Dow to see margin compression in Q1

Author: Joseph Chang

2019/02/08

Dow, the Materials Science business of DowDuPont to be spun off on 1 April, is expected to show a major decline in Q1 earnings, led by polyethylene (PE) and polyurethanes (PU) margin compression.

“We have consistently been forecasting a period of margin compression in both the polyurethanes and polyethylene chains due to capacity additions across the industry. These dynamics have turned out largely as expected,” said Ed Breen CEO of DowDuPont, on the company’s Q4 earnings conference call.

For Q1 2019, DowDuPont expects Materials Science operating earnings before interest, tax, depreciation and amortisation (EBITDA) to plunge in the low -20% range year on year on a high single-digit decline in sales.

Q1 SALES PROJECTIONS

Within Materials Science, the Packaging & Specialty Plastics segment which houses PE is expected to show the greatest percentage decline in sales – in the low teens. Sales in the Industrial Intermediates & Infrastructure segment which includes polyurethanes are expected to fall in the high single digits. Performance Materials & Coatings revenues should decline in the low single digits.

Dow table

Investors reacted negatively to the guidance – not only on the weakness in Materials Science, but also conservative guidance on the Specialty Products side. DowDuPont’s stock price plunged over 9% in early trading on 31 January.

“Looking ahead [for Dow], at this early stage in 2019, we’re seeing stabilisation in our key product spreads, and demand remains robust. We see the first half of the year as a time to focus on stabilising prices in order to rebuild margins as we move into the middle of the year,” said Jim Fitterling, CEO-Elect of Dow.

Dow will also take action to mitigate headwinds, including deferring discretionary spending to the latter half of 2019 or into 2020 to adjust to the macro environment, he noted.

Capital spending (capex) for Dow in 2019 is expected to remain at 2018 levels at around $2.5bn, said Fitterling.

Overcapacity is clearly an issue, but the demand side remains healthy, he said.

“We continue to see the businesses grow at about 1.5x GDP. From a demand standpoint, I do not see a problem,” said Fitterling.

In Q4 2018, the Materials Science business saw operating EBITDA down 12% year on year to $2.1bn on 1% lower sales of $11.8bn. Volumes grew 1% but were offset by local prices (-1%) and currency (-1%).

Within Materials Science, the Packaging & Specialty Plastics segment saw a 13% decline in operating EBITDA to $1.1bn as sales slide 4% to $4.9bn. The segment’s EBITDA margin fell to 18.8% versus 20.9% in the year-ago period.

As oil prices plunged toward the end of December, the export markets were “pretty quiet” in the last two weeks of the month, leading to a build-up in US PE inventories, noted Fitterling.

However, there are signs of a PE turnaround in early 2019, though not enough to prevent heavy year-on-year declines expected in Q1 2019.

“Some of that’s starting to turn around in the first quarter. We’re seeing [PE] pricing movements in January/February – up 3 [cents/lb], up 3 [cents/lb] in January and February,” said Fitterling.

For all of 2019, while there was no full-year guidance issued for Materials Science (nor will there be for the Dow spin-off), Dow expects conditions to improve as the year progresses.

“The bulk of the new [PE] capacity came on in the back half of 2018. If you look forward into 2019, you don’t have that much new capacity coming on, so I expect operating rates are going to improve 200-300 basis points (2-3 percentage points) through the year,” said Fitterling.

“But clearly we’ve got to rebuild some margins in the quarter. So it was mostly sentiment at the end of the year that drove that build-up in inventory and I think what we will see as we come out of Chinese New Year is a pull on the demand side that will start to rebuild those volumes and margins,” he added.

DE-STOCKING TO PERSIST INTO Q2

DowDuPont expects de-stocking to continue through Q1 and into Q2, continuing a trend that arose at the end of 2018. The Q4 de-stocking went beyond what DowDuPont normally sees at the end of the year, said Breen.

He expects the de-stocking should correct itself in the next few months, with markets returning to normal by the second half of the year.

Not all of DowDuPont’s end-markets saw weakness during Q4. The following summarises the comments that company executives made about demand during the fourth quarter:

■ Demand rose in most regions for Packaging & Specialty Plastics. The largest increases in demand came from industrial, consumer, flexible food and specialty packaging.

■ Volumes rose for elastomer and wire-and-cable applications.

■ Falling oil prices hurt demand for microbial control products, which are sold by the Nutrition and Health business of the Specialty Products division.

■ Weakness in US housing markets hurt sales for Sorona, a polyester made of renewable propanediol (PDO) and purified terephthalic acid (PTA), used to make carpet fibre.

Regarding other DowDuPont businesses, photovoltaics continue to be in a tough space, said Marc Doyle, chief operating officer for the Specialty Products division. Volumes are coming back, but the company is still facing some pricing pressure.

Solar panels are an important end market for such products as ethylene vinyl acetate (EVA) and polyvinyl butyral (PVB).

SPECIALTIES OUTLOOK

Looking past Q1, Doyle expects to continue to see strength in most of the end markets served by Specialty Products. He specified semiconductors, aerospace, health and nutrition, industrial and infrastructure.

Doyle also expects consumer electronics to recover following the Q4 weakness caused mostly by smart phones, he said.

Doyle expects demand to recover among some of the end-markets that suffered from destocking, although he did not specify which ones.

DowDuPont’s outlook follows that of other chemical companies, which also noted destocking during Q4 and expect conditions to improve after Lunar New Year.