In 2019, the massive industrial conglomerate DowDuPont split off into three companies. Dow (DOW)focuses on commodity chemicals, DuPont de Nemours mostly deals with specialty chemicals, and Corteva is an agriculture chemical and seed company.
Surprisingly, Dow stock has been down since the spinoff despite its results improving mightily. What's more, Dow pays a juicy $0.70-per-share quarterly dividend — good for a forward dividend yield of 5.6%.
Let's discuss why Dow is a fundamentally sound business and a reliable dividend stock that is worth investing in now.
Dow has Put Up Impressive Results
In its second-quarter 2023 earnings presentation, Dow outlined its growth since the spinoff. The results are very impressive.
Free cash flow FCF is the big standout, which is up big-time since the spinoff. Just like dividend yield is calculated by dividing dividend per share by the price per share, FCF yield is FCF per share divided by the price per share. It shows how much FCF each share of the company is yielding.
There are a couple of ways of looking at Dow's 10% FCF Yield. The first is that the company could support a 10% dividend yield if it distributed all of its FCF to shareholders through a dividend. And the second is that the business is generating a tenth of its value in FCF in just one year, and at its current pace, would earn its entire value in FCF in 10 years.
Of course, there's no guarantee that Dow will be able to sustain this FCF yield rate. If anything, it's unlikely given the past performance and cyclical nature of the industry. Rather, the takeaway here is that Dow is performing at a very high level, a level where it can easily support buybacks and dividend payments. And yet, the stock has gone essentially nowhere since the spinoff, making it an underappreciated dividend stock.
Why Dow Stock is Under Pressure
If you focused solely on Dow's performance over the last year, you'd see lower EBITDA, earnings, and FCF.
DOW NORMALIZED DILUTED EPS (TTM) DATA BY YCHARTS
DOW NORMALIZED DILUTED EPS (TTM) DATA BY YCHARTS
A snapshot of the present can be misleading for such a cyclical company. A better solution is to look at an average value over a period of time, which is why Dow provided three-year averages in its Q2 earnings presentation.
Smoothing out ebbs and flows in performance is especially important for a cyclical company. Cyclical stock valuations can start to look far more expensive if earnings are contracting — which is what is happening with Dow. Dow's business is under pressure because of lower demand across its end markets paired with higher input costs. Commodity chemical companies are vulnerable to changes in industrial and commercial demand and energy prices — both factors are working against Dow right now, with demand going down and energy prices going up. The growth may be negative in the short term, but Dow is still making a sizable amount of EBITDA and FCF. And nothing about the short-term dynamic affects the long-term outlook for Dow.
An Improved Balance Sheet
A more permanent way of looking at the stability of a cyclical company and its ability to support the dividend is by evaluating the balance sheet. Referring back to the table, Dow's balance sheet is in far better shape today than it was at the time of the spinoff.
The net debt position is down 32.3% in less than five years. And the diluted share count is down, too, thanks to buybacks. A healthier balance sheet provides the cushion needed to ride out a cyclical downturn. Having a low debt position can leave room to make a timely acquisition when there's value in the market.
Dow Stock is Worth a Closer Look
Dow has taken advantage of higher FCF and earnings by making meaningful improvements to the balance sheet. From an operational and financial health standpoint, Dow is in far better shape today than before the spinoff.
The company is fully capable of continuing to deliver value to shareholders and grow over time. Given these improvements, the stock looks like a great value and a solid source of steady passive income.
Originally published on Fool.com
