Away from the daily market noise and volatility, there are some old-economy stocks that don’t get as much investor attention as they deserve. The new-born Dow Inc. is one such player, which after its recent spin-off from the parent DowDuPont Inc., is offering a very attractive income-generating opportunity.
Dow shares began trading on April 1 after the old Dow Chemical Co. (NYSE:DOW) and DuPont Co. (NYSE:DWDP) announced a grand $120-billion merger in 2017, with an intention to create three separate entities.
Corteva Agriscience is expected to become a separate company in June and will focus on pesticides and other agricultural products. DuPont will also spin out in June as a specialty chemicals company.
The third one is the new Dow, entirely focusing on material sciences, plastics and silicones, and is expected to generate more than $9 billion in earnings this year, before interest, taxes, depreciation and amortization.
What makes it a compelling income-generating opportunity is the chemical producer’s clear focus to return most of the income back to investors in the shape of dividends and share buybacks. According to the company’s presentation to investors, the new Dow will pay out 65% of its net income to shareholders each year through stock buybacks and a hefty dividend.
The company plans to achieve that goal by spending less on new factories and through a more focused approach to its target markets after cutting down the number of its business units to six from 15. Plastics and packaging is now the Dow’s largest business, accounting for about half of revenue and earnings, with operations in 31 countries.
A Cyclical Stock But Paying Hefty Dividend
Its stock currently pays $0.7 dividend a share, with an annual yield of about 5%. With the targeted payout ratio of 45% of the company’s net operating income, that dividend is quite conservative and potentially has more room to grow as the group cuts costs and takes advantage of its leading market position in the global plastic business.
That said, investors should be aware that plastic, being a derivative of oil, is a highly cyclical business where demand and supply is closely tied to the global economic growth and other macro influences.
In its first quarterly earnings after the spinoff, Dow said last week that its core earnings from operations fell 24% in Q1 2019, hurt by a weak pricing environment for its chemicals. The drop was in line with analysts’ expectations. The pricing was beginning to improve in its key markets, with a recovery in crude prices that is expected to benefit full-year earnings, Dow said in the earnings statement, adding it expects to make revenue between $11-$11.5 billion for the second quarter.
The weak earnings report, coupled with the U.S.-China trade dispute, have hurt the stock in its early trading days. After surging $60.52 in April, a jump of 26% from its “when-issued” level that preceded the distribution of the new stock, Dow stock was trading at $52.64 a share yesterday.
But that pullback is a good entry point if you’re a long-term investor, willing to stay invested with an aim to earn steadily growing income.
“Dow offers a compelling value opportunity,” Robert Koort, an analyst at Goldman Sachs Group. said in a note in April cited by Bloomberg.
“In addition to a promising cyclical positioning, we believe the transformation from ‘old Dow’ to ‘new Dow’ suggests more shareholder-friendly capital allocation and a leaner, more focused cost structure.”
Goldman has a $71 a share price target for Dow, higher than analysts’ average estimate of $62.67 for next 12-month period..
Bottom Line
The new Dow has a much better business focus and more potential to provide a regular income. Its 5% dividend yield, a low debt level, and an investment-grade credit rating make it a strong candidate for your income portfolio. The recent selloff offers a good entry point to lock-in its juicy yield.