Chemical bellwethers’ second-quarter results reflect the impact of unfavorable commodity prices and demand, but cost cutting efforts and savvy execution are driving margins higher. Let’s go around the horn for incremental industry insights across the space. Dow Chemical is executing the best at the moment.
DuPont (DD), Dow Chemical (DOW), and Eastman Chemical (EMN) all reported negative impacts from pricing on their top lines in the calendar second period. DuPont’s Performance Chemicals segment, which was spun-off into The Chemours Company (CC) on July 1, reported the largest negative impact for the company with pricing lowering sales by 6% in the period. Each of Dow Chemical’s operating segments experienced sales falling due to pricing, the largest of which came in its Performance Plastics segment, which reported a 21% decrease in sales from the year-ago period due to pricing. Eastman’s overall results were boosted by revenue from acquisitions in the quarter, but pricing hurt revenue by 7% from the second quarter of 2014.
Lower corn volume in Latin America, decreased soybean volume in North America, and “tight” farmer economics have contributed to challenging times across the chemicals industry. The reduction in demand for crop protection applications is being felt by companies like DuPont, which generated over one-third of its revenue in the second quarter of 2015 from its Agriculture segment. Though its segment revenue was boosted by acquisitions, Eastman also felt the effects of reduced demand for its agriculture products. Industry participants are not expecting a quick fix within their agricultural operations and point to strong headwinds from currency and lower corn planted area in the back half of the year, but confidence in long-term expansion remains.
Crude oil (USO) may be the most talked about commodity as of late, and rightfully so; the effects of its price changes are seen throughout nearly every industry. Crude oil derivatives are a major portion of chemical companies’ operations, and the price of derivatives, such as propylene and ethylene, often follow crude prices. These reduced prices are lowering the top-line results for chemical companies, as is reflected in the negative pricing impacts outlined above. However, the reduction in derivative input costs has been greater than the reduction in output pricing, helping to improve operating margins in segments producing crude derivatives. Cost cutting across most operating segments is mitigating the adverse impact of revenue declines.
Commodity price volatility is not blindsiding chemical bellwethers, and they have met the changing environment with portfolio transformation strategies. DuPont, for one, has taken several steps to attempt to optimize its operations, including the spin-off of its poor performing Performance Chemicals segment (Chemours). The company also has an operational redesign program in which it is focused on achieving $1 billion in annual run-rate savings. DuPont expects to realize $0.40 in savings per share in 2015 due to the initiative, and the firm increased its operating margin by 180 basis points for ongoing segments in the second quarter on a comparable basis from the year-ago period.
Dow Chemical is also working towards a material divestiture. It will merge a substantial portion of its Chlor-alkali and Downstream Derivatives business with Olin (OLN) in a stock, cash, and debt deal, and will own 50.5% of the new Olin after the deal is completed. The newly-created company will have an increased focus on downstream initiatives and be able to better take advantage of the potential for improving margins associated with the crude derivatives. Dow also has multiple joint ventures that have been performing well. Its operating EBITDA margin increased ~4 percentage points in the second quarter as the company posted an all-time high for period operating EBITDA.
Eastman Chemical is focused on improving its product mix with a greater emphasis on specialty products. The company’s ‘Additive and Functional Products’ segment has benefitted from the acquisition of Taminco, which provides specialty chemicals for a variety of applications, including downstream derivatives operations. Its ‘Advanced Materials’ segment grew its top line via the acquisition of Commonwealth Laminating & Coating in 2014, and the segment should continue to experience margin expansion associated with the reduction of crude oil prices. Eastman experienced overall operating margin expansion of 100 basis points in the second quarter.
For the full year 2015, DuPont is expecting operating earnings per share of $3.10, down from $3.36 in 2014 on a comparable basis. The firm continues to feel the headaches associated with the markets poor perception of the mishandling of its Performance Chemicals segment, and activist investor Nelson Peltz’s failed attempt at reform. At Dow Chemical, on the other hand, the second quarter of 2015 market the 11th consecutive quarter of year-over-year expansion of operating earnings per share, EBITDA, and EBITDA margin, and it is expecting to continue those trends, as the company is confident in its targeted investments in high growth areas. Eastman is confident that it will be able to realize its 6th consecutive year of material earnings per share growth, boosted by its strategic investments and margin expansion.
There have been some questions from members with respect to the magnitude of DuPont’s dividend post-split and its Dividend Cushion ratio that is north of 1. Management has stated that the sum of the third quarter payouts of DuPont and The Chemours Company will be equivalent to that of pre-split DuPont, assuring investors that a raw dividend cut has not occurred. Our dividend analysis supports a resilient payout, though we note our assessment of each individual component of the split-up will be updated accordingly in coming periods. On July 28, along with its second-quarter results, DuPont announced its 444th consecutive quarterly dividend.
Top-line results across the industry will continue to face pressure as a result of volatile raw material and energy costs, pressures in agricultural markets, and challenging currency headwinds. A focus on higher-margin businesses and improving cost structures will be the key to ongoing margin expansion and earnings growth going forward. We think Dow Chemical is best positioned at the moment, given its strategic focus, pristine balance sheet, and recent track record of margin expansion. However, we’re not rushing to add any chemical entity to our newsletter portfolios at the moment.