Shares of Dow Inc. were headed for their first loss as a newly independent public entity, after J.P. Morgan’s Jeffrey Zekauskas became the first analyst to take a bearish stance on the materials science company.
tumbled 4.5% in morning trade, enough to pace the Dow Jones Industrial Average’s
decliners. The price decline of $2.70 was shaving about 18 points off the Dow industrials’ price, which was up 29 points.
Dow, which was spun off from DowDuPont Inc.
Including when-issued trading, the stock had run up 22% amid a 7-session win streak through Thursday.
Zekauskas started coverage of Dow with an underweight rating and a stock price target of $49, which is 14% below current levels.
Of the 17 analysts surveyed by FactSet, Zekauskas is the only one who is bearish, as 12 have the equivalent of overweight ratings and four have the equivalent of hold. The average price target is $61.72, which is 6.8% above current levels.
Zekauskas said he believes Dow is trading at a premium to its most comparable peers, which he said are LyondellBasel Industries N.V.
and Westlake Chemical Corp.
because it offers a higher dividend yield.
He said Dow pays out 25% of EBITDA (earnings before interest, taxes, depreciation and amortization) as a dividend, implying a yield of 4.7%, while Lyondell pays out 20% for a 4.3% yield and Westlake pays out 7% for a yield of 1.3%. Under an uncertain global economic outlook, the yield premium could be at risk.
“We do not believe that Dow would maintain its multiple premium versus other North American petrochemical companies were the possibility of a recession meaningful,” Zekauskas wrote in a note to clients. “The risk to the Dow share price is, for this reason, larger than that of the price risk of the other petrochemical companies as Dow could well lose the dividend premium it receives currently.”
But it’s not all about the dividend. Zekauskas said when Dow Chemical was previously a public company, before it closed its merger with DuPont & Co. in August 2017, he said it traded at a premium valuation to Lyondell because it ha a high-margin agricultural business, which it has since transferred to other parts of DowDuPont as part of the reconfiguration.
And regarding Dow’s ethylene and polyethylene businesses, Zekauskas said he thinks margins have yet to bottom, as the U.S. is likely to add “significant” capacity this year and next.
“We think a combination of slow demand, trade issues limiting efficient export of product and higher raw material costs–because of a significant draw on ethane resources–will lead to lower prices and integrated margins in 2019-2020,” Zekauskas wrote.
He said growth in EBITDA and valuation expansion would be difficult under that environment.