, latex, industrial coatings and lubricants, and agricultural products such as insecticides and herbicides. You couldn't find a company that's more broadly exposed to all phases of an economic recovery; from Silicon Valley to the Corn Belt, Dow supplies virtually everybody with nearly all the components of the chemical and plastics chain.
Many view Dow as an ethylene cycle play, but I think the company is much more than that. In fact, because Dow is a net buyer of ethylene -- a key commodity petrochemical that Dow produces and consumes as a raw material in just about everything -- weak prices can actually benefit the company. Contract prices for ethylene have plunged from 30.6 cents a pound in 2000 to about 20 cents currently. However, spot prices are about 17 cents to 18 cents, suggesting that contract prices could fall even further.
Thanks to its diversification, Dow will probably start to post a big earnings recovery before an improvement occurs in ethylene demand. For example, the company's chlor alkalai (chlorine and caustic) and polystyrene businesses should rebound early this year. Chlor alkalai is mainly used in PVC (polyvinyl chloride) pipes, which are tied to the construction industry, while polystyrene is pervasive in appliances and electronics.
Not only that, Dow has a lot of opportunities below the revenue line to boost profits. The company is expecting to reap $1.1 billion in annual cost savings by 2002 from its merger with Union Carbide, which closed in February of last year. Through the third quarter of 2001, the company had already achieved about $550 million of that goal. Dow has another $230 million in savings targeted for this year from 12 other acquisitions it made over the past 18 months.
Finally, the company aims to harvest another $1.5 billion in cumulative EBIT (earnings before interest and taxes, or operating profit) from its Six Sigma initiatives between 2000 and 2003; more than 40% of that goal has been achieved already. (Six Sigma is a business philosophy that focuses on eliminating defects. It was made famous by
, among others.)
So even without an economic recovery, these initiatives, as well as the elimination of goodwill expense, could add 50 cents to Dow's earnings per share in 2002 and another 30 cents in 2003, according to Judd.
In fact, Dow could produce earnings growth that far surpasses the average
stock. Earnings per share for 2001 is likely to be about 58 cents. But for 2002, analysts are looking for $1.49 a share, a gain of 157%. Judd, for one, expects Dow's earnings per share to continue to grow 61% in 2003, reaching a peak above $7 per share in 2005.
What's more, Judd's estimate of Dow's earnings peak in 2005 may prove to be conservative. Management told analysts at an investors' meeting in November that if, in 2004, its hydrocarbon margins (the price of all Dow's products minus their raw material costs, such as natural gas liquids and refinery byproducts) get back to just half the level reached in the last ethylene cycle peak of 1995, the company would earn $6 a share in that year. That's the beauty of its diversification and cost-cutting efforts.
Dow is currently trading at a
price-to-earnings ratio of just five times Judd's peak earnings estimate. In the year before the last peak -- 1995 -- Dow traded at a forward (year-ahead) price-to-earnings ratio of 9. Using the same multiple on Judd's peak estimate of $7.00 gets us close to his price target of $64.
As the last recession demonstrated, it's better to buy Dow well before the economy starts improving. The potential return is terrific. Not only that, in the meantime, you get paid a 4% dividend yield.
Odette Galli writes daily for TheStreet.com. Before coming to TSC, Galli was a writer at SmartMoney Magazine. Prior to that, she worked as a senior manager at Ark Asset Management where she managed $3 billion in institutional assets. In addition, Galli was a senior vice president at J & W Seligman. She has also served as a research analyst for Morgan Stanley.
In keeping with TSC's editorial policy, Galli doesn't own or short individual stocks, although she owns stock in TheStreet.com. She also doesn't invest in hedge funds or other private investment partnerships. She invites you to send your feedback to