Dow: Our Top Pick Among Petrochemicals Producers; Cost Advantage Endures Despite Near-Term Headwinds

We maintain our favorable long-term outlook for narrow-moat Dow DOW as prospects for global petrochemicals demand remains robust over the next five years or so. Though near-term macroeconomic headwinds will contribute to an overall weak 2023 for the firm, we’re optimistic about recovering end market demand around year-end and beyond. With a solid long-term outlook, the firm’s shares offer material upside relative to our $72 per share fair value estimate.

Dow’s cost advantaged chemical production, which underpins our narrow moat rating, remains intact, evidenced by a very favorable oil-to-gas ratio (measured as the cost of Brent crude oil per barrel versus the cost of Henry Hub natural gas per million British thermal units, or MMBtu) of around 34 times. This is further strengthened by significantly reduced U.S. natural gas prices, which currently sit around $2.20 per MMBtu, about one third of average 2022 levels. Dow’s enduring cost advantage will facilitate superior profitability relative to peers even despite currently tempered demand across end markets.

Dow’s highly diversified end market exposure implies the firm’s growth trajectory often resembles that of overall GDP growth. We therefore anticipate an overall subdued 2023 followed by a rebound in 2024 as demand recovers across the board. For example, we anticipate recoveries in industrial and residential construction will materialize over the next several years. By our estimate, repair and remodel spending will average about 5% growth per year over the next decade, while housing starts will recover to about 1.3-1.4 million new units per year over the long run (compared with less than 1.3 million units in 2023). We anticipate a similar recovery cadence for much of Dow’s other end markets, though we note near-term resilience in a handful of segments, including automotive and agriculture.