Dow Chemical and DuPont: Merging the Leading Chemical Players

(Continued from Prior Part)

Dow Chemical (DOW) had a net debt of $12.1 billion and an EBITDA (earnings before interest, tax, depreciation, and amortization) of $9 billion in 2014. Dow’s net debt-to-EBITDA ratio was 1.3x in 2014. It had a credit rating of “BBB” from Moody’s. DuPont is relatively better placed than Dow Chemical in terms of financial leverage. DuPont’s net debt-to-EBITDA ratio was 1.1x with a net debt of $6.2 billion. It had an EBITDA of $6 billion in 2014.

After combining their operations, the merged entity DowDuPont will have total debt of ~$18.2 billion with a net debt-to-EBITDA ratio of 1.2x. Dow Chemical and DuPont are targeting for an investment grade credit rating after merging the two companies. Overall, the financial strength of the combined company is fairly comfortable. It’s within the industry leverage range of 1.5x–2.0x.

DuPont reported an OCF (operating cash flow) of $3.7 billion and a total capital expenditure of $2.0 billion in 2014. With a higher OCF, DuPont’s free cash flow was $1.7 billion. Dow Chemical reported higher free cash flow of $2.9 billion despite the huge capital expenditure of $3.6 billion in 2014. Overall, the combined company would have total free cash flow of $4.6 billion in 2014.

Going forward, the combined company’s free cash flow is expected to rise. Dow Chemical already completed the major capex for the US gulf projects and the Sadara joint venture. These projects are expected to add $3 billion per annum to the company’s EBITDA from 2018 onwards. DuPont has an average capital expenditure of $1.8 billion. It doesn’t have any major capacity expansion planned. As a result, the combined company’s free cash flow is expected to increase significantly. The cost and growth synergy will boost the combined company’s profitability.

Dow Chemical has high dividend payout ratio of around 45%. Dow bought back shares worth more than $5.0 billion. Overall, the company plans to buy back shares worth $9.5–$10.0 billion by 2016. DuPont has a relatively lower dividend payout ratio of around 35%. DuPont also repurchased shares worth $4.3 billion since 2010. Going forward, the combined company is expected to have a dividend payout ratio of 35–45%. Considering the strong free cash flow generation, DowDuPont will continue with its share buyback strategy along with its higher dividend payout.

Overall, DowDuPont is a financially sound company. On the basis of the financials in 2014, the merged company will have revenue of more than $80 billion and EBITDA of $15 billion with ~18% EBITDA margins. The company is expected to generate higher free cash flow, driven by higher operating earnings and lower capital expenditure. With higher free cash flow, the company will continue with a higher shareholder reward strategy. It will also help to reduce the debt level. With this merger, the company will have a competitive edge over major players like BASF, Syngenta (SYT), and Monsanto (MON). However, the successful integration of these two companies and the implementation of the separation into three public companies will be key for the future operating and financial performance.

Investors can invest in the iShares U.S. Basic Materials ETF (IYM) to get exposure to the US chemical industry. IYM invests in most of the US chemical companies. Dow Chemical and DuPont each form 11% of IYM’s total holdings.

Browse this series on Market Realist:

• Part 1 - Analyzing the US Chemical Industry’s Biggest Merger
• Part 2 - Will the Dow Chemical and DuPont Merger Have Operational Synergy?
• Part 3 - DowDuPont Will Spin Off into 3 Independent Public Companies