Equity Valuation and Analysis - Mark Moore
Equity Valuation and Analysis - Mark Moore
Equity Valuation and Analysis - Mark Moore
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<strong>Equity</strong> <strong>Valuation</strong> <strong>and</strong> <strong>Analysis</strong><br />
Frank Puskarich: Frank.Puskarich@ttu.edu<br />
Greg Garrison: Greg.Garrison@ttu.edu<br />
JB Richter: Joseph.Richter@ttu.edu<br />
Justin Matthews: Justin.Matthews@ttu.edu<br />
Valued at: November 1, 2007
Table of Contents<br />
Executive Summary 3<br />
Business/Industry <strong>Analysis</strong> 7<br />
Firm Overview 10<br />
Industry Overview 12<br />
Five Forces Model 14<br />
Rivalry among against firms 14<br />
Threat of new entrants 20<br />
Threat of substitutes 22<br />
Bargaining Power’s 22<br />
Value Chain <strong>Analysis</strong> 26<br />
Firms Competitive Advantage 30<br />
Accounting <strong>Analysis</strong> 36<br />
Key Accounting Policies 37<br />
Accounting Flexibility 42<br />
Evaluating Accounting strategy 44<br />
Quantitative <strong>Analysis</strong> 49<br />
Manipulation Diagnostics 50<br />
Financial <strong>Analysis</strong> 58<br />
Credit <strong>Analysis</strong>/Z-score 78<br />
Forecasting <strong>Analysis</strong> 82<br />
Cost of Capital 90<br />
Methods of Comparables 94<br />
Intrinsic Model <strong>Valuation</strong> 103<br />
<strong>Analysis</strong> Recommendation 109<br />
Appendix 112<br />
Reference 128<br />
Dow Chemical <strong>Analysis</strong> Page 2
Executive Summary<br />
Investment Recommendation: Overvalued, Sell (11/1/07)<br />
DOW-NYSE $44.14 Altman's Z-score<br />
Revenue(2006) $49,124(M) 2002 2003 2004 2005 2006<br />
<strong>Mark</strong>et Cap 39.47(B) 1.82 2.12 2.53 2.98 3.07<br />
Shares Outst<strong>and</strong>ing<br />
962.3(M)<br />
Dividend Yield 3.75% Financial Based <strong>Valuation</strong>s<br />
3-month Avg. Daily Trading Vol. 5,632.49(M) Trailing P/E: 10.31<br />
Percent Institutional Ownership 68.20% Forward P/E: 11.22<br />
Book Value per share $19.13 P.E.G.: 1.473<br />
ROE 21.82% P/B: 2.25<br />
ROA 8.11% P/EBITDA: 7.14<br />
P/FCF: 17.76<br />
Cost of Capital R Squared Beta Ke EV/EBITDA: 8.04<br />
Ke Estimation 14.80%<br />
5 Yr (3 month) 0.3081 1.5 14.80% Intrinsic <strong>Valuation</strong>s<br />
Discounted Dividends $32.53<br />
Published Beta 0.8 Free Cash Flows $22.95<br />
Kd 5.89% Residual Income $24.20<br />
WACC(bt) 9.23% Abnormal Earnings Growth $27.21<br />
WACC(at) 7.94%<br />
Dow Chemical <strong>Analysis</strong> Page 3
Industry <strong>Analysis</strong><br />
In 1897, chemist Herbert Henry Dow began the Dow Process Company in<br />
Midl<strong>and</strong>, Michigan where he exclusively sold bleach <strong>and</strong> potassium bromine. In the<br />
course of just under a century, the Dow Chemical Co. (DOW) is the largest American<br />
chemical manufacturer <strong>and</strong> the second largest the world. With over 43,000 employees<br />
located in over 175 production facilities worldwide, Dow continues to be an innovative<br />
producer of chemical products that range anywhere from plastics, chemicals (both basic<br />
<strong>and</strong> performance grade), agricultural chemicals <strong>and</strong> even hydrocarbon energies.<br />
Dow competes in the chemical manufacturing industry which comprises of nearly<br />
26 major competitors <strong>and</strong> countless numbers of small to mid-sized firms. Despite facing<br />
competition from numerous firms around the globe, Dow maintains a comm<strong>and</strong>ing<br />
market share over its top domestic competitors such as DuPont, Lyondell, Huntsman,<br />
<strong>and</strong> Exxon Mobil.<br />
To remain successful in the chemical business, we identified several key success<br />
factors that will ultimately determine how well the company is performing in this<br />
industry. This industry is characterized as have vast economies of scale, high barriers to<br />
entry, <strong>and</strong> low levels of competition between competitors. This industry also has a<br />
heavy emphasis on continuing innovation <strong>and</strong> therefore carries a low level of product<br />
differentiation while still requiring high expenditures both fixed assets <strong>and</strong> Research <strong>and</strong><br />
Development expenses.<br />
By following its key success factors <strong>and</strong> maintaining its cost-leadership business<br />
strategy, Dow Chemical can continue its success as being one of the largest chemical<br />
manufacturing company <strong>and</strong>, most importantly, to accomplish its stated goal as<br />
“constantly improving what is essential to human progress by mastering science <strong>and</strong><br />
technology with the vision to be the largest, most profitable, <strong>and</strong> most respected<br />
chemical company in the world” (Dow Mission Statement).<br />
Dow Chemical <strong>Analysis</strong> Page 4
Accounting <strong>Analysis</strong><br />
When analyzing a company’s annual reports, it is important to measure the<br />
overall transparency of the financial statements <strong>and</strong> to evaluate the level of disclosure<br />
for significant line items that correspond to the firm’s key success factors. Due to the<br />
varying degrees of flexibility that the General Accepted Accounting Principles (GAAP)<br />
allow in financial reporting, it is imperative that we recognize these significant line<br />
items, identify <strong>and</strong> remove potential “red flags”, <strong>and</strong> asses a true economic value to the<br />
firm.<br />
By having numerous opportunities at their disposal to influence the method of<br />
computing financial data, managers of firms are often tempted to hide or withhold<br />
various information from financial statements for the purpose of disguising results <strong>and</strong><br />
therefore inflating the true economic value of the company. By identifying the numbers<br />
that relate to firm’s key success factors such as economies of scale, cost leadership,<br />
<strong>and</strong> high investments in Research <strong>and</strong> Development, we were able to locate any item<br />
that could potentially distort the true performance of the company. An example would<br />
be Dow’s policy of not capitalizing their operating leases, which we all know can<br />
significantly alter Dow’s income statement <strong>and</strong> balance sheet.<br />
Despite the questionable strategy of their operating leases, we found Dow to<br />
considerably conservative in their accounting policies <strong>and</strong> therefore gave us some<br />
degree of confidence in the disclosure of their information.<br />
Financial <strong>Analysis</strong>/Forecasting <strong>Analysis</strong>/Cost of Capital Estimates<br />
When analyzing a firm’s financial statements, analysts use various financial ratios<br />
to compare performance with that of its given industry. Some of the more relevant<br />
ratios used, were measuring Dow’s liquidity, profitability, operating efficiency as well as<br />
Dow’s capital structure, in reference to the chemical industry. Also, we forecasted<br />
Dow’s financial statements to show where Dow is heading in the future, <strong>and</strong> to where<br />
Dow Chemical <strong>Analysis</strong> Page 5
they may st<strong>and</strong> against their competition. The last financial ratio tool we used in<br />
valuing Dow Chemical Co, was regression analysis which allowed us to underst<strong>and</strong> what<br />
costs were being put into the company.<br />
In referring to Dow’s liquidity ratios, they show the ability to covert their assets<br />
into readily available cash in a timely manner. Although Dow extends the opportunity<br />
for purchasers to buy on credit, their ratios show that they are able to collect on their<br />
receivables quickly. This is shown in Dow’s day’s supply of receivables ratio where they<br />
collect on their receivables in a substantially lower number of days compared to their<br />
competition <strong>and</strong> industry as a whole. Their profitability ratios illustrate how Dow has<br />
become much more profitable in their earnings as well as exp<strong>and</strong>ing their growth<br />
strategy. With this expansion in the past couple of years, Dow has been able to<br />
balance out their overload of liabilities. Dow has shown progress of improvement in<br />
each of the 8 liquidity ratios throughout the five year span, with the exception of<br />
Working Capital, which still averages out higher than the industry average of 7.01.<br />
The profitability ratios were also a great tool in showing that Dow’s structure <strong>and</strong><br />
commitment to profitability are strong. Dow has consistently shown to outperform its<br />
competitors in operating efficiency <strong>and</strong> productivity. These ratios were extremely<br />
helpful in that efficiency <strong>and</strong> productivity are both key success factors of Dow. With<br />
these consistencies, Dow has begun to emerge as the primary holder of this industry<br />
market share.<br />
After computing these financial ratios, we used them to forecast our financial<br />
statements out to 10 years in the future. By doing so, we were able to identify Dow’s<br />
growth trends <strong>and</strong> possible room for improvement. Our growth rate showed to be<br />
consistent with historical prices, which can look positive in the eyes of investors.<br />
Dow Chemical <strong>Analysis</strong> Page 6
<strong>Valuation</strong>s<br />
In determining Dow’s current state, we used several valuation models that were<br />
precisely weighted to conclude if Dow’s stock price is overvalued, undervalued, or<br />
priced fairly. We had to base our valuation on the intrinsic models, because the<br />
method of comparables had too many inconsistencies within the industry. Although<br />
these comparables were not completely relevant in our valuation, they showed that<br />
Dow’s stock price was slightly undervalued. Once again, these ratios did not carry a<br />
heavy weight in our decision of valuing our company, because the 8 different valuation<br />
ratios were scattered with a wide range of prices.<br />
In shaping our final estimates of Dow’s value, we looked closely at the five<br />
intrinsic models that include: Residual Income Model, Free Cash Flow Model,<br />
Discounted Dividend Model, Abnormal Growth Model, <strong>and</strong> Long-Run Return on <strong>Equity</strong>.<br />
The least accurate model within our valuation was the Discounted Dividends model<br />
because it is extremely difficult to forecast dividends, growth, <strong>and</strong> treasury re-purchases<br />
<strong>and</strong> issuances. This model yielded the highest price ($32.53) of any other model due to<br />
these fallacies. The Residual Income model was the most precise <strong>and</strong> held the largest<br />
bias for our estimation of Dow’s stock price due to the accurate estimations of expected<br />
returns <strong>and</strong> earnings. This model valued our price per share to be $24.20. Although<br />
Residual Income was the most accurate model, Free Cash Flows <strong>and</strong> the Abnormal<br />
Earnings Growth models were also both consistent. This isn’t surprising because of the<br />
tie between the Residual Income Model <strong>and</strong> AEG. These models contributed to our<br />
valuation that Dow is overvalued.<br />
Business & Industry <strong>Analysis</strong><br />
Company Overview<br />
Dow Chemical Co. (DOW) is the top American based chemical company <strong>and</strong> the<br />
second largest in the world. Dow is well diversified, leaning heavily on innovation <strong>and</strong><br />
Dow Chemical <strong>Analysis</strong> Page 7
esearch <strong>and</strong> development. In addition, Dow is the single largest concentration of<br />
PhD’s as well as Engineers in the entire United States. Dow’s headquarters reside in<br />
small Midl<strong>and</strong>, MI where a wide range of products <strong>and</strong> services are distributed<br />
worldwide.<br />
When the company was started in 1897 by chemist Herbert Henry Dow, it was<br />
limited to selling bleach <strong>and</strong> potassium bromide. Later, Dow Chemical Company was<br />
incorporated in 1947 under Delaware law taking over the rights of the former Michigan<br />
Company. Today, Dow operates in six major segments producing everything from food<br />
<strong>and</strong> fresh water, to pharmaceuticals <strong>and</strong> paints, to packaging <strong>and</strong> personal care<br />
products. Dow’s current workforce is composed of over 43,000 employees worldwide<br />
driving towards the common goal of innovation. With 175 plants <strong>and</strong> facilities<br />
worldwide, Dow is able to control their overhead costs by reducing transportation costs<br />
<strong>and</strong> controlling various markets (Dow.com).<br />
With Dow’s primary focus on innovation <strong>and</strong> Research <strong>and</strong> Development, they<br />
can solely concentrate on exp<strong>and</strong>ing the growth of their company. On February 6,<br />
2001, Union Carbide Corporation became a wholly owned subsidiary of The Dow<br />
Chemical Company. Bought for $11.6 billion by Dow, Union Carbide Corporation sells<br />
most of its products to Dow for cheaper prices <strong>and</strong> has become one of the top<br />
performers in the Dow family (Dow Chemical 10-K).<br />
While Dow only has a few major competitors, there are 26 other main companies<br />
in the chemical industry. Dow’s major competitors consist of: DuPont (DD), Exxon<br />
Mobil (XOM), Lyondell (LYO), <strong>and</strong> Huntsman (HUN). Dow’s current market cap is at<br />
39.77B, which puts them within 10% of the highest competitor, DuPont (excluding XOM<br />
who only competes on a limited basis). For this reason <strong>and</strong> reasons of inability to<br />
separate the different factions of XOM, they will not be considered in this report. In<br />
addition, Dow’s stock performance throughout the past five years has been on a<br />
rollercoaster ride pricing out at as high as $56.24 in February 2005, to as low as $33.54<br />
Dow Chemical <strong>Analysis</strong> Page 8
in July of 2006. Comparing Dow’s stock price with fellow competitors, Dow’s growth<br />
was right alongside fellow competitors, until late last year where they saw a decline.<br />
The decline in Dow’s stock price was an example of rough market conditions as well as<br />
an extreme fluctuation in energy costs.<br />
Stock Price’s of Industry (5 Year)<br />
LYO- Lyondell<br />
HUN-Huntsman<br />
DD-DuPont<br />
XOM-Exxon Mobil<br />
DOW- Dow Chemical<br />
According to Dow’s statement of commitments <strong>and</strong> goals, they plan on pursuing<br />
a business strategy of sustainability <strong>and</strong> innovation. In order for Dow to achieve these<br />
goals of growth, they must retain financial order while increasing investments in<br />
positive opportunities, especially in emerging geographies abroad as well as business<br />
performance. With expectations of increases in capital expenditures, Dow looks to<br />
maintain safety <strong>and</strong> reliability of the company. Dow has stated that they will continue<br />
their policy of reducing debt by either using a portion of its cash, or by issuing new<br />
debt. With economic conditions remaining healthy <strong>and</strong> the costs of energy prices<br />
staying stable, Dow looks to dominate the chemical industry in 2007.<br />
Dow Chemical <strong>Analysis</strong> Page 9
2002 2003 2004 2005 2006<br />
Net Sales $27,609 $32,632 $40,161 $46,307 $49,124<br />
Total Assets $39,562 $41,891 $45,885 $45,934 $45,581<br />
Sales Growth<br />
(DOW) 0.70% 18% 23% 15.30% 6.10%<br />
Industry Sales<br />
Growth 2.03% 18.62% 22.98% 18.03% 7.01%<br />
* Net sales <strong>and</strong> Total Assets measured in millions of dollars<br />
According to the growth chart provided above, Dow shows consistency with the<br />
industries average growth. This allows for confidence within Dow’s company because it<br />
illustrates their ability to maintain a realistic <strong>and</strong> sustainable growth rate. The industry<br />
average might be slightly higher due to the fact that Exxon Mobile’s entire enterprise<br />
growth rate is factored into this average.<br />
Firm Overview<br />
Dow is a highly diversified company with six major operating segments. Their<br />
six segments consist of products such as: Performance plastics, performance chemicals,<br />
agricultural sciences, basic plastics, basic chemicals <strong>and</strong> hydrocarbons <strong>and</strong> energy.<br />
Listed below are a few of the many products produced in plants by Dow.<br />
Plastics are Dow’s overall top product <strong>and</strong> top seller according to earnings. “In<br />
2006, Dow’s EBIT (Earnings before Interest/Income Tax) was $1,629 million <strong>and</strong> shows<br />
signs of continual growth” (Dow Chemical 10-K). Offering a large range of high<br />
performance plastics, Dow is a world-leading provider in electrical performance using<br />
specialized plastic wire <strong>and</strong> cable compounds. Dow also sells a high performance<br />
plastic that makes automobiles more fuel efficient <strong>and</strong> safer by using the formula of<br />
Styrene-Acrylonitrile to bond the glass <strong>and</strong> control outside sound (Dow.com).<br />
Dow Chemical <strong>Analysis</strong> Page 10
Dow provides consumers with specialized chemical products that meet an<br />
assortment of needs. Their basic core chemicals serve as vital raw materials for the<br />
industry. They play a big role in making various products more durable <strong>and</strong> reliable as<br />
well as making household cleaning materials more successful. Dow also uses<br />
polyacrylic acid compounds, which are used in detergents <strong>and</strong> put into waste water<br />
plants for cleansing.<br />
Dow’s Agrosciences department manufactures <strong>and</strong> promotes products that<br />
develop <strong>and</strong> maintain crop production, by killing insects, weeds <strong>and</strong> protecting crops<br />
from diseases. This segment is also in the research of producing bio-technology, such<br />
as seeds <strong>and</strong> healthy oils for plants. Although the smallest segment now, Dow looks to<br />
put emphasis on its Agrosciences for the future in hoping that further research will form<br />
a break-through product.<br />
“Dow’s Hydrocarbons <strong>and</strong> Energy business is the world leader in the production<br />
of olefins <strong>and</strong> aromatics, <strong>and</strong> is at the forefront of efforts to secure advantaged<br />
feedstock positions in emerging geographies as well as new potential energy <strong>and</strong><br />
feedstock sources to create long-term competitive advantage for Dow”<br />
(www.Dow.com). With the energy business at a current boom, Dow has the potential<br />
to secure <strong>and</strong> entire market segment. Although energy prices have been high, Dow is<br />
in the process of researching alternate materials to produce high amounts of energy.<br />
The world is moving into a direction of a “cleaner environment” where new dem<strong>and</strong>s<br />
will start to grow <strong>and</strong> sources of supply will be vacant.<br />
With the diversification <strong>and</strong> wide range of products, Dow is able to gain a<br />
competitive advantage over its competitors.<br />
Dow Chemical <strong>Analysis</strong> Page 11
2006 Sales to External Customers<br />
Industry Overview<br />
The chemical industry is composed of companies that produce specialized<br />
chemicals that are converted into vital raw materials that are dominant throughout the<br />
world economy. Polymers <strong>and</strong> plastics represent about 80% of the 70,000 somewhat<br />
products produced in this industry (Wikipedia.org). With chemicals consisting of around<br />
$2 trillion of global enterprise, the US companies control most of the output by<br />
employing over a million employees. The chemical industry is one of the fastest<br />
growing industries in the world, <strong>and</strong> with the increasing technological advances, it<br />
seems that it will continue to exp<strong>and</strong>.<br />
Dow Chemical Company ranks second in the world only behind Baden Aniline<br />
<strong>and</strong> Soda Factory (BASF) of Germany, according to total chemical sales. These two<br />
companies are near monopolies in the industry by their dominating total sales, along<br />
with their name recognition. Although BASF is in competition with Dow for world<br />
ranking, they however don’t compete over customers. Dow dominates the United<br />
Dow Chemical <strong>Analysis</strong> Page 12
States as well as some smaller areas of Europe while BASF swallows up Europe with<br />
fewer few top competitors.<br />
With the dominance of BASF in Europe, the window of competition within the US<br />
opens up to Dow <strong>and</strong> its domestic rivals. The four major competitors in this segment<br />
include DuPont, Exxon Mobil, Lyondell Chemical <strong>and</strong> Huntsman Corp. Research <strong>and</strong><br />
Development is the main push for all five of these companies where competition is<br />
fierce for the most cutting-edge material or solution.<br />
2006 R&D Expenses<br />
*Numbers represented in millions of dollars<br />
Exxon Mobil’s company as a whole is valued at a much higher dollar amount than<br />
any of the other competitors. However, Exxon Mobil states that only 11% of its 2006<br />
earnings came from the chemical segment.<br />
The chemical industry is highly interdependent with the sale <strong>and</strong> purchase of<br />
fellow competitors materials <strong>and</strong> products. “The chemical industry itself consumes 26<br />
percent of its own output” (Wikipedia.org). For instance, it is common for a company<br />
like Dow to buy a competitors material for cheap, to later combine that material with its<br />
own. By doing this, Dow is cutting down on various expendetures <strong>and</strong> time, which in<br />
the long-run, shaves down overhead costs.<br />
Dow Chemical <strong>Analysis</strong> Page 13
Five Forces Model<br />
In ordered to evaluate a given industries foundation of profitability <strong>and</strong> structure,<br />
an important evaluation tool, The Five Forces Model, can be implemented to assess that<br />
industry. The Five Forces Model identifies the key success factors that a company can<br />
pursue in order to become profitable. This model identifies sources of competition that<br />
include: rivalry among existing firms, threat of new entrants, <strong>and</strong> the threat of<br />
substitute products. This model also conveys the relationship of power that both the<br />
buyer <strong>and</strong> supplier possess. These relationships are identified in the last two<br />
components of the Five Forces Model, bargaining power of buyers <strong>and</strong> bargaining<br />
power of suppliers. In order to evaluate how successful a company is within a given<br />
industry, it is crucial that they follow their identified success factors within this model.<br />
Chemical Industry<br />
Rivalry Among Existing Firms<br />
Threat of New Entrants<br />
Threat of Substitute Products<br />
Bargaining Power of Buyers<br />
Bargaining Power of Suppliers<br />
MODERATE<br />
LOW<br />
LOW<br />
LOW<br />
LOW /<br />
MODERATE<br />
Rivalry among Existing Firms<br />
In the business of chemical manufacturing, the firms that comprise this industry<br />
engage in low to moderate levels of competition. This industry is characterized as<br />
having high levels of growth, low concentration of competitors, very adaptive learning<br />
curves, many barriers to entry <strong>and</strong> exit, <strong>and</strong> also large economies of scale with an<br />
Dow Chemical <strong>Analysis</strong> Page 14
ample amount of excess capacity. Given the circumstances that this firm competes in,<br />
the Dow Corporation has become the largest supplier of chemicals in the United States<br />
<strong>and</strong> continues to be a major innovator.<br />
Industry Growth<br />
25.00%<br />
20.00%<br />
15.00%<br />
Industry Growth Rate<br />
10.00%<br />
industry growth<br />
5.00%<br />
0.00%<br />
5.00%<br />
1 2 3 4 5 6<br />
*Vertical axis periods are represented by: 2001(1), 2002(2), 2003(3), ect.<br />
As the graph above clearly illustrates, the chemical manufacturing industry is an<br />
enterprise that has experienced a surge in net sales in 2003 following the 2002<br />
recession <strong>and</strong> the September 11th attacks that preceded it, proving that this industry<br />
operates in a business environment that is sustainable. Because of the rise in industrial<br />
growth, firms that compete in this industry do not spend excessively on advertisements<br />
<strong>and</strong> other marketing campaigns in order to capture market share from one another.<br />
Despite the fact that the industry has experienced above average growth, the threat of<br />
new entrants is set off by the initial high cost of capital; therefore, assuring that firms in<br />
this industry can successfully maintain the current market share.<br />
Dow Chemical <strong>Analysis</strong> Page 15
<strong>Mark</strong>et Growth in Net Sales (Millions)<br />
$60,000.00<br />
$50,000.00<br />
$40,000.00<br />
$30,000.00<br />
$20,000.00<br />
DOW<br />
HUN<br />
LYO<br />
DD<br />
$10,000.00<br />
$-<br />
2001 2002 2003 2004 2005 2006<br />
Global <strong>Mark</strong>et Share<br />
In the United States alone, there exist 170 major chemical companies along with<br />
countless other small to medium sized chemical manufacturing facilities. With the<br />
addition of foreign competition, there is an estimated 4,500 facilities worldwide. “By<br />
controlling nearly 46% American market share, Dow is by far the largest chemical<br />
manufacturing firm in the United States <strong>and</strong> the second largest in the world”<br />
(Wikipedia.org). This industry is characterized as having low to moderate levels of<br />
competition amongst contending firms.<br />
Dow Chemical <strong>Analysis</strong> Page 16
<strong>Mark</strong>et Share within United States<br />
50.00%<br />
45.00%<br />
40.00%<br />
35.00%<br />
30.00%<br />
25.00%<br />
20.00%<br />
15.00%<br />
10.00%<br />
5.00%<br />
0.00%<br />
2001 2002 2003 2004 2005 2006<br />
DOW<br />
HUN<br />
LYO<br />
DD<br />
Differentiation<br />
Because product-line’s follow the same chemical formula <strong>and</strong> production process<br />
amongst all competitors, the industry competes in a manufacturing environment that<br />
sells very homogenous products. Therefore, not much differentiation can be made<br />
between its products <strong>and</strong> the competition. However, several firms have made numerous<br />
advancements in the field of chemistry <strong>and</strong> now offer synthetically made chemicals that<br />
seek to differentiate between competitors. The following table provides the recently<br />
acquired advancements in the chemical manufacturing industry.<br />
Scale Inhibitors<br />
Aminoethylethanolamine<br />
Dow Chemical <strong>Analysis</strong> Page 17
Chlorine<br />
Ethylcellulose<br />
Hydroxyethylcellulose<br />
Methyl Cellulose<br />
Methylene Chloride<br />
Perchlorethylene<br />
Thioglycolic Acid<br />
Diethylenetraimine<br />
Glutaradehyde<br />
Hydroxypropyl Methycellulose<br />
Methyl Chloride<br />
Methy Glucosidederatives<br />
Polypropylene Glycols<br />
Trichlorethyene<br />
(www.chemweek.com/bluebook.pdf)<br />
Economies of Scale/ Learning Economies<br />
In order for it to maintain its leverage over the competition, a company must<br />
employ a larger, more specialized workforce than its rivals. “The scope of production<br />
encompasses nearly 12% of European manufacturing’s added value” (Wikipedia.org).<br />
With sales forecast predicting stable levels of growth over the next few years, many<br />
firms in this industry have made plans to exp<strong>and</strong> their operations in hopes of capturing<br />
more market share from competitors.<br />
Total Assets<br />
(in millions) 2001 2002 2003 2004 2005 2006<br />
DOW 35,515 39,562 41,891 45,885 45,934 45,581<br />
HUN 4,827 5,044 8,737 9,437 8,871 8,445<br />
LYO 6,703 7,448 7,633 15,928 15,089 17,846<br />
DD 40,319 34,621 37,039 35,632 33,291 31,777<br />
Dow Chemical <strong>Analysis</strong> Page 18
It is also important to note that this industry is identified with having a very<br />
adaptive learning curve. Essentially what this means is that as soon as a company<br />
introduces a new <strong>and</strong> innovative product on the market, the competitors in that<br />
industry are quick to copy the design <strong>and</strong> exploit it. This process ensures that any form<br />
of differentiation is avoided.<br />
Fixed assets to Variable Costs ratio:<br />
FA/VC Ratio 2001 2002 2003 2004 2005 2006<br />
DOW 0.5683 0.5802 0.5046 0.4038 0.3537 0.3304<br />
HUN 0.7118 0.7868 0.8052 0.6163 0.5124 0.4468<br />
LYO 1.2945 0.8175 0.7335 1.3205 0.3959 0.4626<br />
DD 0.7943 0.758 0.4763 0.5194 0.495 0.5136<br />
The fixed asset to variable costs ratio serves as an excellent tool to help measure<br />
the degree of competition within an industry. If a company was to have a high FA/VC<br />
ratio, then that would indicate that the firm is committed to the industry <strong>and</strong> must<br />
continue its operations rather than temporarily cease production. As the graph above<br />
indicates, the industry is very liquid, especially for all competitors. The reason this might<br />
be, is attributable to the constant acquisitions <strong>and</strong> sale of property, plant, <strong>and</strong><br />
equipment by companies such as Lyondell, who openly trade fixed assets on the open<br />
market.<br />
Excess Capacity<br />
Dow Chemical <strong>Analysis</strong> Page 19
Because the industry that the companies compete in contains more providers<br />
than buyers, the industry participates in an ample excess capacity market. Since a<br />
couple of firms produce completely homogenous products, it must keep prices low or at<br />
least on par with competitors in order to effectively participate in the market. This<br />
information is reflected in the industry growth rate graph listed above.<br />
Barriers to Exit<br />
Since the facilities of a chemical manufacturing firm are tailored made to<br />
specialty products, this business is faced with extremely difficult <strong>and</strong> very costly barrier<br />
to exit. Due to the fact that many other industries have no practical use for other<br />
company’s facilities, the only plausible scenario that the companies could pursue in the<br />
case of an exit would be through an acquisition from a competitor.<br />
Conclusion<br />
Since the chemical companies participate in an industry with low levels of<br />
competitor concentration, costly barriers to entry, <strong>and</strong> consistently high levels of<br />
industrial growth with ample amounts of excess capacity, our firm would classify the<br />
chemical manufacturing industry that Dow competes in as having low to moderate<br />
levels of competition.<br />
Threat of New Entrants<br />
Determining the threat of new entrants into the industry is vital for valuing the<br />
company. To do this there are certain things that have to be taken into consideration.<br />
These are scale of economies, first mover advantage, distribution <strong>and</strong> relationship<br />
access <strong>and</strong> legal barriers. Once each of these have been considered <strong>and</strong> evaluated it<br />
can be determined the threat level established by the possibility of new entrants.<br />
Scale of Economies<br />
Dow Chemical <strong>Analysis</strong> Page 20
First we must consider scale of economies. Scale of economies is the<br />
determination of whether or not size will make a significant difference in market<br />
entrance. As for the chemical industry, we have determined that size is a large factor.<br />
The customers are usually in manufacturing <strong>and</strong> need to buy large quantities to fulfill<br />
their needs. Also, the suppliers of the raw materials are large corporations that deal in<br />
bulk amounts <strong>and</strong> are not scaled to sell to small, startup firms. Scale of economies<br />
plays a large role in entering the chemical manufacturing industry.<br />
First Mover Advantage<br />
The second consideration is first mover advantage. This is the advantage<br />
created by being first in the industry. For example, already having the government<br />
licenses, the technical staff, <strong>and</strong> have developed the st<strong>and</strong>ard for the industry. Due to<br />
the nature of chemical manufacturing, we must consider emission licenses <strong>and</strong><br />
st<strong>and</strong>ards set by the EPA, environmental protection agency. Since Dow is in the top ten<br />
on highest levels of emissions, it is reasonable to assume that the EPA is not going to<br />
grant more licenses easily. Dow has an extreme advantage over new entrance in the<br />
learning economies since they have a full arsenal of chemists <strong>and</strong> chemical engineers.<br />
After being in business for over 60 years Dow has created a high st<strong>and</strong>ard for new<br />
entrants to meet. First mover advantage plays a critical role in hampering new entrants<br />
into the industry.<br />
Channels of Distribution<br />
Next, we must consider the channels of distribution <strong>and</strong> relationships. These<br />
are the networks between suppliers, manufactures, <strong>and</strong> customers. For example, a<br />
new entrant would face the possibility of having to build a reputation with customers on<br />
the quality of their products or with suppliers on their ability to purchase in the<br />
quantities that they are set up the deal in. These existing channels <strong>and</strong> manufacturing<br />
locations can easily impede new companies from becoming major players in the<br />
Dow Chemical <strong>Analysis</strong> Page 21
industry. Dow has manufacturing facilities worldwide as well as distribution centers<br />
that make it hard to compete in purchasing supplies <strong>and</strong> selling products.<br />
Research <strong>and</strong> Development<br />
Because this is such an intense research <strong>and</strong> development industry the legal<br />
barriers make it hard for entrance for any company to start up in. Furthermore, because<br />
of the nature of this industry, a firm has limited entry through the use of patents <strong>and</strong><br />
copyrights. Not to mention state <strong>and</strong> national regulations that controls the use of these<br />
chemicals.<br />
The overall threat of new entrants into the Chemical Manufacturing industry is<br />
low. It can be concluded based on the economies to scale, the first mover advantage,<br />
the access to channels of distribution <strong>and</strong> relationships, <strong>and</strong> the legal barriers that the<br />
threat of a new entrances into this market is highly unlikely.<br />
Threat of Substitute Products<br />
No matter the industry, there is always some level of threat of substitute<br />
products. This threat comes in the form of comparable products for comparable prices.<br />
If there is a comparable product that performs exactly as another product pricing will<br />
play a large role in overall market performance.<br />
As in the case of the chemical manufacturing industry, the overall threat of<br />
substitute products is very low. They manufacture a series of very specialized products<br />
that have very specific uses in the manufacturing of end user products. For example,<br />
Dow manufactures the plastic compound that containers for cleaning products are<br />
made from, but they do not make the end user container or cleaning product.<br />
Therefore, this is more of a niche market segment that is small enough to avoid the<br />
threat of both substitutes <strong>and</strong> new products.<br />
Bargaining Power of Customers<br />
Dow Chemical <strong>Analysis</strong> Page 22
The bargaining power of buyers can best be split in to two categories: price<br />
sensitivity <strong>and</strong> relative bargaining power. Firms with high price sensitivity incorporate<br />
a low cost strategy. Where as a firm with a low cost sensitivity rely on differentiation of<br />
their products. In addition, industries with high relative bargaining power cause firms<br />
to compete on price because of the undifferentiated product selection. This means that<br />
there a low switching cost for the buyer between competing products, which allows<br />
them to choose the lowest price possible. In contrast, buyers in a low relative<br />
bargaining power industry are susceptible to the price of doing business. This means<br />
that operating expenses are not an issue to the firm because it can raise its prices to<br />
compensate for the added expenses.<br />
The chemical industry as a whole is a low price sensitive market due to the lack<br />
of competition. The Dow chemical company in itself is a leader in this industry, <strong>and</strong> in<br />
certain market segments it is the only producer of these specialized products. A few of<br />
these products are: scale inhibitors, aminoethylethanolamine, aminohydroxy compound,<br />
<strong>and</strong> chlorine.<br />
In addition, the bargaining power in the chemical industry is very high in most<br />
marketing segments due to the lack of differentiation between products. This gives the<br />
buyer the advantage of getting the same product at the lowest price.<br />
Price Sensitivity<br />
Price sensitivity is very important in this industry because products in this<br />
industry are undifferentiated. Thus, an increase in price will cause consumers to seek<br />
the same product from other companies. The chemical industry as a whole consumes<br />
26% of its own product. Therefore, firms will buy products from their competitors if it<br />
will reduce cost, while maintaining efficiency. Furthermore, the chemical industry relies<br />
on some of its own products to manufacture other products.(www.wikipedia.org)<br />
Bargaining Power<br />
Dow Chemical <strong>Analysis</strong> Page 23
Throughout the chemical industry bargaining power for buyers is very high<br />
because of price sensitivity <strong>and</strong> the low levels of switching cost. Buyers can obtain the<br />
same product from competitors with low switching cost, which is a big advantage to<br />
them. However, in certain specialized products that Dow manufactures, there are no<br />
competitors. Therefore, the bargaining power of the buyer in these market segments is<br />
very low due to the fact that these products are only produced by Dow.<br />
Conclusion<br />
There are many factors in dealing with the bargaining power of buyers in the<br />
chemical industry. Two of the main factors are price sensitivity <strong>and</strong> relative bargaining<br />
power. In dealing with this industry, each firm must consider these two ideas in<br />
assessing the degree of competition. While the industry focuses on cost leadership, it<br />
becomes imperative that they lower as many input costs as possible in order to increase<br />
profits. If a company can hold bargaining power over a supplier, they can purchase<br />
materials at a cheaper price which in effect would increase a companies bottom-line.<br />
Bargaining Power of Suppliers<br />
The bargaining power of suppliers is very important in determining how a<br />
company can go about pricing its own product. Industries with high bargaining power<br />
for suppliers can dictate the market price to firms that need their product. This allows<br />
the supplier to be in control of pricing decisions that the firm must incur to obtain the<br />
needed product. On the other h<strong>and</strong>, industries with low bargaining power are under<br />
the control of the firm, <strong>and</strong> must compete on the bases of price. Firms in this case<br />
have the power to make suppliers compete for their business. If the firm is dissatisfied<br />
with the services provided by the supplier, they can look for alternative suppliers to<br />
obtain the same product.<br />
Price sensitivity<br />
Dow Chemical <strong>Analysis</strong> Page 24
Price sensitivity of suppliers in the industry is a key to how the company runs.<br />
In the chemical industry there is a large variety of similar products. Therefore,<br />
suppliers must compete on the basis of price. If both products are of the same quality,<br />
then price is the only factor in choosing which firm to purchase from. As previously<br />
stated, switching prices in this industry are low for the buyer, which puts pressure on<br />
the supplier to maintain the lowest cost in order keep their customer. Since the<br />
switching costs are low the supplier is at a disadvantage in terms of their bargaining<br />
power. However, in the case of specialty products the suppliers themselves control the<br />
price sensitivity of the product. Thus, Dow has numerous examples of relative<br />
bargaining power because they are the only manufacturers of certain products. This is<br />
essentially a monopoly with these products because there are no competitors.<br />
Relative Bargaining Power<br />
The relative bargaining power of suppliers in the chemical industry is moderately<br />
low. Since most of the products are so similar there are plenty of substitutes that a<br />
firm can choose from. One of the key factors that help Dow, is their br<strong>and</strong> recognition.<br />
In some instances, firms may choose Dow on the basis of their good name rather than<br />
buy another product at a cheaper cost. Dow has been an industry leader for years <strong>and</strong><br />
has proven its reliable quality, which has set them apart from their competition.<br />
Conclusion<br />
The competitive advantage of this industry is strongly tied in with the bargaining<br />
power of both buyers <strong>and</strong> suppliers. Other things to consider are product<br />
differentiation <strong>and</strong> switching cost, which can hurt a firm if these factors are not taken<br />
into consideration. It is for this reason that there is a low level of bargaining power for<br />
the supplier in this industry.<br />
The Five Forces Model Conclusion<br />
Dow Chemical <strong>Analysis</strong> Page 25
According to Alfred D. Ch<strong>and</strong>ler, the author of the book titled Shaping the<br />
Industrial Century, Ch<strong>and</strong>ler characterizes the chemical manufacturing industry as<br />
having “successful chemical firms followed definite "paths of learning" whereby first<br />
movers <strong>and</strong> close followers created entry barriers to would-be rivals by building<br />
"integrated learning bases" (or organizational capabilities) which enabled them to<br />
develop, produce, distribute, <strong>and</strong> sell in local <strong>and</strong> then worldwide markets. Also they<br />
followed a "virtuous strategy" of reinvestment of retained earnings <strong>and</strong> growth through<br />
diversification, particularly to utilize "dynamic" scale <strong>and</strong> scope economies relating to<br />
new learning in launching "next generation" products” (wikipedia.org). This industry is<br />
characterized has having moderate levels of competition among existing firms, low<br />
threat levels of new entrants, substitute products, <strong>and</strong> bargaining power of buyers while<br />
bargaining power of suppliers ranges to levels of low to moderate.<br />
Value Chain <strong>Analysis</strong><br />
Overall Classifications of the Industry<br />
To summarize the industry as a whole it can be broken down to the following<br />
categories: low to moderate rivalry amongst existing firms, low threat of new entrants,<br />
<strong>and</strong> a low threat of substitutes. In relation to the bargaining power of the buyer <strong>and</strong><br />
supplier there is a mixture of both low <strong>and</strong> high bargaining power in this industry.<br />
There are several aspects that will now be discussed to support these conclusions. To<br />
begin with, the most important factors are a mix of constant research <strong>and</strong> development<br />
in this ever evolving market, high levels of economies of scale <strong>and</strong> scope, <strong>and</strong><br />
established distributor relationships. In addition, efficient production, lower input costs,<br />
superior products variety, <strong>and</strong> are the final key factors in this industry.<br />
To begin the breakdown of this industries competitive strategy, one must first<br />
break it down between cost leadership <strong>and</strong> product differentiation. It is clear that firms<br />
in this industry must compete based on cost leadership; however, differentiation of<br />
products is necessary in order to be successful in certain market segments. In most<br />
Dow Chemical <strong>Analysis</strong> Page 26
cases, firms will choose to implement either cost leadership or differentiation of<br />
products, but in this industry both strategies are required to be successful.<br />
Through the evaluation of the value chain, one can get a better underst<strong>and</strong>ing of<br />
how firms in this industry are able to turn a profit. In general, this process begins with<br />
the supplier to firm relationship. This relationship involves the exchange of goods <strong>and</strong><br />
services for money. Then the firm turns the raw materials into the final products, which<br />
are then sold to other firms or consumers. “Chemicals are used to make a wide variety<br />
of consumer goods, as well as thous<strong>and</strong>s inputs to agriculture, manufacturing,<br />
construction, <strong>and</strong> service industries” (www.wikipedia.org). By underst<strong>and</strong>ing the value<br />
chain, the industry can show the relevance of each strategy implemented, <strong>and</strong><br />
determine if new strategies must be incorporated. Furthermore, if strategies are not<br />
having the desired effect the firm must choose a new approach to combat these issues<br />
to maintain their competitive advantage.<br />
Competitive strategy<br />
“The profitability of a firm is influenced not only by its industry structure, but also<br />
by the strategic choices it makes in positioning itself in the industry” (Palepu <strong>and</strong><br />
Healy). Firms in this industry use the economies of scale <strong>and</strong> scope, efficient<br />
production, lower input costs to strategize in the cost leadership approach. In addition,<br />
the use of the differentiation approach is carried out through superior product variety,<br />
research <strong>and</strong> development, <strong>and</strong> more flexible delivery. In order for firms in the industry<br />
to maintain their competitive advantage, they must not only compete through cost<br />
leadership. It is vital to their survival that they produce superior products <strong>and</strong> invest in<br />
research <strong>and</strong> development, so that their competitors do not surpass them.<br />
Economies of Scale <strong>and</strong> Scope<br />
Another important factor to consider when evaluating a company is examining<br />
the scale of its operations <strong>and</strong> the scope of the consumer dem<strong>and</strong>. Since the chemical<br />
Dow Chemical <strong>Analysis</strong> Page 27
industry on competes in a low to moderate level of competition amongst rival firms who<br />
produce completely homogeneous products, it is imperative that everyone maintains a<br />
“cost leadership” approach to its business. Therefore, in order to decrease the average<br />
cost of production, the firms emphasized a managerial specialization of production.<br />
Managerial Specialization is a method where a firm examines the production process to<br />
identify <strong>and</strong> remove inefficiencies in the product assembly <strong>and</strong> to find new ways to<br />
increase efficiency. By making the production process more efficient, each firm can<br />
lower its long-run average cost <strong>and</strong> therefore increase profits. The economies of scope<br />
for the chemical industry are very beneficial. Since most of the chemical industry is<br />
based on production of raw chemicals for other industries, for example making the<br />
chemicals that go into h<strong>and</strong> lotions <strong>and</strong> other cosmetics. Most of the companies that<br />
buy chemicals to include in their production are more focused on cost than<br />
differentiation; therefore, it is necessary for all firms to work on great scales of<br />
operations to keep its overhead low.<br />
Lower input Cost<br />
In order for firms to make a profit in this industry, it is necessary for them to<br />
lower input costs, which in turn will raise revenues. Globalizing markets are becoming<br />
the most cost effective form for lowering costs. Larger companies that endorse<br />
purchasing power are using their size <strong>and</strong> money to bully foreign prices. According to<br />
recent research, 50% of chemical companies’ costs are from raw materials. If<br />
companies are not able to lower their input costs, they will be forced to raise the price<br />
of their products to offset high energy costs. This would in turn, allow competitors to<br />
gain an advantage if they were able to produce the same product at a cheaper cost.<br />
Consumers are turned away from price increases <strong>and</strong> usually look elsewhere to<br />
purchase that same product. As previously shown, firms in this industry will buy each<br />
other’s products in order to maintain a lower input cost. If it is cheaper for a company<br />
to purchase materials from a competitor rather than produce it on their own, most<br />
companies will pursue this option. In conclusion, the leverage of input costs is a key<br />
Dow Chemical <strong>Analysis</strong> Page 28
strategy to gain or maintain market share in the chemical industry. Whether costs are<br />
reduced by purchasing abroad, or product prices are increased to offset costs, chemical<br />
companies are struggling with the high prices of energy.<br />
Efficient Production<br />
Since much of the industry is based on commoditization, it is necessary for all<br />
companies to work towards the most efficient production available. This is<br />
accomplished by reducing waste, energy consumed, <strong>and</strong> increasing efficiency in<br />
production methods. To identify how efficiency has changed, we compared input costs<br />
per unit before <strong>and</strong> after we implemented the new/more efficient production process.<br />
Constant research <strong>and</strong> development is put into creating more efficient means of<br />
producing product <strong>and</strong> reducing or reusing waste products produced by the production<br />
plants. One way to accomplish this is to reduce gases lost due to leaks in tanks.<br />
Another would be reclaiming <strong>and</strong> reusing waste products to extract as much of the<br />
usable chemicals as possible.<br />
Investments in Research <strong>and</strong> Development<br />
In the chemical industry, a strong research <strong>and</strong> development strategy is crucial<br />
in order to achieve both an effective <strong>and</strong> efficient product. A firms R&D strategy can be<br />
improved by increasing the number of production plants <strong>and</strong> facilities, hiring more<br />
qualified chemical engineers, <strong>and</strong> constantly researching new ways to innovate. These<br />
investments are necessary to not only come up with more efficient ways to make an<br />
existing product, but also to create new <strong>and</strong> innovative products for the future. In the<br />
year 2006, the industry on average, spent close to $855 million on Research <strong>and</strong><br />
Development expenses. Research <strong>and</strong> development is a major strategy where<br />
competition is fierce for the most cutting edge material <strong>and</strong> solution. Firms in this<br />
industry spend billions of dollars on research <strong>and</strong> development, which further illustrates<br />
their desire to gain competitive advantage over each other. Since firms are so<br />
interdependent, if one were to fall behind in research <strong>and</strong> development they would find<br />
Dow Chemical <strong>Analysis</strong> Page 29
themselves buying products from their competitors instead of producing the same<br />
products themselves. It is for this reason that research <strong>and</strong> development is m<strong>and</strong>atory<br />
in the chemical industry.<br />
Flexible Delivery<br />
Due to the globalization of the chemical industry, flexible delivery is an important<br />
strategy that can separate one company from another. For example, if you need<br />
products in the United States <strong>and</strong> the two firms that produce it are in Europe <strong>and</strong> the<br />
U.S. it would be more practical to buy your product locally. The nature of the chemical<br />
industry is the process of moving raw materials from one firm to another. Therefore,<br />
the more flexible a supplier can be with a buyer, the greater the chance they have for<br />
continued business. In addition, companies are taking the initiative to hire<br />
transportation services to improve their delivery system. This further illustrates the<br />
industries recognition of the importance of flexible delivery to improve customer<br />
satisfaction.<br />
Superior Product Variety<br />
Since the firms that compete in the chemical industry produce completely<br />
homogeneous products, it becomes imperative that a firm differentiates from its<br />
competitors. In order to achieve a specialty product, a firm can make variations within<br />
the production process to add value to that particular product. It is apparent that firms<br />
who invest heavily in research <strong>and</strong> development of new <strong>and</strong> innovative chemicals’ have<br />
consistently shown higher returns. Companies customize their products made-to-order<br />
to meet customer preferences <strong>and</strong> dem<strong>and</strong>s. An example of superior product<br />
differentiation would be the growing sector of performance chemicals <strong>and</strong> plastics. In<br />
this industry, many firms produce basic chemicals <strong>and</strong> plastics; however, the companies<br />
that can add variations in the production process can distinguish themselves <strong>and</strong> add<br />
value to the product. These variations can increase quality, product life, address<br />
environmental concerns, <strong>and</strong> enhance performance effectiveness. While all firms<br />
Dow Chemical <strong>Analysis</strong> Page 30
cannot compete on a large scale of product inventory, firms that excel in product<br />
specialization can capture a considerable portion of overall market share.<br />
Firm Competitive Advantage <strong>Analysis</strong><br />
With the recent internal analysis of Dow Chemical, management has restructured<br />
priorities that will allow Dow to keep an advantage over its competitors. Moving its<br />
primary focus to their niche <strong>and</strong> market segment, Dow has improved its quality <strong>and</strong><br />
services by centralizing their visions. Dow has implemented strategies such as: streamlining<br />
employment, lowering high energy costs, globalization <strong>and</strong> investing more into<br />
research <strong>and</strong> development. In addition to these strategies, Dow has also employed<br />
professional companies to maintain such things as global transportation <strong>and</strong> plant<br />
productivity. While competing with a strategic mix between cost leadership <strong>and</strong><br />
product differentiation, Dow has widened its customer base. By doing this, Dow has<br />
gained an advantage over the competition by improving strategies in: economies of<br />
scale <strong>and</strong> scope, efficient production, lower input costs, superior product variety, more<br />
flexible delivery <strong>and</strong> investment in research <strong>and</strong> development.<br />
Economies of Scale <strong>and</strong> Scope<br />
Another important factor to consider when evaluating a company is examining<br />
the scale of its operations <strong>and</strong> the scope of the consumer dem<strong>and</strong>. Since the Dow<br />
Corporation competes in a low to moderate level of competition amongst rival firms<br />
who produce completely homogeneous products, it is imperative that Dow maintains a<br />
“cost leadership” approach to its business. Therefore, in order to decrease the average<br />
cost of production, the Dow Company has emphasized a managerial specialization of<br />
production. By making the production process more efficient by eliminating wasted time<br />
<strong>and</strong> products, Dow can lower its long-run average cost (i.e. lowering variable cost per<br />
unit), <strong>and</strong> therefore increase profits. The economies of scope for the chemical industry<br />
are very beneficial to Dow. Since most of Dow’s production is in producing by-products<br />
for other companies, Dow essentially doesn’t have to bother with advertising or any<br />
Dow Chemical <strong>Analysis</strong> Page 31
other costly marketing schemes to attract consumers. Most of the companies that buy<br />
chemicals to include in their production are more focused on cost than differentiation;<br />
therefore, Dow gains an advantage due its vast scales of operation <strong>and</strong> its ability to<br />
offer the same form of chemicals at a discount price.<br />
Efficient Production<br />
With the implementation of the Six Sigma approach in 1999, Dow has increased<br />
productivity immensely while also cutting back on human labor. Six-Sigma is a set of<br />
practices that improve processes by eliminating defects. This approach allows for Dow<br />
Chemical to reduce variation in like products, control <strong>and</strong> analyze production, as well as<br />
increase the involvement by upper-management in ensuring product quality. Since<br />
implementing Sigma, Dow has seen an immediate 30% reduction in staffing costs along<br />
with an increase in value creation from reinvested working capital. “Over a five year<br />
period, this equates to nearly $90 million in value creation for our company” (Jon<br />
Walker, Human Resources Information, www.Dow.com). By reducing the amount of<br />
human labor needed as well as over-seeing all production activity, Dow has increased<br />
productivity within its plants. In addition, with the defects of materials being<br />
recognized more quickly by the Six Sigma software, Dow can correct problems more<br />
effectively <strong>and</strong> assure quality management. In addition to the success of the Six Sigma<br />
process, Dow had also formed an alliance with the leading software company Aspen<br />
Technology. AspenTech is a leading supplier in software designed to analyze <strong>and</strong><br />
automate processes in manufacturing plants. Dow’s process manufactures use the<br />
AspenTech software to maintain <strong>and</strong> operate efficient <strong>and</strong> safe plants while reducing<br />
various shop expenses such as raw material <strong>and</strong> energy costs. Dow uses its scale <strong>and</strong><br />
scope of economics to increase its production efficiency. Dow is constantly improving<br />
their manufacturing process to reduce waste <strong>and</strong> cost. This is exhibited in their winning<br />
of the 2007 Chemical Processing Magazine’s Plant innovation award. They were<br />
awarded this for their work in recycling chlorinated organic material<br />
(www.chemicalprocessing.com/bluebook.pdf). This new process saves the company<br />
Dow Chemical <strong>Analysis</strong> Page 32
approximately $600-800M/yr. It is through constant R&D that Dow is able to<br />
streamline their production facilities to create more efficient production.<br />
Lower Input Costs<br />
With energy costs currently at a boom, Dow has made a significant effort to<br />
lower input costs. Dow’s raw material costs (energy costs), account for about 50% of<br />
their total input costs. With newly incorporated joint ventures in the global market,<br />
Dow is now able to purchase feedstock (material in most raw materials) for a third of its<br />
current costs. These cost savings will directly affect Dow’s earnings because of the<br />
sales in global markets don’t affect their end selling price. Dow has not only cut costs<br />
through the recognition of the global market, but has also done so through innovation<br />
techniques. In 2007, Dow won the Chemical Processing Magazine’s Plant Innovation<br />
Award for its efforts in the recycling of wasted materials. Dow recognized that they<br />
were losing revenue on all the wasted material that was being incinerated on a daily<br />
basis. By recycling the material <strong>and</strong> turning it into useful feedstock, Dow has seen a<br />
$600-$800 million/yr savings as well as a massive reduction in pollution.<br />
Superior Product Variety<br />
By having such a variety of materials <strong>and</strong> products available for consumers <strong>and</strong><br />
manufacturers, Dow has pushed itself even further past the competition. Dow operates<br />
in six major segments that manufacture performance plastics, basic plastics,<br />
performance chemicals, basic chemicals, agricultural sciences as well as hydrocarbons<br />
<strong>and</strong> energy sources. While the plastics segment makes up over 50% of Dow’s sales,<br />
this segment is also the world’s largest producer of plastics. Along with plastics, Dow is<br />
one of the top producers of chemical products. A majority of Dow’s chemical<br />
production is bought by fellow competitors within the industry. Producing such a wide<br />
variety of specialized products, Dow is able to dip into multiple markets <strong>and</strong> create a<br />
larger target niche. With the continual studies by some of the top Ph. D’s <strong>and</strong><br />
Engineers in the United States, expansion is the only way Dow’s product lines can<br />
Dow Chemical <strong>Analysis</strong> Page 33
move. In addition, Dow has the highest R&D expense of any other competitor in the<br />
industry ($1,164 mill.) <strong>and</strong> is looking to produce the most cutting-edge products.<br />
Flexible Delivery<br />
As one of the world's leading multi-national manufacturing companies, Dow<br />
increased the efficiency of its global transportation by partnering with one of the lead<br />
logistics provider’s worldwide. BDP International had a long track record of exceptional<br />
global transportation as well a time tested reputation for great customer service. BDP<br />
h<strong>and</strong>les all of Dow’s Marine Packaged Cargo business, as well as their global supply<br />
chain analysis <strong>and</strong> implementation, through a strategic approach. "It reflects our longheld<br />
belief that there is no 'one-size-fits-all' logistics solution. From the start, the goal<br />
then <strong>and</strong> now has been to drive value back to Dow through their global supply chain,<br />
through a strategic approach, metrics <strong>and</strong> metrics analysis initiatives, as well as<br />
transactional order execution functions" (John Bolte, BDP Chief Operating Officer,<br />
www.BDPoint.com). Employees of BDP are what make Dow’s global market succeed.<br />
BDP has appointed a whole team of employees to over-see <strong>and</strong> operate Dow’s delivery<br />
of products. With the global transportation taken care of, Dow can put primary focus<br />
on the production process. With plants in over 15 states in the U.S., Dow is able to<br />
deliver products in a timely <strong>and</strong> efficient manner. With the hazard of chemicals being<br />
transported, Dow played a key role in the creation of the American Chemistry Council’s<br />
Responsible Care. With the help of this council, Dow set the st<strong>and</strong>ard for security <strong>and</strong><br />
safety in the chemical transportation business.<br />
Investment in Research <strong>and</strong> Development<br />
Like previously mentioned, Dow is an industry leader in Research <strong>and</strong><br />
Development. In December 2006, Dow reportedly employed 5,600 people in a variety<br />
of research <strong>and</strong> development positions. Putting such an emphasis on the development<br />
of new products as well as refining existing ones shows that Dow is looking to exp<strong>and</strong>.<br />
In the chemical industry, the majority of competition is in the R&D department. The<br />
Dow Chemical <strong>Analysis</strong> Page 34
company with the most innovative, cutting-edge product grabs the attention of buyers.<br />
Dow’s Research <strong>and</strong> Development expenses have slowly gotten higher year after year.<br />
Without the constant development of new products, Dow would lose its competitive<br />
edge. With the construction under progress with the Dow Center in Shanghai, Dow is<br />
placing a state of the art research <strong>and</strong> development lab that compares to no other.<br />
Housing one of the top research labs in the world, Dow is looking to exp<strong>and</strong> even<br />
further into the global market.<br />
Dow’s R&D Expenses<br />
$’s in millions<br />
In comparing the returns from the past three years of Research <strong>and</strong><br />
Development expenses relative to the Gross Profit of the proceeding years, Dow shows<br />
on average a 14.48% return on R&D Investments.<br />
Looking Ahead<br />
Dow Chemical has continued to improve in striving to be the industries best.<br />
With their production progress at an all time high, Dow looks to increase sales even<br />
higher with the variety of products offered. With their vast movement into the global<br />
market, Dow looks to keep input costs low by purchasing materials abroad. With<br />
Dow Chemical <strong>Analysis</strong> Page 35
energy costs looking to come down in the future <strong>and</strong> with the continual increases in<br />
R&D expenses, Dow’s earnings are consistently continuing to swell.<br />
* From this point on we will no longer consider Exxon Mobile a direct<br />
competitor within this industry. Exxon Mobile only competes in this<br />
industry on a small percentage of products manufactured.<br />
Accounting <strong>Analysis</strong><br />
Shareholders <strong>and</strong> stakeholders, current <strong>and</strong> potential, of a firm do not have<br />
direct access to the internal accounting information found in the general ledger. For<br />
this reason, they must rely on the information disclosed in the company’s 10-k filings to<br />
get an overview of the health <strong>and</strong> direction of a company. Unfortunately, the<br />
information found in a company’s financials is not always an accurate view of the<br />
operations of a company. By allowing flexibility to managers for the purpose of<br />
depicting a true representation of a business <strong>and</strong> industry, GAAP leaves a fair amount<br />
of latitude in how certain thing are reported – leading to the potential for distortion in<br />
expenses, liabilities, assets, <strong>and</strong> revenues. This brings forth the necessity for<br />
accounting analysis. Accounting analysis not only uses the company <strong>and</strong> industry<br />
information, but also estimations <strong>and</strong> assumptions based on research of current<br />
markets to gauge the accuracy <strong>and</strong> completeness of the statements. The main goal of<br />
accounting analysis is to determine how confident in the numbers presented on a<br />
company’s financial statements an analyst is.<br />
For the most part, financial analysts follow a six step accounting analysis to<br />
determine the quality <strong>and</strong> accuracy of a firm’s recordings. In the first step,<br />
Dow Chemical <strong>Analysis</strong> Page 36
identification of accounting policies, analysts must weigh the firm’s critical factors <strong>and</strong><br />
risks in relevance to the estimations <strong>and</strong> policies provided in the financials. In an<br />
industry, a firm incorporates its success factors as well as its potential risks within its<br />
competitive strategy. Next, analysts must perform an assessment of a firms accounting<br />
flexibility. Flexibility varies from company to company, in which various policies are<br />
chosen to utilize different components. Flexibility is determined by how much of a<br />
choice managers have in how certain items are reported on their financials. For<br />
example, R&D accounting is very inflexible, while pension plan estimation is very<br />
flexible. Thirdly, analysts evaluate the firm’s actual accounting strategy. This step is<br />
used to determine how the firm’s policies compare to that of its fellow competitors<br />
within the industry. This evaluation also looks into the management’s structure, looking<br />
for significant transactions or changes in policies for the benefit of obtaining accounting<br />
objectives. For the fourth step, analysts evaluate the quality of the firm’s disclosures.<br />
While managers hold a choice in the amount of disclosure they wish to provide, the<br />
more information provided allows for a more transparent look into the firms<br />
performance by investors. If there is too much disclosure, the analyst must consider<br />
the possibility that the company is trying to hide something in plain sight by adding lots<br />
of ‘noise’ to the financial statements. Next, the analysts go through the financials<br />
looking for potential ‘red flags’. A red flag is defined as a questionable accounting<br />
procedure that may lead to distortion of the firm’s value (Business <strong>Analysis</strong> &<br />
<strong>Valuation</strong>). Finally, if the analysis reveals a red flag, adjustments are made to the<br />
financial statement to gauge whether or not the distortions would have a significant<br />
impact of the view of the company’s positions.<br />
Key Accounting Policies<br />
A firm should look to its key success factors to add value <strong>and</strong> gain a competitive<br />
advantage in an industry. Reason being, “That analyst should identify <strong>and</strong> evaluate the<br />
policies <strong>and</strong> the estimates the firm uses to measure its critical factors <strong>and</strong> risks.”<br />
Mentioned previously in the five forces model, Dow <strong>and</strong> the industry as a whole key<br />
Dow Chemical <strong>Analysis</strong> Page 37
success factors include: tight cost control, economies of scale, <strong>and</strong> high investment in<br />
research <strong>and</strong> development. Of all of our key success factors related to DOW we found<br />
it interesting of the amount of money that is disclosed with research <strong>and</strong> development.<br />
With the flexibility provided by GAAP, firm’s can “dress up” their figures <strong>and</strong> numbers to<br />
be viewed as more appealing to shareholders <strong>and</strong> potential investors. Holding these<br />
key success factors, Dow structures its accounting policies as following:<br />
Growth<br />
Dow’s focus on continual growth has allowed them to top the industry in market<br />
share, as well as providing a strategy that makes them competitive in annual net sales.<br />
In 2006, they set an annual company record by recording just over $49 billion in sales;<br />
a 6% increase from 2005. “With energy costs soaring in North America, Dow has<br />
begun to see significant increases in dem<strong>and</strong> in its European, Asian, <strong>and</strong> Latin American<br />
markets” (2006 Dow 10-K). Dow continues to gain <strong>and</strong> maintain relationships on the<br />
global level as well. Purchasing materials abroad has lowered their input costs<br />
substantially, assisting in their overall growth. With the construction of numerous topof-the-line<br />
plants <strong>and</strong> laboratories in India <strong>and</strong> China, increased efforts in recruitment,<br />
<strong>and</strong> the acquisitions <strong>and</strong> mergers that have taken place in recent years, Dow looks to<br />
capitalize its sales growth in newly opened markets.<br />
By looking at Dow’s balance sheet, it is apparent that the 5.8% growth in<br />
property, plant, <strong>and</strong> equipment captures the underlying principle of Dow’s growth<br />
strategy. With the 14% increase in inventories for the years 2005 to 2006, Dow<br />
continues to allow for future growth with the selling of more products.<br />
Dow’s Growth in KSF’s<br />
Dow Chemical <strong>Analysis</strong> Page 38
Post-Retirement Benefit Plans<br />
The chemical manufacturing industry is a highly priced competitive market with<br />
multiple suppliers of st<strong>and</strong>ardized products. Since it is a struggle to compete on price,<br />
Dow must focus on cost control in order to remain profitable. Retirement plans make<br />
up a majority of a company’s operating expenses. Dow provides a reasonable level of<br />
disclosure on these plans, which allows for outsider interpretation. There was a 52.5%<br />
increase in pension plan liability between 2001 <strong>and</strong> 2002 that can be attributed to the<br />
acquisition of Union Carbide. Other than this vast increase, there has been a<br />
continuous decrease of, 16.9% <strong>and</strong> 6.5% respectively, in Dow’s pension liabilities in<br />
2005 <strong>and</strong> 2006. These changes are due to a change in pension policies that took place<br />
between the years of 2004 <strong>and</strong> 2005. In addition, Dow is constantly changing their<br />
discount rate, which is able to increase savings for the company that therefore leads to<br />
higher profits. Currently their benefit plans are over-funded, but not by a significant<br />
amount. Most of the over-funding at this point can be accounted for by the exceptional<br />
investment period of 2006. During this period, they experienced almost 2 times their<br />
expected rate of return. Their pension plan accounts for just fewer than 50% of their<br />
total long-term liabilities recorded in 2006. However, these plans account for only 16%<br />
of their total liabilities. Until this past year, Dow’s actual <strong>and</strong> expected rates of return<br />
have been within .05% respectively.<br />
Dow Chemical <strong>Analysis</strong> Page 39
Operating <strong>and</strong> Capital Leases<br />
Operating leases are used a great deal in the chemical manufacturing industry.<br />
Dow regularly leases properties for administrative offices, warehouses, railcars,<br />
computers, <strong>and</strong> equipment under operating leases. Operating leases usually are<br />
expensed on the Income Statement <strong>and</strong> stay off the balance sheet, which reduces<br />
liabilities <strong>and</strong> future obligations. “At the termination of these leases, Dow has the<br />
choice of purchasing these properties <strong>and</strong> equipment based on a fair market value”<br />
(2006 Dow 10-K). According to Dow’s 10-k, they will wait to the maturity date of the<br />
operating lease to purchase the building or equipment once it is paid off. By using this<br />
rent to own method Dow is able to make smaller payments, decrease liabilities, while<br />
maintaining such a large network. Dow doesn’t disclose much information pertaining to<br />
their lease agreements, which may distort areas of their financials. Costs for operating<br />
leases are generally more cost effective <strong>and</strong> lead to reduced purchasing costs at the<br />
leases termination. The Chemical Industry as a whole uses Operating lease over<br />
Capital leases due to the fact that the industry thrives on innovation. In order to stay<br />
competitive in terms of innovation, firms must constantly upgrade their production<br />
facilities in order to meet new product dem<strong>and</strong>s. Therefore, by the use of an Operating<br />
lease, a firm can avoid the risk of holding an obsolete factory, as well as, other cost<br />
associated with it. By classifying these operating leases as rental expense on the<br />
Income Statement, Dow has recorded expenses on these leases (net of sublease rental<br />
income) as follows: 2006, $441 million, 2005, $451 million <strong>and</strong> in 2004, $456 million.<br />
Even though these operating expenses seem high, the cost to capitalize would be far<br />
greater. Operating leases as well as the way they are disclosed are a key accounting<br />
policy used by Dow. With the non-transparent information on their leases, Dow shows<br />
a potential of distorted expenses <strong>and</strong> costs.<br />
Research <strong>and</strong> Development<br />
Dow Chemical <strong>Analysis</strong> Page 40
As seen in previous figures, firms in this industry stress their growth strategy<br />
primarily through intense research <strong>and</strong> development. By defining high investment in<br />
research <strong>and</strong> development as one of their key success factors, the proper disclosure<br />
<strong>and</strong> accounting policy on R&D becomes important. As an industry leader in research<br />
<strong>and</strong> development expenses, Dow has gained value in the progression of new products,<br />
improvement of existing products, in addition to the newly constructed plants <strong>and</strong><br />
laborites. With the addition of a 5,600 member R&D team <strong>and</strong> a state of the art facility<br />
in Shanghai, Dow seeks to gain market share by increasing their product lines. Many<br />
companies try to take advantage of the flexibility provided by GAAP with regards to the<br />
way they record research <strong>and</strong> development. Although some firms record R&D as an<br />
asset, this is incorrect because it is impossible to perceive the value added to the firm in<br />
the future. Dow reports the costs as operating expenses along with Selling, General<br />
<strong>and</strong> Administrative expenses. In 2006, research <strong>and</strong> development consisted of 41% of<br />
operating expenses. Because Dow has performed at a profitable level shown in their<br />
increases in net income, they do not need to record their R&D as an asset to look better<br />
to investors.<br />
Goodwill<br />
With Dow being as large of a firm as it is goodwill is not a huge factor on their<br />
balance sheet. Back in 2004 when DOW purchased Hampshire Chemical Corporations,<br />
the total write off for the company was only $13 million dollars. Furthermore, on the<br />
consolidated balance sheet in 2006 the total amount of goodwill that year was $3,242<br />
(in millions, when assets totaled $45,581 (in millions). As a group we came to the<br />
conclusion that goodwill for DOW is not one of their key success factors when DOW has<br />
more assets placed elsewhere throughout the company.<br />
Hedging<br />
Through Dow’s business operations they are exposed to market risk. These<br />
include foreign exchange rates, interest rates, equity prices, commodity prices <strong>and</strong><br />
other market factors. To protect themselves, Dow has the ability to minimize these<br />
Dow Chemical <strong>Analysis</strong> Page 41
isks through hedging transactions. According to Dow’s 10-k, “entering into these<br />
hedging transactions, pursuant to established guidelines <strong>and</strong> policies which enable it to<br />
mitigate the adverse effects of financial market risk.” If Dow were not to use these<br />
transactions they would be exposed to all these factors which would effect their<br />
consolidated financial statements in a negative way. Although following these practices<br />
starting in 2006, Dow began the year with an accumulated derivative loss of $127<br />
million.<br />
Conclusion<br />
Firms accounting policies can have a huge impact on investor’s decisions. By<br />
providing high disclosure <strong>and</strong> proper use of policies, firm’s financial statements appear<br />
transparent <strong>and</strong> make it much easier to form inferences <strong>and</strong> set values. The industries<br />
key accounting policies listed above make it easier to translate what their key success<br />
factors are in improving <strong>and</strong> adding value to the company.<br />
Accounting Flexibility<br />
Throughout the industry, companies that are publicly traded are required to<br />
present numerous reports to the SEC each year. Within these requirements, the<br />
numbers in these reports must follow the guidelines of the General Accepted<br />
Accounting Principles (GAAP). As found in the book, Business <strong>Analysis</strong> <strong>and</strong> <strong>Valuation</strong><br />
Tools, “managers have the flexibility in deciding their accounting policies as well as their<br />
estimates related to key success factors.” To be more specific, managers have the<br />
flexibility to decide whether to use different methods to be more elastic in this industry.<br />
Most firms use post-retirement benefit plans <strong>and</strong> research <strong>and</strong> development as key<br />
areas of flexibility. As previously stated, these numbers can be adjusted by the use of<br />
Operating leases as opposed to Capital leases, or changes in pension obligations<br />
through new pension plans or changes in the discount rates associated with these<br />
Dow Chemical <strong>Analysis</strong> Page 42
policies. These variations can account for adjustments in a firms long term liabilities,<br />
<strong>and</strong> inconsistencies associated with their expenses <strong>and</strong> net income.<br />
Research <strong>and</strong> Development<br />
As mentioned above, GAAP’s flexibility in the way they allow research <strong>and</strong><br />
development to be recorded can cause many firms to take advantage of the amount of<br />
disclosure they chose to provide. The reason being that many firms in this industry<br />
want to record research <strong>and</strong> development as an asset rather an expense because they<br />
perceive the money spent will generate future cash flows. The logic behind reporting<br />
R&D as an asset instead of an expense is that a firm can capitalize the cost over the<br />
useful life of the products/services resulting from R&D. With this in mind, it must be<br />
assumed that the money put into its research <strong>and</strong> development, <strong>and</strong> operating<br />
expenses (including general, selling, <strong>and</strong> administrative expense) may not fully reflect<br />
all the costs associated with R&D. In the industry, it is typical to see anywhere for 40<br />
to 50% of a firms operating expenses to be invested in research <strong>and</strong> development.<br />
This shows that the industry uses a high degree of the differentiation approach in order<br />
to maintain a competitive advantage. Dow consumes just over 41% of their total<br />
operating expenses in research <strong>and</strong> development, which in 2006 accounted for 21% of<br />
their income. From these percentages, it can be determined that Dow is placing a<br />
significant amount of its income back into the business that is working toward<br />
generating future cash flows. This is a good indication of their investment into the<br />
future of the company. By applying this much of their income back into the business,<br />
managers are sending the signals that they are confident in the continued success of<br />
the business <strong>and</strong> industry.<br />
Operating Leases<br />
Many firms in the chemical industry use the recording of “off balance sheet”<br />
assets otherwise known as operating leases quite frequently. The reason being that a<br />
conglomerate like Dow as well as other firms in the chemical industry are able to use a<br />
Dow Chemical <strong>Analysis</strong> Page 43
facility or building without assuming all the risk that comes along if they were to own it.<br />
Because of GAAP’s loose requirements, managers have the flexibility whether to<br />
distinguish it from a capital lease or an operating lease. By choosing to use an<br />
operating lease, firms are able to lower their long term liabilities by simply expensing<br />
these payments each year. However, this makes it hard to determine how much these<br />
expenses actually are because they are consolidated in the category of “Other long<br />
term expenses.” Due to the fact that there are such loose requirements set up by<br />
GAAP, managers have given very low disclosure based around these figures.<br />
Throughout Dow’s 10-k, they have given the figures of the bare minimum yearly<br />
payments of these leases. These payments include (2007) $251 million, (2008) $208<br />
million, (2009) $179 million, (2010) $137 million, (2011) $85 million, <strong>and</strong> (2012 <strong>and</strong><br />
thereafter) $565 million. Thus, it nearly impossible to determine how firms like Dow are<br />
accounting for these expenses.<br />
2001 2002 2003 2004 2005 2006<br />
$<br />
$<br />
$<br />
$<br />
$<br />
$<br />
Property<br />
35,890<br />
37,934<br />
40,812<br />
41,898<br />
41,934<br />
44,381<br />
$<br />
$<br />
$<br />
$<br />
$<br />
$<br />
Net Sales<br />
28,075<br />
27,609<br />
32,632<br />
40,161<br />
46,307<br />
49,124<br />
$<br />
$<br />
$<br />
$<br />
$<br />
$<br />
Inventories<br />
4,440<br />
4,208<br />
4,050<br />
4,957<br />
5,319<br />
6,058<br />
Evaluating Accounting Strategy<br />
Given a firms accounting flexibility, management have the option of reporting or<br />
omitting key provisions within its financial statement. Through the use of an aggressive<br />
accounting strategy, a firm can choose to exclude imperative information on how<br />
Dow Chemical <strong>Analysis</strong> Page 44
certain numbers effecting key success factors where formed. On the other h<strong>and</strong>, a<br />
conservative accounting strategy would increase the transparency of the company,<br />
which in turn would increase investor confidence. To determine the type of accounting<br />
strategy used, one must focus on the level of disclosure a company provides within<br />
their financial reports.<br />
In the chemical <strong>and</strong> plastic industries, those which DOW competes in, there is a<br />
mixture of conservative <strong>and</strong> aggressive accounting. There is a high level of disclosure<br />
in the product segmentation reports, which gives not only an overview of the product<br />
line, but also the sales growth, volume of production, competition, <strong>and</strong> product<br />
licensing rights for each manufactured goods. In addition, subjects related to the<br />
growth of the company also have high disclosure of their values. In the areas that are<br />
crucial to the growth of the company such as properties, plant <strong>and</strong> equipment, net<br />
sales, <strong>and</strong> inventories, we see that Dow has made a considerable investment in all<br />
three sectors.<br />
Aside from the advances in these areas, the firm has also been restructuring<br />
their business model by cutting back on manufacturing labor, ceasing operations from<br />
inefficient production facilities, <strong>and</strong> increasing the R&D staff. Furthermore, in the areas<br />
of Research <strong>and</strong> Development, we are able to see a high level of disclosure. DOW has<br />
increased its intellectual capital by hiring 5,600 experienced <strong>and</strong> knowledgeable<br />
professionals, <strong>and</strong> built new state-of-the-art production facilities to yield new <strong>and</strong><br />
innovative products. This shows that Dow, along with other competitors in this<br />
industry, know the importance of R&D, <strong>and</strong> seek to gain a competitive advantage by<br />
increasing the amount of funding associated with it in hopes of generating future cash<br />
flows.<br />
On the other h<strong>and</strong>, there is a low level of disclosure in Capital/Operating leasing.<br />
Firms can choose to capitalize their leases or expense them through Operating Leases.<br />
When using a capital lease, the lease is treated as an asset on the firms Balance Sheet,<br />
Dow Chemical <strong>Analysis</strong> Page 45
<strong>and</strong> the payment of principle <strong>and</strong> interest are written as liabilities. In contrast, an<br />
Operating lease is treated as an expense on the Income Statement that is taken out of<br />
revenues, which reduces Net Income <strong>and</strong> Retained Earnings. A company that chooses<br />
to use an Operating Lease benefits in terms of reducing liabilities because it is<br />
considered an “off Balance Sheet” activity. The information pertaining to Dow’s<br />
Operating Lease provides absolutely no insights on the current state of their lease<br />
agreements. The only information regarding leasing contracts was an annual expense<br />
in 2005 in the amount $451 million <strong>and</strong> a forecast of expected payments from 2006<br />
through 2012 <strong>and</strong> beyond. By looking at the table of future expected payments, an<br />
expert can find the net present value of operating leases through computation by using<br />
a 6.65% cost of capital rate <strong>and</strong> discounting the expected future payments back to their<br />
present values.<br />
Minimum Operating Lease Commitments at December 31, 2006 (in millions)<br />
Years DOW's future value PV Factor Net Present Value<br />
2007 $251 .937 $235<br />
2008 $208 .879 $183<br />
2009 $179 .824 $148<br />
2010 $137 .773 $106<br />
2011 $85 .725 $62<br />
2012 <strong>and</strong> thereafter $565 .679 $383<br />
Total $1,425 $1117<br />
note: discount rate of 6.65% chosen due to cost of capital rate<br />
Cost of capital rate determined by using average rate of long-term debt disclosed in note K of 2006 10K<br />
Dow Chemical <strong>Analysis</strong> Page 46
Operating leasing is considered a relevant concept of innovation, which is a<br />
significant aspect for this firm. Since the industry is constantly changing <strong>and</strong> requiring<br />
new <strong>and</strong> innovative production facilities, it is beneficial for DOW to keep potentially<br />
“obsolete” property, plant, <strong>and</strong> equipment off their balance sheets. However, it is also<br />
important to note that companies in this industry rely heavily on their Operating Leases,<br />
<strong>and</strong> the fact that DOW has withheld some information <strong>and</strong> has barely met the GAAP<br />
requirements of disclosure causes some concern <strong>and</strong> raises the risk of impairment on<br />
their financial transparency.<br />
Finally, there is a relatively high level of disclosure in the financial statements<br />
regarding Dow’s retirement pension plan. This company’s retirement pension plan plays<br />
a significant role in how well DOW performs in the key success factor of cost leadership.<br />
Since Dow engages in heavy price competition with rivals, it is imperative that this firm<br />
lowers as many expenses as possible in order to obtain an above par industry profit.<br />
The company’s retirement pension package accounts for well over 50% of their longterm<br />
liability <strong>and</strong> approximately 16% of their total liabilities. DOW provides an in depth<br />
look at the company’s retirement policy <strong>and</strong> their employee benefit package, however,<br />
it is somewhat difficult to measure the company’s net present value for providing these<br />
services. DOW does an excellent job proving key features of the computations of their<br />
pension-plan expenses such as using a higher discount rate to lower future retirement<br />
obligations.<br />
U.S. Plan Assumptions for Other Postretirement Benefits (in millions)<br />
Benefit Obligations at Net Periodic Costs for the<br />
December 31<br />
Year<br />
Year 2006 2005 2006 2005<br />
Discount Rate 5.89% 5.60% 5.60% 5.88%<br />
Initial health care cost trend rate 8.79% 9.50% 9.50% 10.16%<br />
Dow Chemical <strong>Analysis</strong> Page 47
Ultimate health care cost trend<br />
rate (assumed to be reached in<br />
2011) 6% 6% 6% 6%<br />
In relation to other companies the ultimate health care cost trend does not affect<br />
Lyondell. “The health care cost trend rate assumption does not have a significant effect<br />
on the amounts reported due to limits on Equistar’s maximum contribution level to the<br />
medical plan”( Lyondell 10-k). Equistar being one of the companies that Lyondell had<br />
merged with back in 2002. One of Dow’s other competitor’s however, DuPont will have<br />
an initial health care cost rate of 10%, ultimately reaching its peak through the years<br />
2011-2012. Another point of interest on DuPont’s 10-k was how if a single percentage<br />
point went up or down effected total service, interest cost <strong>and</strong> also the effect on<br />
postretirement benefit obligation.<br />
1% point Increase 1% Point Decrease<br />
Effect on total of service <strong>and</strong> interest cost<br />
$6 ($3)<br />
Effect on postretirement benefit obligation<br />
$82 ($55)<br />
In conclusion, the DOW corporation overall meets industry st<strong>and</strong>ards by giving<br />
relatively high disclosure on key success factors such as growth, Research &<br />
Development, product segmentation, <strong>and</strong> cost-reducing pension plans. With a few<br />
exceptions (i.e. operating leases) <strong>and</strong> a wealth of accounting flexibility at their disposal,<br />
DOW as a whole follows a reasonably conservative accounting strategy when<br />
presenting information on their financial statements <strong>and</strong> therefore has the ability to<br />
increase investor confidence in their firm.<br />
Quality of Disclosure<br />
The quality of information that is disclosed by a company plays an important role<br />
in how financiers look at the information provided by the company in its financial<br />
statements. The higher level of quality disclosure gives investors <strong>and</strong> lenders a more<br />
Dow Chemical <strong>Analysis</strong> Page 48
transparent view of how a company operates. The following sections will discuss Dow<br />
Chemical’s level of disclosure <strong>and</strong> confidence in the transparency that they are<br />
providing. Disclosure is defined as, “the giving out of information, either voluntarily or<br />
to be in compliance with legal regulation or workplace rules” (Wikipedia.org)<br />
Sales Data<br />
One of the ways it is possible to assess the transparency of data is viewing how<br />
well broken down into different segments the sales information is. These segments can<br />
be based on different criteria. A good example of this would be listing sales based on<br />
geographic locations. Dow chemical, breaks their sales down into their 6 main sales <strong>and</strong><br />
operating sections based on the types of products produced <strong>and</strong> sold. Unfortunately,<br />
they do not break their research <strong>and</strong> development expenses into the same segments<br />
making it hard to attribute the cost of research to each segment, which makes it<br />
difficult to guess how R&D is affecting each of the segments.<br />
Performance<br />
Plastics<br />
Performance<br />
Chemicals<br />
Agricultural<br />
Sciences<br />
Basic<br />
Plastics<br />
Basic<br />
Chemicals<br />
Hydrocarbons<br />
<strong>and</strong> Energy<br />
Unallocated<br />
<strong>and</strong> Other<br />
2006 28% 16% 7% 24% 11% 13% 1%<br />
2005 27% 16% 7% 24% 12% 13% 1%<br />
2004 26% 16% 8% 23% 14% 12% 1%<br />
(Dow 10-k)<br />
While information such as the table above seems to provide useful information, in<br />
actuality it is just noise to fill up the 10-k. This is one of the things that a full analysis<br />
helps determine, how relevant is the information?<br />
Quantitative <strong>Analysis</strong><br />
Dow Chemical <strong>Analysis</strong> Page 49
An important aspect of financial analysis is to gage the level the performance of<br />
not only other firms but the industry as well. We accomplished this task through the<br />
sales manipulation diagnostics, <strong>and</strong> expense ratios. Net Sales/Cash from sales, Net<br />
Sales/Accounts Receivables, <strong>and</strong> Net Sales/Inventory are all considered sales<br />
manipulative diagnostics which will measure the performance of the firm. Asset<br />
turnover, cash flow from operations/Operating income, pension expense/ SG&A, <strong>and</strong><br />
cash flow from operations/Net operating assets are all expense ratio diagnostics that<br />
show allocation from revenues to expenses. Drastic changes from year to year can<br />
signal a red flag of accounting discrepancy, <strong>and</strong> therefore require immediate attention.<br />
Sales Manipulation Diagnostics<br />
Sales manipulation diagnostics are keys to signaling “red flags” or manipulation<br />
in the form of revenues. This can be checked by looking at financial statements from<br />
year to year of not only a single firm but also the industry as a whole. The company’s<br />
diagnostics that will be discussed are: Dow, DuPont, Lyondell, <strong>and</strong> Huntsman.<br />
Net Sales/Cash from Sales<br />
The ratio of Net Sales/Cash from Sales represents the amount of cash a<br />
company receives from transactions versus transactions made on credit, i.e. credit<br />
Dow Chemical <strong>Analysis</strong> Page 50
cards. In a perfect sales environment, this ratio would be 1:1; where all net sales are<br />
purchased in cash. This perfect ratio is especially hard to meet in the chemical industry<br />
because the amount of materials purchased is usually bought in bulk. Most clients do<br />
not possess enough cash on h<strong>and</strong> to pay for the products in the full amount. In looking<br />
in the 5 year sales figure, Dow shows the most consistent ratio of direct cash to credit<br />
ratio. Huntsman showed a large peck in 2003 <strong>and</strong> Lyondell in 2004 indicating that a<br />
large percentage of their sales where on credit. Changes in there allowances for credit<br />
sales can attribute to the decrease in these ratios in the past few years. In relation to<br />
the cash to cash cycle those peaks in 2003, Huntsman, <strong>and</strong> 2004, Lyondell, clearly<br />
indicate a rise in net sales. However, with their net sales increasing their cash from<br />
sales did not increase which in turn means the majority of their sales in 2003 <strong>and</strong> 2004<br />
were purchased on credit. Whereas, Dow <strong>and</strong> DuPont have created stability in not only<br />
their net sales, but the majority of their sales came through the purchases with cash.<br />
Net Sales/Net Accounts Receivable<br />
The receivables turnover ratio is one of the ways an individual is able to assess a<br />
company’s liquidity. “The decrease in receivables turnover is the most negative factor<br />
Dow Chemical <strong>Analysis</strong> Page 51
in the liquidity evaluation” (ratio’s h<strong>and</strong>out). As shown above the three companies<br />
DOW, DuPont, <strong>and</strong> Huntsman have a steady rate across the board showing a favorable<br />
ratio. This positive trend not only has a positive effect on liquidity, but also current<br />
liabilities have not changed either. Lyondell however, has a clear drop off indicating a<br />
negative impact on liquidity for the company. This diagram shows that when a<br />
company is to purchase on credit from Lyondell that it takes longer for them to convert<br />
that into cash. Furthermore, because of this decrease in the receivables turnover some<br />
companies sometimes have to use short-term debt as a source of cash to be able to<br />
continue into the next period. As Lyondell has shown on their 10-k, in September of<br />
2004 they had to restructure their debt because of the acquisition of a new company<br />
changing their liabilities in 2004-2006, one of the main factors for this decrease in their<br />
receivables turnover.<br />
Net Sales/Inventory<br />
Dow Chemical <strong>Analysis</strong> Page 52
The inventory turnover is key indicator in the firm of how a firm is able to turn<br />
inventory into profits. If a company has low inventory turnover an investor should<br />
assume low sales with an excess of inventory. “High inventory levels are unhealthy<br />
because they represent an investment with a rate of return of zero” (investopedia.com).<br />
Which in turn if prices were to fall, then that company would be in trouble. With Dow<br />
maintaining a consistent inventory turnover along with DuPont there is no real concern.<br />
However, according to Dow’s 10-k because of the recent rises in energy costs <strong>and</strong> plant<br />
operating rates this turnover has begun to decrease. Lyondell had a huge drop off in<br />
2004, along with a quick turnaround in 2005 possibly due to an overstatement of<br />
inventory. Huntsman had a “red flag” with a sharp rise in 2003 due to a large amount<br />
of inventory with an even larger amount of sales. To control this Huntsman starting in<br />
2004 reduced inventories while liquidating parts of their LIFO inventory to not only cut<br />
inventory but sales cost as well. Overall, in the industry all these companies are using a<br />
LIFO method. With the exception of DuPont though, each one of these companies is<br />
struggling to maintain a solid inventory turnover.<br />
Net Sales/Cash from sales<br />
2002 2003 2004 2005 2006<br />
DOW 1.01 1.01 1.03 1.01 0.99<br />
DD 0.99 1.01 1.03 0.96 1.02<br />
HUN 0.99 1.34 1.05 0.99 0.98<br />
LYO 1.01 1.01 1.23 1.01 1.02<br />
Net Sales/Net A/R<br />
2002 2003 2004 2005 2006<br />
DOW 5.03 5.50 5.46 5.84 6.10<br />
DD 6.18 6.40 5.59 6.82 6.32<br />
HUN 5.26 6.28 5.99 7.17 8.48<br />
Dow Chemical <strong>Analysis</strong> Page 53
LYO 8.24 8.42 3.79 11.10 10.25<br />
Net Sales/Inventory<br />
2002 2003 2004 2005 2006<br />
DOW 6.56 8.06 8.10 8.71 8.11<br />
DD 5.45 6.57 6.09 5.62 5.55<br />
HUN 4.45 11.61 7.58 8.07 6.94<br />
LYO 9.48 10.89 3.67 11.23 9.84<br />
Expense Manipulation Diagnostics<br />
The expense diagnostics that will be discussed are the Asset Turnover, Cash flow<br />
from Operations/ Operating Income, <strong>and</strong> Pension Expense/SG&A. Similar to the<br />
revenue diagnostics these are ratios that can signal a “red flag” on the year to year<br />
financial statements of not just the firm itself, but the industry as well.<br />
Asset Turnover (Sales/Assets)<br />
Dow Chemical <strong>Analysis</strong> Page 54
The Asset Turnover ratio is one way of determining the possible over-statement<br />
of assets. Ideally, there should be a slight rise over time to compensate for growth in<br />
sales as well as inflation. Dow <strong>and</strong> DuPont have risen at a steadily increasing rate over<br />
the 5 years reviewed, helping to establish a confidence in their asset statement. In<br />
regards to Lyondell this sharp rise should be a “red flag” of overstated assets. Overall,<br />
the companies starting in 2005 have maintained a steady asset turnover.<br />
CFFO/OI<br />
This ratio compares the cash flow from operations to the income a company<br />
receives from operating activities. For a company to have operating cash flows being<br />
supported by operating income allows for a positive ratio. A firm’s goal is to have a<br />
small ratio which will show investors that firm is generating revenue through<br />
operations. However, when the ratio decreases operating income is not solely<br />
supporting the company thus forces the company to get cash from elsewhere. This<br />
could lead to a potential “red flag” because of the possible manipulation of the numbers<br />
by the manager, <strong>and</strong> the actual numbers being recorded. The dramatic change in<br />
Dow’s 2002 to 2003 ratio can be explained by the purchase of Union Carbide. In 2004<br />
<strong>and</strong> beyond this has allowed Dow to maintain a small ratio.<br />
Pension Expense/SG&A<br />
Dow Chemical <strong>Analysis</strong> Page 55
From a financial st<strong>and</strong>point, the pension expense ratio allows outsiders or<br />
investors to see how much general expenses are being spent on pension to the retired<br />
employees. Having a large ratio would be bad for a company because it would then<br />
show a majority of expenses going to retired employees. However, if you were to have<br />
a low ratio then a majority of your expenses are not going to the pension plan. The<br />
overall look at the industry is not good. Reason being there is a steady decline in all<br />
the firms which shows no pension responsibility, which is a clear “red flag” indicator.<br />
CFFO/NOA<br />
Dow Chemical <strong>Analysis</strong> Page 56
This ratio is an indication of how effectively the fixed assets produce income.<br />
Preferably, in this industry there will be a rise over time, followed by a decline because<br />
of the fixed assets reaching their peak potential. In order to reverse this process,<br />
companies must invest in new <strong>and</strong> better property, plant <strong>and</strong> equipment. With the<br />
increased investment in net operating assets (property, plant <strong>and</strong> equipment), a<br />
company allows itself for potential growth. From the perspective of the company a<br />
large ratio is ideal. It shows that your net operating assets are able to generate<br />
income. With the exception of Dow <strong>and</strong> Lyondell, Huntsman <strong>and</strong> DuPont are able to<br />
maintain an upward sloping ratio.<br />
Asset Turnover<br />
2002 2003 2004 2005 2006<br />
DOW 0.69 0.78 0.88 1.01 1.08<br />
DD 0.69 0.73 0.77 0.80 0.86<br />
HUN 0.49 0.79 1.01 1.19 1.25<br />
LYO 0.44 0.49 0.37 1.23 1.25<br />
CFFO/OI<br />
2002 2003 2004 2005 2006<br />
DOW -3.39 2.1588 0.70 0.69 0.84<br />
DD 1.04 2.0499 1.18 0.62 0.87<br />
HUN 0.78 1.2585 0.69 1.35 1.21<br />
LYO 1.66 -103 3.64 0.83 0.76<br />
Pension Expense / SGA<br />
2002 2003 2004 2005 2006<br />
DOW 3.54 3.64 3.89 3.08 2.65<br />
DD 1.89 1.67 1.39 1.94 1.79<br />
HUN 1.17 1.08 0.75 0.92 0.83<br />
LYO 2.69 2.73 0.86 0.39 0.36<br />
CFFO / NOA<br />
2002 2003 2004 2005 2006<br />
DOW 0.15 0.27 0.19 0.33 0.30<br />
DD 0.18 0.26 0.32 0.25 0.36<br />
LYON 0.12 0.04 0.05 0.24 0.13<br />
HUNT 0.03 0.04 0.02 0.21 0.22<br />
Dow Chemical <strong>Analysis</strong> Page 57
Identifying potential red flags<br />
Identifying potential red flags are an important part of the six step process of<br />
analyzing firms accounting policies <strong>and</strong> procedures. By reviewing financial data over an<br />
extended period, an analyst can quickly determine if there are practices that raise the<br />
risk of misstating assets or liabilities. Such indicators would be a frequent change in<br />
independent auditing firms, unexplained or often accounting changes; unusual changes<br />
in the relationship between sales <strong>and</strong> inventories, or large asset write offs to name a<br />
few (Business <strong>Analysis</strong> & <strong>Valuation</strong>).<br />
After careful analysis of 5 years worth of accounting data, we have been unable<br />
to find any significant discrepancies in Dow’s reporting. Compared to the industry,<br />
Dow’s SEC reporting had no significant changes in format. While some of the data<br />
presented was difficult to decipher, incomes <strong>and</strong> expenses being mixed in the income<br />
statement, it was consistent from year to year <strong>and</strong> not impossible to underst<strong>and</strong> with a<br />
little comparison to the cash flow statement <strong>and</strong> balance sheet.<br />
Overall disclosure was more than adequate to comply with GAAP <strong>and</strong> to give the<br />
average investor good information. As an analyst firm, we would have preferred<br />
greater disclosure regarding where the R&D expenses were spent <strong>and</strong> their operating<br />
leasing obligations, the information was adequate to make a full analysis with very little<br />
estimation. Taken with a grain of salt, the financial statements were adequate to<br />
complete an sufficient analysis.<br />
Undoing Accounting Distortions<br />
With great review <strong>and</strong> to our great relief, we determined that there were no<br />
distortions that required undoing. We review the operating lease agreements <strong>and</strong><br />
found them to change to overall long term liabilities by less that 5% if converted to<br />
capital leases. After review the industry st<strong>and</strong>ard <strong>and</strong> Dow’s pension plan, we<br />
Dow Chemical <strong>Analysis</strong> Page 58
determined that they were easily within the normal range for being over/understated<br />
without it being excessive. We did have some concerns regarding the forecasting for<br />
future obligations, but current <strong>and</strong> past actual contributions <strong>and</strong> returns have more<br />
than compensated for our concerns.<br />
Financial <strong>Analysis</strong><br />
Financial <strong>Analysis</strong> is a vital tool in the performance evaluation of a specific<br />
company, as well as competitors in a given industry. These ratios are performed after<br />
analyzing <strong>and</strong> evaluating a company’s financial statements. The analysis of the<br />
financial statements helps to, “evaluate the financial dimensions of management<br />
performance, detect emerging trends <strong>and</strong> to help explain relationships contained in the<br />
basic financial statements (Financial Statement <strong>Analysis</strong> Worksheet, Alamo Co).” There<br />
are 3 different types of basic ratio’s that are put together by viewing the three different<br />
basic financial statements. These three ratios’ include: Liquidity ratios, Profitability<br />
ratios, <strong>and</strong> Capital Structure ratios. At the conclusion of performing these ratio’s, a<br />
company then begins to set forecasts for the company’s future performance. Usually, a<br />
company will limit its forecasts to the major line items on the Income Statement,<br />
Balance Sheet, <strong>and</strong> the Statement of Cash Flows.<br />
In the final section of this financial analysis are the financial forecasts of Dow’s<br />
financial statements. Financial forecasts are predictions of a company’s future<br />
performance based on past data. These forecasts simulate growth rates that a<br />
company looks to continue within the coming years. In this section, Dow is forecasted<br />
for the upcoming 10 year span on their Income Statement, Balance Sheet, <strong>and</strong><br />
Statement of Cash Flows.<br />
Liquidity Ratios<br />
Dow Chemical <strong>Analysis</strong> Page 59
Liquidity ratios refer to the ability of a company to quickly convert assets into<br />
quick cash in a timely manner in order to pay off current debts. Poor liquidity ratios can<br />
usually point to non-sufficient cash flows throughout the statements.<br />
Current Ratio: (Current Assets/Current Liabilities)<br />
The Current Ratio is calculated by dividing Current Assets over Current Liabilities.<br />
Some basic current assets, which are assets that are readily converted into cash in<br />
short notice, consist of, Cash, Accounts Receivables <strong>and</strong> Inventories. Current Liabilities<br />
might consist of things such as Accounts Payable, Current Notes Payable <strong>and</strong> Accrued<br />
Liabilities. A company would like to see a higher ratio number compared to its<br />
competitors, which would signify how well a company can generate a sufficient profit to<br />
cover their debt. It is also important to note that many creditors look at this ratio to get<br />
an idea of the risk <strong>and</strong> creditworthiness of a firm.<br />
Current Ratio<br />
2002 2003 2004 2005 2006<br />
DOW 1.28 1.38 1.51 1.63 1.62<br />
DD 1.9 1.42 1.92 1.67 1.62<br />
LYO 1.85 1.94 1.94 1.68 1.6<br />
HUN 3.37 1.49 1.74 1.64 1.61<br />
Industry 1.74 1.56 1.78 1.66 1.61<br />
Current Ratio<br />
4<br />
3.5<br />
3<br />
2.5<br />
2<br />
1.5<br />
1<br />
0.5<br />
0<br />
2002 2003 2004 2005 2006<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
Industry<br />
The current ratio is the mix of company’s current assets in comparison to its<br />
current liabilities. Although Dow has the lowest ratio, it still is larger than one <strong>and</strong> has<br />
Dow Chemical <strong>Analysis</strong> Page 60
shown growth approaching just under 1.75:1. This shows that Dow is able to pay off<br />
its debt obligations in a manageable fashion. Dow is also a much larger company than<br />
any of its fellow competitors, so it tends to allow for more holding of liabilities. It should<br />
be noted that this ratio does not give a perspective as to the firms’ capital structure. As<br />
the graph above indicates, Dow <strong>and</strong> its competitors tend to maintain the same levels of<br />
current assets relative to their current liabilities, especially in 2006 where all of the firms<br />
current ratios where nearly identical.<br />
Quick Asset Ratio:[(Cash+Securities+Accounts Receivable)] / (Current Liabilities)<br />
In calculating a company’s Quick Asset Ratio, Cash, <strong>Mark</strong>etable Securities, <strong>and</strong><br />
Accounts Receivables are added together <strong>and</strong> divided over Current Liabilities. This ratio<br />
can be used to “view the sign of a company’s financial strength or weakness<br />
(Investorwords.com).” A higher ratio usually means better things for a company, but<br />
not always. For example, if a company has a really large Acid ratio then that means the<br />
firm does not control balance <strong>and</strong> holds too many quick assets relative to its current<br />
liabilities.<br />
QUCIK ASSETS RATIO<br />
2002 2003 2004 2005 2006<br />
DOW 0.53 0.63 0.76 0.84 0.75<br />
DD 1.13 0.58 1.06 0.89 0.89<br />
LYO 1.15 1.27 1.04 0.88 0.82<br />
HUN 0.53 0.77 1.00 0.86 0.73<br />
INDUSTRY 0.84 0.81 0.97 0.87 0.80<br />
Dow Chemical <strong>Analysis</strong> Page 61
Quick Asset Ratio<br />
1.40<br />
1.20<br />
1.00<br />
0.80<br />
0.60<br />
0.40<br />
0.20<br />
0.00<br />
2002 2003 2004 2005 2006<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
While DuPont <strong>and</strong> Lyondell hold up the industry average of just under 1, Dow<br />
struggles to maintain a high quick asset ratio. Like Dow’s current ratio, liabilities bring<br />
down this ratio compared to its current assets such as accounts receivables <strong>and</strong> readily<br />
available cash. Towards the end of 2005 <strong>and</strong> the beginning of 2006, Dow moves within<br />
the industry’s ratio. Although Dow has the lowest ratio, it is the only company out of<br />
these 4 competitors that shows a continual increase <strong>and</strong> improvement in steadying out<br />
its asset <strong>and</strong> liability bases.<br />
The next 3 ratios measure a sense of liquidity, but also show the efficiency of a<br />
company’s operations. “Operating efficiency results are measured by relating expense<br />
items in the income statement to sales on a percentage basis (Financial Statements<br />
worksheet-Alamo Co).” These three ratios consist of: Inventory Turnover, Receivables<br />
Turnover, <strong>and</strong> Working Capital Turnover.<br />
Inventory Turnover:(Cost of Goods Sold/Inventory)<br />
Inventory turnover is calculated by taking the Cost of Goods Sold (A.K.A. Cost of<br />
Revenue) <strong>and</strong> dividing it by the company’s inventory measured at cost. This ratio is<br />
very important in that it shows how many times a company turns over its products or<br />
Dow Chemical <strong>Analysis</strong> Page 62
inventories within a year; therefore with this method, the larger the ratio, the better<br />
the result. This allows for a company to correct inventory methods when necessary.<br />
INVENTORY TURNOVER<br />
2002 2003 2004 2005 2006<br />
DOW 5.65 6.96 6.91 7.20 6.85<br />
DD 3.79 4.27 4.62 4.39 3.98<br />
LYO 8.42 10.35 3.37 9.95 8.75<br />
HUN 4.31 6.10 6.67 6.92 5.98<br />
INDUSTRY 5.54 6.92 5.39 7.12 6.39<br />
Inventory Turnover<br />
12.00<br />
10.00<br />
8.00<br />
6.00<br />
4.00<br />
2.00<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
INDUSTRY<br />
0.00<br />
2002 2003 2004 2005 2006<br />
Besides the exception of Lyondell, Dow holds a superior inventory ratio. With a<br />
5 year average of 6.7 turns per fiscal year, Dow allows for a continuous flow of new<br />
inventories into its production process which generates a larger ratio than the industry.<br />
While Lyondell’s ratio of turns looks higher, they make a substantial decline between<br />
the years of 2003 <strong>and</strong> 2005. With a higher amount of turns per year than its immediate<br />
competitors, Dow gains a competitive advantage in allowing for more products to be<br />
sold.<br />
Days’ Supply of Inventory: (365/Inventory Turnover)<br />
The Days’ Supply of Inventory correlates with the Inventory Ratio, in which the<br />
number of days in a fiscal year is divided by that Inventory Turnover. A low number is<br />
Dow Chemical <strong>Analysis</strong> Page 63
preferred, in that this ratio shows the number of days a product sits on a company’s<br />
shelf before it is sold.<br />
DAYS SUPPLIES INVENTORY<br />
2002 2003 2004 2005 2006<br />
DOW 64.59 52.46 52.84 50.72 53.25<br />
DD 96.21 85.52 78.93 83.12 91.63<br />
LYO 43.33 35.27 108.15 36.67 41.7<br />
HUN 84.62 59.88 54.75 52.73 61.08<br />
INDUSTRY 72.19 58.28 73.67 55.81 61.92<br />
120<br />
Days Supplies Inventory<br />
100<br />
80<br />
60<br />
40<br />
20<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
0<br />
2002 2003 2004 2005 2006<br />
The longer inventory sits on a company’s shelves, the longer it takes for a<br />
company to collect money on those products. Like its days of receivables turnover,<br />
Dow’s time of turns are well under the five year industry average of 64.37 days. With<br />
an overall decrease with inventory on Dow’s shelves, it looks as though Dow is trying to<br />
improve its inventory techniques to try <strong>and</strong> retain quicker cash <strong>and</strong> more room for new<br />
inventories.<br />
Receivables Turnover: (Sales/Accounts Receivables)<br />
The Receivables Turnover ratio can be calculated by taking the Net Sales (A.K.A.<br />
Revenue) for that year <strong>and</strong> dividing it over the Accounts Receivables which can be<br />
located at the top of the balance sheet under current liabilities. This ratio measures<br />
Dow Chemical <strong>Analysis</strong> Page 64
how efficient a company is in extending credit to its purchasers, as well as the<br />
effectiveness of asset use.<br />
A/R Turnover<br />
2002 2003 2004 2005 2006<br />
DOW 8.86 9.13 8.45 9.04 9.85<br />
DD 6.18 6.4 5.59 5.55 5.28<br />
LYO 9.59 9.77 4 10.82 10.08<br />
HUN 6.1 6.32 5.99 7.17 8.48<br />
A/R Turnover<br />
12.00<br />
10.00<br />
8.00<br />
6.00<br />
4.00<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
2.00<br />
2002 2003 2004 2005 2006<br />
Dow’s accounts receivables turnover is relatively higher than what the five year<br />
industry turnover was at 7.63. This shows that Dow’s policies on repayment of its<br />
credits are not competitive with its fellow competitors. If credits are not dealt with<br />
properly, they can build of interest for a company which can lead to unneeded<br />
expenditures that bring down total profitability. Dow’s ratio increases due to their<br />
accounts receivables growing at a higher percentage than the sales they are making.<br />
This is not a huge factor due to the rapid rate at which they collect their receivables in<br />
a timely fashion.<br />
Days’ Supply of Receivables: (365/Receivables Turnover)<br />
Dow Chemical <strong>Analysis</strong> Page 65
This ratio may be calculated by taking the days in a fiscal year, 365, <strong>and</strong> dividing<br />
it by the receivables Turnover. This ratio shows how long (days) that it takes for a<br />
company to get paid up to full by its creditor buyers.<br />
Days Supply of Receivables<br />
2002 2003 2004 2005 2006<br />
DOW 41.19 39.98 43.2 40.39 37.06<br />
DD 59.05 57.03 65.27 65.78 69.19<br />
LYO 38.04 37.35 91.19 33.74 36.21<br />
HUN 59.79 57.75 60.89 50.94 43.04<br />
Industry 51.35<br />
Days Supply of Receivables<br />
90.00<br />
80.00<br />
70.00<br />
60.00<br />
50.00<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
40.00<br />
30.00<br />
2002 2003 2004 2005 2006<br />
While Dow’s account receivables turnover is relatively larger than the industry<br />
average, the number of days in which it takes to collect on those accounts is<br />
substantially less than the industry. This means that Dow extends purchases on<br />
credits, but receives the creditor’s money in a reasonable time span.<br />
Cash-to-Cash Cycle: (Days Supply of Receivables + Days Supply Inventory)<br />
The “Money Mary-go-Round” shows how long it takes for a company’s inventory<br />
to be turned into cash. The concept tracks the number of days by starting with the<br />
company paying for the resources to produce a product, ending with the customer<br />
paying in cash. In this ratio, a smaller number is ideal because the less number of days<br />
Dow Chemical <strong>Analysis</strong> Page 66
inventory sit on the shelves, the less keep-up <strong>and</strong> operating expenses a company must<br />
pay. A fast cash-to-cash cycle also allows for more room on the shelves for new<br />
inventory.<br />
CASH TO CASH CYCLE<br />
2002 2003 2004 2005 2006<br />
DOW 105.78 92.44 96.04 91.11 90.31<br />
DD 155.26 142.55 144.2 148.9 106.82<br />
LYO 81.37 72.62 199.34 70.41 77.91<br />
HUN 144.41 117.63 115.64 103.67 104.12<br />
INDUSTRY 121.705 106.31 138.805 103.523 94.79<br />
Cash to Cash Cycle<br />
250<br />
200<br />
150<br />
100<br />
50<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
INDUSTRY<br />
0<br />
2002 2003 2004 2005 2006<br />
Dow’s Cash-to-Cash cycle is relatively low compared to the chemical industry <strong>and</strong><br />
our competitors. With the rapid collections of account receivables as well as the low<br />
number of days Dow’s inventory sit on shelves, contributes to cash being more<br />
accessible. This becomes a big part of overall production in that it allows for Dow to<br />
purchase <strong>and</strong> operate with more cash. While inventory sits on shelves for days <strong>and</strong><br />
days, realistically a company is losing possible profits. Dow has obviously made this a<br />
priority, <strong>and</strong> has decreased its “Money Mary-go-Round” throughout the past few years.<br />
Working Capital Turnover: (Sales/Working Capital)<br />
Dow Chemical <strong>Analysis</strong> Page 67
This ratio allows for analysis of a company’s upper management, showing how<br />
well they are using their working capital. Working Capital Turnover is calculated by<br />
taking the Net Sales on the Income Statement <strong>and</strong> dividing them over the company’s<br />
Working Capital (Current Assets – Current Liabilities). The Inventory Turnover <strong>and</strong><br />
Receivables Turnover ratios correlate with the Working Capital Turnover, in that a<br />
company usually uses the money within these ratios to purchase inventory.<br />
WORKING CAPITAL TURNOVER<br />
2002 2003 2004 2005 2006<br />
DOW 10.96 9.12 7.46 6.87 7.43<br />
DD 3.77 4.98 3.76 5.34 5.56<br />
LYO 6.06 5.4 2.69 9.74 10.78<br />
HUN 8.29 8.49 7.04 8.84 8.41<br />
INDUSTRY 7.27 7.00 5.24 7.70 8.05<br />
Working Capital Turnover<br />
12<br />
10<br />
8<br />
6<br />
4<br />
2<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
INDUSTRY<br />
0<br />
2002 2003 2004 2005 2006<br />
The larger a company’s working capital turnover is, the more sales they are<br />
generating. Aside from providing a picture of firm’s financial position, this method can<br />
also be used to assess the level of operating performance. While Dow’s Working Capital<br />
Turnover decreases over the 5 year span, it still maintains above the industry average.<br />
In 2006, Dow generated $7.43 in sales for ever dollar of working capital contributed.<br />
This ratio is a good measure of showing how much money a company is putting into its<br />
operations, in comparison to how many sales they are generating off that input.<br />
Dow Chemical <strong>Analysis</strong> Page 68
Liquidity Overview<br />
In the overall scheme of things, Dow looks to be just as liquid as its competitors<br />
if not more. Lyondell <strong>and</strong> Dow hold up the industry average excluding Lyondell’s 2004<br />
year where they saw tremendous decreases in operations, collections, <strong>and</strong> overall<br />
company stability. While Dow extends the possibility of purchases on credits to its<br />
buyers, their account receivables get paid off in a timely fashion. If Dow were to see<br />
increases in its days of receivables in the near future, they may think to reduce the<br />
amount of credit they extend. Also, Dow has been continuing to incur an abundance of<br />
liabilities, but have shown to balance out their debt through their extreme growth policy<br />
of expansion. With the exception of their working capital turnover, Dow has shown<br />
improvements over the 5 year span in every category. Although their working capital<br />
decreased through 2006, they still maintain a level over the industry average of 7.01.<br />
Profitability Ratios<br />
In order to effectively evaluate the true performance of a company, we must<br />
analyze a firm’s ability to generate a profit. After all, it is the profit bottom line that<br />
investors <strong>and</strong> others consider when assessing an economic value to a firm. In order to<br />
evaluate a firm’s profitability, we look at “four significant factors that are critical to a<br />
company’s profits which include 1) Operating Efficiency; 2) Asset Productivity; 3) Rate<br />
of Return on Assets; <strong>and</strong> 4) Rate of Return on <strong>Equity</strong>” (h<strong>and</strong>out from Financial<br />
Statement <strong>Analysis</strong>). Gross Profit Margin, Operating Expense Ratio, <strong>and</strong> Net Profit<br />
Margin all apply to operating efficiency. Asset Turnover is used to evaluate asset<br />
productivity.<br />
Gross Profit Margin: (gross profit / sales)<br />
To determine the Gross Profit Margin for a firm, one must simply take gross<br />
profit (sales – cost of goods sold) <strong>and</strong> divide it by sales. This ratio assess a company’s<br />
ability to retain a proportion of profit from sales, given that is has covered its variable<br />
Dow Chemical <strong>Analysis</strong> Page 69
costs. A firm can increase this ratio by either increasing its level of sales relative to its<br />
cost (i.e. charging higher prices to customers) or by simply reducing its cost of goods<br />
sold.<br />
Gross Profit 2002 2003 2004 2005 2006<br />
DOW 13.87% 13.65% 14.73% 17.34% 15.47%<br />
DD 26.98% 23.10% 23.82% 26.11% 25.46%<br />
LYO 11.16% -0.67% 6.18% 2.44% 5.37%<br />
HUN 9.02% 9.74% 12.59% 15.13% 14.49%<br />
INDUSTRY 15.26% 11.46% 14.33% 15.26% 15.20%<br />
Gross Profit Margin<br />
30%<br />
20%<br />
10%<br />
0%<br />
-10%<br />
2002 2003 2004 2005 2006<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
INDUSTRY<br />
In the chart above, we can see that the industry as a whole has stayed on an<br />
even keel for the most part of the last decade. Dow has been persistent with the<br />
industry average of 14%, which would suggest that the company has not made any<br />
real changes to their pricing levels. It is also important to note that the firm has slide<br />
slightly ahead of the industry average, which would indicate that Dow is continuing to<br />
adjust their performance to the market.<br />
Operating Profit Margin: (operating income / sales)<br />
Another profitability tool that is commonly used is the operating profit margin,<br />
which is the operating income divided by the net sales. This ratio provides an<br />
assessment of operating efficiency <strong>and</strong> how well a firm’s sales are covering its variable<br />
costs. A firm can increase this ratio by either lowering it’s per unit operating costs or<br />
increasing its sales price relative to its variable expenses.<br />
Dow Chemical <strong>Analysis</strong> Page 70
OPERATING PROFIT MARGIN<br />
2002 2003 2004 2005 2006<br />
DOW 0.09 0.08 0.11 0.16 0.11<br />
DD 0.10 0.02 0.07 0.15 0.14<br />
LYO 0.05 -0.01 0.01 0.07 0.05<br />
HUN 0.02 0.03 0.03 0.07 0.07<br />
INDUSTRY 0.07 0.04 0.06 0.11 0.09<br />
Operating Profit Margin<br />
0.18<br />
0.16<br />
0.14<br />
0.12<br />
0.10<br />
0.08<br />
0.06<br />
0.04<br />
0.02<br />
0.00<br />
2002 2003 2004 2005 2006<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
INDUSTRY<br />
From the table, we see that Dow held an 11.38% operating profit margin in 2006; this<br />
essentially means that for every dollar of revenue collected from sales, roughly 11 cents<br />
is made available to cover other expenses for items such as interest <strong>and</strong> taxes. As the<br />
graph above indicates, we see that Dow follows industry pattern closely, while<br />
maintaining a considerable advantage over its competitors.<br />
Operating Expense Ratio: (SGA / sales)<br />
In order to remain competitive in this industry, it is imperative that a firm<br />
reduces as many costs <strong>and</strong> expenses as humanly possible in order to generate a profit<br />
above industry average. To find the operating expense ratio, you must take the total<br />
selling, general, <strong>and</strong> administrative expenses <strong>and</strong> divide them by total revenue. This<br />
ratio identifies how well a company manages expenses <strong>and</strong> how those expenses are<br />
matched to the revenues they generated. A firm can reduce its operating expense ratios<br />
Dow Chemical <strong>Analysis</strong> Page 71
y improving efficiency within production which would spread a lower cost over the<br />
same sales base.<br />
Operating Expense Ratio 2002 2003 2004 2005 2006<br />
DOW 0.06 0.04 0.04 0.03 0.03<br />
DD 0.12 0.11 0.11 0.12 0.12<br />
LYO 0.05 0.05 0.05 0.03 0.03<br />
HUN 0.06 0.06 0.07 0.06 0.07<br />
INDUSTRY 0.07 0.07 0.07 0.06 0.06<br />
Operating Expense Ratio<br />
0.15<br />
0.10<br />
0.05<br />
0.00<br />
2002 2003 2004 2005 2006<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
INDUSTRY<br />
As the diagram indicates, we can observe that the industry as a whole does a<br />
decent job of not letting operating expenses get out of h<strong>and</strong>. Since one of Dow’s key<br />
success factors is competing in a cost leadership industry, we can judge that firm is<br />
performing an exceptional job at keeping operating expenses lower than the industry<br />
average of .07, which gives it a slight advantage over its competitors.<br />
Net Profit Margin: (NI / sales)<br />
The Net Profit Margin (or Return on Sales as it’s more commonly known) consist<br />
of dividing Net Income by Sales. This formula provides “an indicator of a company’s<br />
pricing policies <strong>and</strong> its ability to control cost (Wikipedia.com)”.<br />
Dow Chemical <strong>Analysis</strong> Page 72
Net Profit Margin 2002 2003 2004 2005 2006<br />
DOW -1.22% 5.30% 6.96% 9.75% 7.58%<br />
DD -4.59% 3.60% 6.51% 7.72% 11.48%<br />
LYO -4.54% -8.47% 0.93% 3.14% 0.89%<br />
HUN -0.89% -4.62% -2.40% -0.33% 2.18%<br />
INDUSTRY -2.81% -1.04% 3.00% 5.07% 5.53%<br />
Net Profit Margin<br />
15%<br />
10%<br />
5%<br />
0%<br />
-5%<br />
-10%<br />
2002 2003 2004 2005 2006<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
INDUSTRY<br />
Net Profit Margin essentially sums up the two previous formulas, Gross Profit<br />
Margin <strong>and</strong> the Operating Expense Ratio. The chart above shows the overall<br />
performance level of the industry as a whole, which has been increasing exponentially<br />
since 2003 after suffering a drastic recession that persisted throughout all of the year<br />
before. Dow has been a top performer in the industry with an overall average of 6%;<br />
however, we can see signs of competitors slowly starting to catch up with Dow <strong>and</strong><br />
starting to compete on their level.<br />
Asset Turnover: (sales / assets)<br />
Asset turnover is the key formula for determining a firm’s asset productivity, which is<br />
essentially how well a company utilizes its assets in order to generate revenues. The<br />
asset turnover is determined by taking total sales <strong>and</strong> dividing them by total assets.<br />
Dow Chemical <strong>Analysis</strong> Page 73
Asset Turnover 2002 2003 2004 2005 2006<br />
DOW 0.7 0.78 0.88 1.01 1.08<br />
DD 0.69 0.73 0.77 0.8 0.86<br />
LYO 0.44 0.47 0.36 1.12 1.17<br />
HUN 0.49 0.79 1.01 1.19 1.25<br />
INDUSTRY 0.58 0.69 0.75 1.03 1.09<br />
Asset Turnover<br />
1.50<br />
1.00<br />
0.50<br />
0.00<br />
2002 2003 2004 2005 2006<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
INDUSTRY<br />
As we can see, the industry as a whole has been steadily increasing productivity<br />
<strong>and</strong> efficiency, which in turn would increase profitability of the firms. In Dow’s case, we<br />
can conclude that firm has been struggling in this sector <strong>and</strong> is having difficulty to stay<br />
on par with the industry average which currently st<strong>and</strong>s at .83.<br />
Return on Assets: (NI / assets from previous year)<br />
The return on assets incorporates a company’s operating efficiency <strong>and</strong> asset<br />
productivity into one comprehensive equation. To compute return on assets, you simply<br />
take a firms profit margin (net income / sales) <strong>and</strong> multiply it by the asset turnover<br />
(sales / assets). An even easier way to compute the return on assets is to simply take<br />
net income <strong>and</strong> divide it by total assets.<br />
Return on Assets 2002 2003 2004 2005 2006<br />
DOW -0.95% 4.37% 6.68% 9.84% 8.11%<br />
DD -2.74% 2.81% 4.81% 5.77% 9.46%<br />
LYO -1.99% -3.96% 0.34% 3.52% 1.04%<br />
HUN -0.43% -3.66% -2.42% -0.39% 2.72%<br />
INDUSTRY 2.29% -1.56% 1.83% 4.58% 4.59%<br />
Dow Chemical <strong>Analysis</strong> Page 74
Return on Assets<br />
15%<br />
10%<br />
5%<br />
0%<br />
-5%<br />
2002 2003 2004 2005 2006<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
INDUSTRY<br />
Much like the Asset Turnover Ratio, the Return on Assets is a measuring tool<br />
used to gage how well the company is performing in the areas of efficiency <strong>and</strong><br />
productivity <strong>and</strong> how well the company is utilizing its assets to generate a profit. By<br />
analyzing the graph above, we can tell how much of an impact the recession of 2002<br />
had on the industry, which hit record lows during the proceeding quarters. However, we<br />
have seen a resurgence in late 2003 that has continued to regain much of its<br />
profitability. In Dow’s case, we can tell that the firm has consistently held a<br />
comm<strong>and</strong>ing advantage over its competitors with an overall average of 6%.<br />
Return on <strong>Equity</strong>: (NI / equity from previous year)<br />
The return on investment (ROE) “measures the profitability to owner’s interest in<br />
total assets” (Financial Statement <strong>Analysis</strong> h<strong>and</strong>out). A firm’s return on equity is<br />
subjective to both return on assets <strong>and</strong> the company’s capital cost structure (debt to<br />
equity relationships). A simple computation of this rate would be net income divided by<br />
total stockholders equity.<br />
Return on <strong>Equity</strong> 2002 2003 2004 2005 2006<br />
DOW -3.24% 15.17% 20.88% 32.61% 25.68%<br />
DD -7.63% 10.74% 18.20% 18.07% 9.46%<br />
LYO -12.55% -26.12% 1.92% 17.65% 5.83%<br />
HUN -6.57% 170.38% 59.61% -2.28% 13.23%<br />
INDUSTRY -8.93% 43.26% 24.99% 16.95% 18.58%<br />
Dow Chemical <strong>Analysis</strong> Page 75
Return on <strong>Equity</strong><br />
60%<br />
40%<br />
20%<br />
0%<br />
-20%<br />
2002 2003 2004 2005 2006<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
INDUSTRY<br />
Perhaps one of the most important ratio to look at when valuing a company’s<br />
profitability is the Rate of Return on <strong>Equity</strong>. As the data indicates, Dow began to beat<br />
the industry average beginning mid 2004. However, it is imperative to take into account<br />
the bizarre <strong>and</strong> dramatic shifts in the ratios for Dow’s competitors. Upon investigating<br />
Huntsman’s 2003 <strong>and</strong> 2004 annual 10-K reports, we see that the company’s<br />
tremendous growth in the return on equity was attributable a change in accounting<br />
policies.<br />
Profitability Overview<br />
After analyzing the previous ratios <strong>and</strong> emerging trends in the industry, it is<br />
evident that the Dow Corporation has consistently <strong>and</strong> continually performed above<br />
average against their competitors in the matters of operating efficiency <strong>and</strong><br />
productivity, which are both considered key success factors for this industry. Given its<br />
track record of outperforming the industry averages <strong>and</strong> its steadily increasing trend in<br />
market share, it becomes apparent to any investor that the Dow Corporation is quite a<br />
profitable company that has much potential for even greater profitability in the future.<br />
Capital Structure Ratio’s<br />
The capital structure of the company allows investors to see how a company<br />
acquires its assets. “In analyzing capital structure, there are two primary concerns: the<br />
amount of debt relative to the owners’ equity; the ability to service the principal <strong>and</strong> the<br />
Dow Chemical <strong>Analysis</strong> Page 76
interest requirements on debt” (Ratio <strong>Analysis</strong> H<strong>and</strong>out). By looking under the liabilities<br />
section of the balance sheet <strong>and</strong> checking owners’ equity on the income statement an<br />
investor is able to do so by looking for three ratios. These three ratios are debt to<br />
equity, times interest earned, <strong>and</strong> debt service margin.<br />
Debt to <strong>Equity</strong>: (Total liabilities/Total Owners’ <strong>Equity</strong>)<br />
The importance of this ratio is that by taking this figure one is able to judge a<br />
firm based upon how much of the company is threatened by credit risk. By calculating<br />
the percentage of total liabilities <strong>and</strong> dividing it by total owners’ equity an investor is<br />
able to see how the company is mostly financed. By keeping this number low it shows<br />
how the majority of the business is funded primarily through equity rather than debt.<br />
DEBT TO EQUITY<br />
2002 2003 2004 2005 2006<br />
DOW 4.19 3.57 2.74 2 1.67<br />
DD 2.55 2.74 2.03 2.66 2.33<br />
LYO 5.32 5.6 4.67 4.04 4.6<br />
HUN 14.19 -44.11 -23.73 4.82 3.85<br />
INDUSTRY 6.56 3.97 3.15 3.38 3.11<br />
Debt to <strong>Equity</strong><br />
7<br />
6<br />
5<br />
4<br />
3<br />
2<br />
1<br />
0<br />
2002 2003 2004 2005 2006<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
INDUSTRY<br />
While the industry average shows to be extremely low, after taking out<br />
Huntsman’s negative numbers, the industry moves to a more respectful 4.03. With this<br />
ratio, you want a lower number, which shows that you are internally funding operations<br />
Dow Chemical <strong>Analysis</strong> Page 77
instead of externally by debt. Dow shows a tremendous decrease in their debt to<br />
equity ratio; where in 2006 it hits 1.67, the total industries lowest mark.<br />
Times Interest Earned: (NIBIT/ Interest Expense)<br />
Times interest earned is net income before interest <strong>and</strong> taxes (Income from<br />
Operations) divided by interest expense. This is a key indicator to determine if income<br />
from operations is able to cover interest charges. This can be a huge concern to stock-<br />
holders for the reason that if income from operations cannot cover the required interest<br />
charges, than there can be no profits.<br />
Times Interest Earned<br />
2002 2003 2004 2005 2006<br />
DOW 3.14 3.19 6.16 10.36 9.07<br />
DD 6.92 1.41 4.98 7.88 8.24<br />
LYO 0.45 -0.04 0.2 1.95 1.69<br />
HUN 0.34 0.42 0.43 1.68 2.1<br />
Industry 3.53<br />
Times Interest Earned<br />
9.00<br />
7.00<br />
5.00<br />
3.00<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
1.00<br />
-1.00<br />
2002 2003 2004 2005 2006<br />
Dow has the strongest ability within the industry, to make their interest<br />
payments within the fiscal year. While the industry average sits at 3.53, in 2005 Dow<br />
pays of $1 of interest, 10.36 times. Allowing interest to pile up is one of the main ways<br />
Dow Chemical <strong>Analysis</strong> Page 78
to fall into debt financing <strong>and</strong> possibly bankruptcy. Once again, Dow continues to<br />
improve throughout the 5 year span.<br />
Credit <strong>Analysis</strong><br />
Using the Altman Z-score model, we computed Dow’s bankruptcy score (Credit score),<br />
based on five different fixed variable ratios. In order to obtain a loan, a lending company will<br />
usually analyze a company’s credit to evaluate if they will be able to pay back their money.<br />
“Studies measuring effectiveness of the Z-score have shown the model is often accurate in<br />
predicting bankruptcy (&2%-80% reliability)” (Valuebasedmanagement.com). If a company’s<br />
Z-score were to fall below 1.8, bankruptcy is very likely. A score between 1.8 <strong>and</strong> 2.6 is<br />
considered to be in the “grey area”, or borderline of bankruptcy. If a company obtains a credit<br />
score of 3.0 or higher, bankruptcy is not likely <strong>and</strong> a firm remains strong<br />
(Valuebasedmanagement.com).<br />
The following is the equation we used in calculating Altman’s Z-score:<br />
Z-score=1.2(Working Capital/Total Assets) + 1.4(Retained Earnings/Total Assets) +<br />
3.3(Earnings Before Interest <strong>and</strong> Taxes/Total Assets) + 0.6(<strong>Mark</strong>et Value of <strong>Equity</strong>/Book Value<br />
of Liabilities) + 1.0(Sales/Total Assets)<br />
The largest weight distributed within this model comes from the (EBIT/Total<br />
Assets) ratio. The smallest weight distribution comes from how the firm is correlated with the<br />
market.<br />
Dow’s Altman Z-Score<br />
2002 2003 2004 2005 2006<br />
Z-score 1.82 2.12 2.53 2.98 3.07<br />
*Z-score work shown in Appendix<br />
Referring to the table above, we came to a conclusion that Dow was barely avoiding<br />
bankruptcy from 2002-2004. While throughout this five year period Dow’s Z-score has<br />
increased, this shows lenders that Dow has improved its default risk. With the acquisition of<br />
Dow Chemical <strong>Analysis</strong> Page 79
Union Carbide in late 2004, Dow’s credit scored increased improved to push out of the “grey<br />
area”, <strong>and</strong> into a state of a low bankruptcy possibility.<br />
Debt Service Margin: (Operating Cash Flow/ Notes Payable Current)<br />
Debt service margin is measured by taking operating cash flows <strong>and</strong> dividing it<br />
by notes payable current. It allows an investor to see if the annual installments are<br />
able to be covered by operating cash flows. “Cash provided by operations should be<br />
viewed as a major source of cash used to retire long-term debt” (Ratio <strong>Analysis</strong><br />
H<strong>and</strong>out). By having a high debt service margin it relieves the company of having to<br />
use operating cash flows for debt, <strong>and</strong> gives it the ability to use it on something else.<br />
Debt Service Margin<br />
0.70<br />
0.60<br />
0.50<br />
0.40<br />
0.30<br />
0.20<br />
0.10<br />
DOW<br />
DD<br />
LYO<br />
HUN<br />
0.00<br />
-0.10<br />
2002 2003 2004 2005 2006<br />
2002 2003 2004 2005 2006<br />
DOW -0.04 0.05 0.23 0.49 0.52<br />
DD 0.43 0.58 0.58 0.37 0.62<br />
LYO 0.07 0.02 0.05 0.27 0.15<br />
HUN 0.03 0.04 0.03 0.22 0.26<br />
Industry 0.25<br />
While analyzing the debt service margin ratio, a larger number is preferred<br />
because generated cash is preferred to be larger than the debt being paid off in notes.<br />
The reason for Dow’s substantial jump from 2002 on, is explained by their purchase of<br />
Union Carbide in late 2002. With this purchase, it opened many doors for new<br />
Dow Chemical <strong>Analysis</strong> Page 80
endeavors <strong>and</strong> cash flows. In 2006, Dow cut back on its debt financing <strong>and</strong> began to<br />
finance through internal operations.<br />
SGR & IGR <strong>Analysis</strong><br />
Internal Growth Rate: (ROA (1- DIV/NI)<br />
The IGR ratio can be computed by taking companies Return on Assets ratio, <strong>and</strong><br />
multiplying it by 1 minus the Dividend Payout Ratio. The IGR explains the highest<br />
possible growth point a company can obtain without receiving outside funding. It also<br />
shows how a company circulates its retained earnings by accumulating larger total<br />
assets. This is a good growth model to make available to investors, because it shows<br />
the growth of the company excluding any debt financing.<br />
IGR<br />
2004 2005 2006<br />
DOW 3.55% 6.88% 4.93%<br />
DD 1.02% 1.73% 5.32%<br />
LYO -0.96% 1.94% -0.24%<br />
HUN 0.00% -0.49% 2.43%<br />
INDUSTRY 2.28% 3.51% 4.22%<br />
*Companies did not disclose previous years in their 10K to come up with IGR.<br />
Throughout the years of 2002 to 2005 we saw a persistent growth rate that rose<br />
at a stable basis. However, in 2006 the Internal Growth Rate saw a decline that was<br />
attributed to the decrease in Net Income as well as the increase in dividend payout.<br />
Also, Dow’s plant <strong>and</strong> factory growth plan began to be implemented around early 2003.<br />
Dow was able to grow using internal funds without having to finance through debt<br />
instruments.<br />
Sustainable Growth Rate: (IGR (1 + (D/E))<br />
The Sustainable Growth Rate is the highest growth rate a company can maintain<br />
without needing to increase its financial leverage (Utilization by a company of its<br />
Dow Chemical <strong>Analysis</strong> Page 81
orrowed monies). In calculating SGR, multiply the company’s Internal Growth Rate by<br />
1 plus Debt divided by <strong>Equity</strong>. IGR influences this ratio, in which a higher Internal<br />
Growth Rate will produce a higher Sustainable Growth Rate.<br />
Sustainable Growth Rate<br />
2002 2003 2004 2005 2006<br />
4% 15% 24% 33% 25%<br />
Dow’s Sustainable Growth Rate follows a very similar pattern as their IGR. While<br />
IGR is a component of a company’s SGR, it however is not the only factor. With a slight<br />
decrease in 2006, Dow saw reduced debt alongside with increasing financial equities.<br />
Knowing that these two ratios can draw conclusions of future profits a 8% decline, in<br />
SGR, <strong>and</strong> a 1.95% decline in IGR. This decrease is primarily a cause of future<br />
obligations that we have because of our operating leases. With the incremental growth<br />
patterns, Dow’s globalization <strong>and</strong> expansion efforts look to continue to bring continuous<br />
growth for the years to come. However, with this incremental growth Dow will be<br />
forced to take on new debt decreasing both the IGR <strong>and</strong> SGR. Furthermore, in the long<br />
run it will reduce profits for Dow as well.<br />
Overview<br />
Dow has made increases towards exp<strong>and</strong>ing growth potential by both internal<br />
<strong>and</strong> sustainable approaches. While decreasing the possibility of having to finance<br />
through debt, Dow has increased its asset base as well as overall net income. With<br />
growth being a high priority in Dow’s future outlook, the expansion of plants <strong>and</strong><br />
factories globally, have shown to be a major part of the success. Compared to the<br />
chemical industry, Dow has a much lower Cash-to-Cash ratio. This allows for Dow to<br />
receive cash on h<strong>and</strong> at a much faster basis. This allows for Dow to look more liquid to<br />
investors as well as allowing for easier cash flows <strong>and</strong> movements.<br />
Dow Chemical <strong>Analysis</strong> Page 82
Financial Statement Forecasting <strong>Analysis</strong><br />
In this segment, we will forecast the financial statements for the Dow<br />
Corporation <strong>and</strong> also disclose the criteria <strong>and</strong> methodology that were used to develop<br />
our estimates. The three financial statements that we will be examining are the balance<br />
sheets, income statements, <strong>and</strong> statement of cash flows. By looking at the past<br />
performance of the balance sheets <strong>and</strong> income statements, we can determine the<br />
historical growth rates for key line items <strong>and</strong> use those averages to develop a ten year<br />
forecast for those figures. Aside from analyzing Dow’s numbers, we will also calculate<br />
an industry average of Dow’s competitors to establish a benchmark to compare with. It<br />
is also important to note that aside from using historical averages, the balance sheet<br />
analysis will also include averages for liquidity ratios in their forecasts (i.e. inventory<br />
turnover, current ratios, asset turnover, accounts receivable turnover). In the cash flow<br />
analysis section, we will primarily be using two expense manipulation diagnostics, the<br />
Cash Flows from Operations/ Operating Income (CFFO/OI) <strong>and</strong> the Cash Flows from<br />
Operations / Net Income (CFFO/NI), both of which were discussed earlier in the<br />
accounting analysis section of this report.<br />
Dow Chemical <strong>Analysis</strong> Page 83
Dow Chemical<br />
(In millions, except per share amounts) 2001 2002 2003 2004 2005 2006 Assumed 2007 2008 2009 2010 2011<br />
Forecasted<br />
2012 2013 2014 2015 2016<br />
Income Statement<br />
% increase % increase % increase % increase % increase<br />
Sales Increase -1.66% 18.19% 23.07% 15.30% 6.08% 9.00%<br />
Net Sales/Net Revenue $28,075 $27,609 $32,632 $40,161 $46,307 $49,124 $ 53,545.16 $ 58,364.22 $ 63,617.00 $ 69,342.54 $ 75,583.36 $ 82,385.87 $ 89,800.59 $ 97,882.65 $ 106,692.09 $ 116,294.37<br />
COGS 23,780 28,177 34,244 38,276 41,526 84.00% $ 44,977.93 $ 49,025.95 $ 53,438.28 $ 58,247.73 $ 63,490.03 $ 69,204.13 $ 75,432.50 $ 82,221.42 $ 89,621.35 $ 97,687.27<br />
Gross Profit 3,829 4,455 5,917 8,031 7,598 $ 8,567.23 $ 9,338.28 $ 10,178.72 $ 11,094.81 $ 12,093.34 $ 13,181.74 $ 14,368.10 $ 15,661.22 $ 17,070.73 $ 18,607.10<br />
R & D 1,066 981 1,022 1,073 1,164 2.40% $ 1,285.08 $ 1,400.74 $ 1,526.81 $ 1,664.22 $ 1,814.00 $ 1,977.26 $ 2,155.21 $ 2,349.18 $ 2,560.61 $ 2,791.06<br />
SG&A 1,598 1,392 1,436 1,545 1,663 3.40% $ 1,820.54 $ 1,984.38 $ 2,162.98 $ 2,357.65 $ 2,569.83 $ 2,801.12 $ 3,053.22 $ 3,328.01 $ 3,627.53 $ 3,954.01<br />
Amortization of intangibles 65 63 81 55 50<br />
Purchased in-process research <strong>and</strong> development charges<br />
Restructuring charges 543 114 591<br />
Gain on asset divestitures 563<br />
Total Operating Expenses 26,444 30,550 36,702 40,894 44,994 89.80% $ 48,083.55 $ 52,411.07 $ 57,128.07 $ 62,269.60 $ 67,873.86 $ 73,982.51 $ 80,640.93 $ 87,898.62 $ 95,809.49 $ 104,432.35<br />
Merger-related expenses <strong>and</strong> restructuring 280<br />
Asbestos-related credit 828 177<br />
<strong>Equity</strong> in earnings of nonconsolidated affiliates 40 322 923 964 959<br />
Sundry income net 54 146 136 755 137<br />
Interest income 66 92 86 138 185<br />
Operating Income 2,433 2,642 4,604 7,270 5,588 10.20% $ 5,461.61 $ 5,953.15 $ 6,488.93 $ 7,072.94 $ 7,709.50 $ 8,403.36 $ 9,159.66 $ 9,984.03 $ 10,882.59 $ 11,862.03<br />
Interest expense <strong>and</strong> amortization of debt discount 774 828 747 702 616<br />
Income before Income Taxes <strong>and</strong> Minority Interests (622) (33,254) (39,386) (42,526) (47,620) 11.00% $ (52,858.20) $ (58,672.60) $ (65,126.59) $ (72,290.51) $ (80,242.47) $ (89,069.14) $ (98,866.75) $ (109,742.09) $ (121,813.72) $ (135,213.23)<br />
Provision for income taxes (280) (82) 877 1,782 1,155<br />
Minority interests' share in income 63 94 122 82 93<br />
Income before Cumulative Effect of Change (405) 1,739 2,797 4,535 3,724<br />
in Accounting Principle<br />
Cumulative effect of change in accounting 67 (9) (20)<br />
principle<br />
Net Income Available for Common Stockholders ($338) $1,730 $2,797 $4,515 $3,724 7.00% $ 3,748.16 $ 4,085.50 $ 4,453.19 $ 4,853.98 $ 5,290.84 $ 5,767.01 $ 6,286.04 $ 6,851.79 $ 7,468.45 $ 8,140.61<br />
Share Data<br />
Earnings before cumulative effect of change ($0.44) $1.89 $2.98 $4.71 $3.87<br />
in accounting<br />
principle per common share basic<br />
Earnings per common share basic ($0.37) $1.88 $2.98 $4.69 $3.87<br />
Earnings before cumulative effect of change ($0.44) $1.88 $2.93 $4.64 $3.82<br />
in accounting<br />
principle per common share diluted<br />
Earnings per common share diluted ($0.37) $1.87 $2.93 $4.62 $3.82<br />
Common stock dividends declared per share $1.34 $1.34 $1.34 $1.34 $1.50<br />
of common stock<br />
Weighted-average common shares outst<strong>and</strong>ing 910.50 918.80 940.10 963.20 962.30<br />
basic<br />
Weighted-average common shares outst<strong>and</strong>ing 910.50 926.10 953.80 976.80 974.40<br />
Dow Chemical <strong>Analysis</strong> Page 84
Income Statement<br />
When forecasting the income statement, the first thing we estimated was the<br />
growth rate of the firm. With the fluctuation in the industry as a whole we knew this<br />
would present a problem with forecasting a constant growth rate. We assumed a 9%<br />
growth rate, which we thought was sufficient for such a conglomerate. In addition, this<br />
growth rate produced numbers that seemed to flow well with Dow’s past performance.<br />
Furthermore, our gross profit margin over the past three years was 15.85%, <strong>and</strong> our<br />
forecasted gross profit/net sales in any selected year were on par with this figure. The<br />
next step we took was to find our cost of goods sold. Upon looking at our consolidated<br />
income statement, we found that COGS was 85% of net sales. We followed this<br />
process for research <strong>and</strong> development as well as selling <strong>and</strong> general administrative<br />
expenses; meaning the estimates of R&D <strong>and</strong> the SG&A expenses are a direct<br />
percentage of forecasted sales of that year. Next we added these expenses together to<br />
find the total operating expenses. After comparing the growth rates of gross profits<br />
<strong>and</strong> total operating expenses, we see that operating expenses are increasing at a faster<br />
rate relative to the gross profits growth rate. This can best be explained by the fact<br />
that Dow Chemical is the largest consumer of oil <strong>and</strong> petroleum-based products. With<br />
the recent surge in oil prices, Dow’s cost of raw materials is increasing dramatically.<br />
This presents a significant dilemma for Dow in the future as there is no way to<br />
determine when or if these raw material prices will ever level out. In conclusion, we<br />
express concern about Dow’s ability to maintain its cost leadership business strategy,<br />
which is the cornerstone of Dow’s key success factors.<br />
Dow Chemical <strong>Analysis</strong> Page 85
Balance Sheet<br />
Assets<br />
Current Assets<br />
Cash <strong>and</strong> cash equivalents $1,484 $2,392 $3,108 $3,806 $2,757 6.00% $ 3,030.86 $ 3,303.64 $ 3,600.96 $ 4,379.53 $ 4,773.69 $ 5,203.32 $ 5,671.62 $ 6,182.06 $ 6,738.45 $ 7,344.91<br />
<strong>Mark</strong>etable securities <strong>and</strong> interest-bearing 89 42 84 32 153<br />
deposits 13% 18% 20% 22% 16%<br />
Accounts <strong>and</strong> notes receivable:<br />
Trade (net of allowance for doubtful receivables 2006:<br />
$122; 2005: $169) 3,116 3,574 4,753 5,124 4,988 $ 5,903.55 $ 6,434.86 $ 7,014.00 $ 7,645.26 $ 8,333.34 $ 9,083.34 $ 9,900.84 $ 10,791.91 $ 11,763.18 $ 12,821.87<br />
Other 2,369 2,356 2,604 2,802 3,060<br />
Inventories 4,208 4,050 4,957 5,319 6,058 $ 6,703.12 $ 7,306.40 $ 7,963.98 $ 8,680.73 $ 9,462.00 $ 10,313.58 $ 11,241.80 $ 12,253.57 $ 13,356.39 $ 14,558.46<br />
Deferred income tax 109 698 384 321 193<br />
0.3699 0.3089 0.3120 0.3056 0.3520<br />
Total current assets 11,375 13,112 15,890 17,404 17,209 35.00% $ 17,680.01 $ 19,271.21 $ 21,005.61 $ 25,547.25 $ 27,846.50 $ 30,352.69 $ 33,084.43 $ 36,062.03 $ 39,307.61 $ 42,845.30<br />
Investments<br />
Investment in nonconsolidated affiliates 1,565 1,878 2,698 2,285 2,735<br />
Other investments 1,689 1,971 2,141 2,156 2,143<br />
Noncurrent receivables 577 230 189 274 288<br />
Total investments 3,831 4,079 5,028 4,715 5,166<br />
Property<br />
Property 37,934 40,812 41,898 41,934 44,381<br />
Less accumulated depreciation 24,137 26,595 28,070 28,397 30,659<br />
Net property 13,797 14,217 13,828 13,537 13,722<br />
Other Assets<br />
Goodwill 3,189 3,226 3,152 3,140 3,242 7.00% $ 3,536.00 $ 3,854.24 $ 4,201.12 $ 5,109.45 $ 5,569.30 $ 6,070.54 $ 6,616.89 $ 7,212.41 $ 7,861.52 $ 8,569.06<br />
Other intangible assets (net of accumulated 613 579 535 443 457<br />
amortization 2006: $620; 2005: $552)<br />
Deferred income tax assets noncurrent 3,776 4,113 4,369 3,658 4,006<br />
Asbestos-related insurance receivables 1,489 1,176 1,028 818 725<br />
noncurrent<br />
Deferred charges <strong>and</strong> other assets 1,492 1,389 2,055 2,219 1,054<br />
Total other assets 10,559 10,483 11,139 10,278 9,484<br />
Total Noncurrent Assets 28,187 28,779 29,995 28,530 28,372 65.00% $ 32,834.30 $ 35,789.38 $ 39,010.43 $ 47,444.89 $ 51,714.93 $ 56,369.28 $ 61,442.51 $ 66,972.34 $ 72,999.85 $ 79,569.83<br />
Total Assets $35,515 $39,562 $41,891 $45,885 $45,934 $45,581 $ 50,514.30 $ 55,060.59 $ 60,016.04 $ 72,992.14 $ 79,561.43 $ 86,721.96 $ 94,526.94 $ 103,034.37 $ 112,307.46 $ 122,415.13<br />
Liabilities <strong>and</strong> Stockholders' <strong>Equity</strong><br />
Current Liabilities<br />
Notes payable $580 $258 $104 $241 $219<br />
Long-term debt due within one year 797 1,088 861 1,279 1,291<br />
Accounts payable:<br />
Trade 2,834 2,843 3,701 3,931 3,825<br />
Other 1,789 2,041 2,194 1,829 1,849<br />
Income taxes payable 202 212 419 493 569<br />
Deferred income tax liabilities current 30 241 205 201 251<br />
Dividends payable 326 331 342 347 382<br />
Accrued <strong>and</strong> other current liabilities 2,298 2,520 2,680 2,342 2,215<br />
Total current liabilities 8,856 9,534 10,506 10,663 10,601 $ 10,400.00 $ 11,336.00 $ 12,356.24 $ 15,027.79 $ 16,380.30 $ 17,854.52 $ 19,461.43 $ 21,212.96 $ 23,122.12 $ 25,203.11<br />
28% 29% 31% 35% 37%<br />
Long-Term Debt 11,659 11,763 11,629 9,186 8,036<br />
Other Noncurrent Liabilities<br />
Deferred income tax liabilities noncurrent 994 1,124 1,301 1,395 999<br />
Pension <strong>and</strong> other postretirement benefits 3,775 3,572 3,979 3,308 3,094<br />
noncurrent<br />
Asbestos-related liabilities noncurrent 2,072 1,791 1,549 1,384 1,079<br />
Other noncurrent obligations 3,214 3,556 3,202 3,338 3,342<br />
Total other noncurrent liabilities 10,055 10,043 10,031 9,425 8,514 $ 20,761.30 $ 21,804.65 $ 22,865.99 $ 29,959.04 $ 31,593.18 $ 33,288.98 $ 35,048.57 $ 36,874.15 $ 38,767.97 $ 40,732.30<br />
31% 31% 30% 31% 30%<br />
Minority Interest in Subsidiaries 366 376 449 336 365<br />
Preferred Securities of Subsidiaries 1,000 1,000 1,000 1,000 1,000<br />
Total Liabilities $31,936 $32,716 $33,615 $30,610 $28,516 $ 31,161.30 $ 33,140.66 $ 35,222.23 $ 44,986.83 $ 47,973.47 $ 51,143.50 $ 54,510.00 $ 58,087.11 $ 61,890.09 $ 65,935.42<br />
Stockholders' <strong>Equity</strong><br />
Common stock (authorized 1,500,000,000 shares 2,453 2,453 2,453 2,453 2,453<br />
of $2.50 par value each; issued 981,377,562 shares)<br />
Additional paid-in capital 8 274 661 830<br />
Unearned ESOP shares (61) (30) (12) (1) 0<br />
Retained earnings 9,520 9,994 11,527 14,719 16,987 $ 19,275.00 $ 21,841.93 $ 24,715.81 $ 27,927.31 $ 31,509.96 $ 35,500.47 $ 39,938.94 $ 44,869.25 $ 50,339.37 $ 56,401.71<br />
Accumulated other comprehensive loss (2,097) (1,491) (977) (1,949) (2,235)<br />
Treasury stock at cost (2006: 23,326,570 shares; (2,189) (1,759) (995) (559) (970)<br />
2005: 14,221,354 shares)<br />
Stockholders' equity 7,626 9,175 12,270 15,324 17,065 $19,353 $ 21,919.93 $ 24,793.81 $ 28,005.31 $ 31,587.96 $ 35,578.47 $ 40,016.94 $ 44,947.25 $ 50,417.37 $ 56,479.71<br />
Total Liabilities <strong>and</strong> Stockholders' <strong>Equity</strong> $39,562 $41,891 $45,885 $45,934 $45,581 $ 50,514.30 $ 55,060.59 $ 60,016.04 $ 72,992.14 $ 79,561.43 $ 86,721.96 $ 94,526.94 $ 103,034.37 $ 112,307.46 $ 122,415.13
Balance Sheet<br />
To start on the balance sheet, the first step we took was to link it to the income<br />
statement we had already forecasted. This can be achieved by using the asset turnover<br />
rate because it includes net sales from the income statement <strong>and</strong> total assets from the<br />
balance sheet.<br />
1.06= (net sales/ total assets)<br />
Adjusted<br />
Total assets = (net sales/1.06)<br />
We assumed a 1.06 asset turnover rate after averaging the last two asset<br />
turnovers for the industry. Dow’s past two averaged out to by 1.05, which added<br />
further confidence for our assumed rate. We choose to only use the past two years<br />
because they showed a lower variability than the years 2002 through 2004, which<br />
increased dramatically in both the industry <strong>and</strong> Dow. Using this 1.06 asset turnover we<br />
had found for Dow in our forecasting analysis, we divided our net sales by this number<br />
to find our total assets for 2007 <strong>and</strong> beyond.<br />
The next line item that was forecasted was total current assets. The common<br />
sized balance sheet seemed to have a pretty consistent 35% current asset ratio, which<br />
we multiplied by the total assets to find current assets for that year. After formulating<br />
the current assets, we subtracted them from the 10 year forecasted total assets, which<br />
gave us our total non-current assets. By the use of the common sized balance sheet,<br />
we were able to determine the cash <strong>and</strong> cash equivalents to be 6% of total asset.<br />
Therefore, when we forecasted out our total assets, we maintained a 6% growth rate in<br />
cash <strong>and</strong> cash equivalent. To forecast inventory, we used the inventory turnover rate,<br />
which we averaged out to be 6.71.<br />
6.71= COGS/Inventory<br />
Adjusted
Inventory = COGS/6.71<br />
This method provides a link between the income statement <strong>and</strong> the balance<br />
sheet. Dividing our COGS, which were previously found on our income statement by<br />
our inventory turnover rate, we were able to forecast inventory for the next 10 years.<br />
The industry average was 6.27, but this was not the best number to choose because of<br />
the heavy fluctuation that occurred from year to year. Therefore, it was more logical to<br />
choose Dow’s inventory turnover because it was less volatile than the industries.<br />
The final Current Asset that we forecasted was accounts receivable. This is yet<br />
another technique used to link the Income Statement with the balance sheet.<br />
9.07 = Net Sales/Accounts Receivable<br />
Adjusted<br />
Accounts Receivable = Net Sales/9.07<br />
By dividing your forecasted Net Sales by 9.07, we were able to forecast out our<br />
accounts receivable for the next ten years.<br />
The st<strong>and</strong>-alone non-current asset that we forecasted was Goodwill. Our<br />
common sized balance sheet gave us 7.5%, which we decreased to 7% after removing<br />
the 2002 <strong>and</strong> 2003 outliers.<br />
Following the forecasts of assets, we computed retained earnings <strong>and</strong><br />
stockholders equity. Since Dow is an equity-based firm, it was important to estimate<br />
equity before liabilities were forecasted. Retained earnings were the first step we took<br />
in this process. To forecast them, we took the previous years retained earnings <strong>and</strong><br />
added the current year net income minus dividends. To forecast total shareholders<br />
equity, we subtracted the retained earnings from the previous years retained earnings.<br />
Then we added that number to the previous shareholders equity to forecast the future<br />
shareholders equity for the next ten years.<br />
Dow Chemical <strong>Analysis</strong> Page 88
To find the forecast for total liabilities, we subtracted the S/E from our total<br />
liabilities & S/E, which we know equals total assets because balance sheets balance.<br />
Next, we found our current ratio to be 1.5 compared to the industry of 1.74 because of<br />
Dow’s generally higher rate of debt financing. Using the formula provided below, we<br />
were able to calculate our current liabilities by dividing our previously stated current<br />
assets over our current ratio of 1.5. This formula was used to generate the forecasted<br />
current liabilities of the upcoming 10 years ending in 2016.<br />
1.05 = CA/CL<br />
Adjusted<br />
CA/1.05= CL<br />
Finally, to calculate our long-term liabilities, we subtracted current liabilities from the<br />
total liabilities.<br />
Dow Chemical <strong>Analysis</strong> Page 89
Cash Flow Statement<br />
Operating Activities<br />
Net Income Available for Common Stockholders ($338) $1,730 $2,797 $4,515 $3,724 $ 3,748.16 $ 4,085.50 $ 4,453.19 $ 4,853.98 $ 5,290.84 $ 5,767.01 $ 6,286.04 $ 6,851.79 $ 7,468.45 $ 8,140.61<br />
Adjustments to reconcile net income to<br />
net cash provided by operating<br />
activities:<br />
Cumulative effect of change in accounting 20<br />
principle (67) 9<br />
Depreciation <strong>and</strong> amortization 2,088 2,079 2,074<br />
Provision for deferred income tax 1,825 1,903 255 740 104<br />
Earnings of nonconsolidated affiliates (311) (378) (553) (469) (343)<br />
in excess of dividends received<br />
Minority interests' share in income 63 (180) 122 82 93<br />
Pension contributions (399) (1,031) (575)<br />
Net gain on sales of ownership interests 63 94 (29) (732)<br />
in nonconsolidated affiliates (4) (235)<br />
Net gain on sales of investments 4 (34) (33) (19)<br />
Net gain on sales of property, businesses (60) (100) (56) (130)<br />
<strong>and</strong> consolidated companies (2) (28)<br />
Other net (gain) loss (8) 69 (29) (12)<br />
Gain on asset divestitures related to formation (65) (10) (563)<br />
of nonconsolidated affiliates (102)<br />
Restructuring charges 8 341 41 586<br />
Asbestos-related credit 168 (177)<br />
Tax benefit nonqualified stock option 34 100 85<br />
exercises 828<br />
Excess tax benefits from share-based payment 31 52 (11)<br />
arrangements<br />
Changes in assets <strong>and</strong> liabilities:<br />
Accounts <strong>and</strong> notes receivable (299) (322) (1,316) (469) 242<br />
Inventories 223 95 (931) (240) (758)<br />
Accounts payable 474 161 1,252 106 (129)<br />
Other assets <strong>and</strong> liabilities 1 347 (429) (135) (515)<br />
Cash provided by operating activities (448) 632 2,670 4,474 4,154 $ 4,819.06 $ 5,252.78 $ 5,725.53 $ 6,240.83 $ 6,802.50 $ 7,414.73 $ 8,082.05 $ 8,809.44 $ 9,602.29 $ 10,466.49<br />
Investing Activities 2,108 3,780<br />
Capital expenditures (1,333) (1,597) (1,775)<br />
Proceeds from sales of property, businesses 163 105 296<br />
<strong>and</strong> consolidated companies (1,623) (1,100)<br />
Acquisitions of businesses 79 231 (149)<br />
Purchase of previously leased assets (1) (10) (263) (208)<br />
Investments in consolidated companies (533) (6) (109) (111)<br />
Investments in nonconsolidated affiliates (71) (129) (208) (103)<br />
Distributions from nonconsolidated affiliates 39 3 60 41 6<br />
Proceeds from sales of ownership interests (98) (80) 62 956 10<br />
in nonconsolidated affiliates 63<br />
Proceeds from asset divestitures related 89 53 845<br />
to formation of nonconsolidated affiliates<br />
Purchases of investments (1,827) (1,400) (1,405)<br />
Proceeds from sales <strong>and</strong> maturities of investments 1,661 1,379 1,383<br />
(1,799) (1,732)<br />
Cash used in investing activities 1,688 1,500 (653) (1,096) (1,907) $ (2,437.62) $ 475.21 $ 517.98 $ (5,450.57) $ 74.04 $ 80.71 $ 87.97 $ 95.89 $ 104.52 $ 113.93<br />
Financing Activities (1,626) (1,676)<br />
Changes in short-term notes payable (152) 74 23<br />
Payments on long-term debt (1,285) (1,559) (1,359)<br />
Proceeds from issuance of long-term debt (510) (285) 658 4<br />
Purchases of treasury stock (472) (857) (15) (68) (739)<br />
Proceeds from sales of common stock 2,932 907 706 398 223<br />
Excess tax benefits from share-based payment (6) (6) 11<br />
arrangements 138 303<br />
Distributions to minority interests (78) (58) (57) (70) (57)<br />
Dividends paid to stockholders (1,217) (1,229) (1,252) (1,287) (1,404)<br />
Cash used in financing activities 787 (1,225) (1,397) (2,508) (3,302)<br />
Effect of Exchange Rate Changes on Cash (5) 29 96 (172) 6<br />
Summary<br />
Increase (Decrease) in cash <strong>and</strong> cash equivalents 1,264 908 716 698 (1,049)<br />
Cash <strong>and</strong> cash equivalents at beginning 220 1,484 2,392 3,108 3,806<br />
of year<br />
Cash <strong>and</strong> cash equivalents at end of year $1,484 $2,392 $3,108 $3,806 $2,757
Statement of Cash Flows<br />
Seeing as calculating the statement of cash flows is not only the hardest<br />
statement to calculate for a firm, but also critical in terms of operating <strong>and</strong> investing<br />
activities. Before we can forecast these cash flows we must first determine the net<br />
income for common stockholders. Fortunately we have forecasted net income from<br />
previous financial analysis that has provided us this information needed to forecast cash<br />
flows from operations. By looking at the net income from the current year minus the<br />
previous year <strong>and</strong> divided by the previous year we came up with a 9% growth rate. By<br />
applying that same 9% growth rate to our sales forecast we were able to forecast cash<br />
from operating activities for the next ten years. We observed that cash flows from<br />
operations remains at a consistent growth which remains on par for the company’s<br />
expansion. To check our estimates from cash flows from operations we applied the<br />
CFFO/OI ratio <strong>and</strong> came to the conclusion that our original estimates were reasonable.<br />
To calculate cash flows from investing we took the total other noncurrent liabilities from<br />
the previous year <strong>and</strong> subtracted total other noncurrent liabilities in the current year.<br />
The recent trend shows the company is increasingly investing in itself; which will help<br />
ensure future profitability.<br />
Cost of Capital<br />
In looking at a firm, the cost of capital is necessary for a valuation. The three<br />
essentials that go into this model consist of: the weighted average cost of capital, the<br />
cost of debt, <strong>and</strong> the cost of equity. The following section takes you through the<br />
process of computing these three elements.<br />
Cost of <strong>Equity</strong> (CAPM)<br />
In computing the CAPM model we must first find the (Ke), which is an estimation<br />
of a companies expected stock returns. Three other variables are used in calculating<br />
CAPM, <strong>and</strong> they consist of the risk free rate, beta, <strong>and</strong> the market risk premium or MRP.
First, to find our risk free rate, we consulted the St. Louis FRED database, where<br />
we matched our regression analysis to the 3 month T-bill interest rate. After computing<br />
our regression analysis, we found that the highest adjusted R^2 were 30.81%, which<br />
was from the 3 month, 5 year T-bill interest rate.<br />
(CAPM) Ke= Rf + B(MRP)<br />
Ke=.043 + 1.5(.07)<br />
Ke=.148<br />
Cost Of Debt<br />
Dow’s cost of debt was computed at 5.89% on a before tax basis. In computing<br />
the cost of debt we consulted Dow’s 10-k, along with the St. Louis Fed (Fred) Database.<br />
In determining our accounts payable <strong>and</strong> accrued expenses <strong>and</strong> liabilities, we used a<br />
three-month non-commercial paper rate of 4.41%, taken off the St. Louis Fed. For<br />
current maturities <strong>and</strong> long term debt we took a 6.7% interest rate straight off Dow’s<br />
10-k. The deferred income-tax liability was taken using the two-year Non-financial<br />
Risk-free government rate from the St. Louis FED, with an interest rate of 2.9%. While<br />
we could not find a compatible rate for long-term liabilities, we took a reasonable<br />
estimate of 4.8% that was assumed from the averages of other line items from longterm<br />
debt. We then assigned each liability line item a weight in reference to total<br />
liabilities <strong>and</strong> multiplied them by their respected interest rates.<br />
Dow Chemical <strong>Analysis</strong> Page 92
Cost of Debt<br />
Liabilities<br />
Source Interest Rate(%) Weight Value<br />
Current Liabilities<br />
Accounts Payable Fed 4.41 0.2079 0.00917 5,674<br />
Current Maturities of L-T Debt 10_k 6.7 0.0473 0.00317 1,291<br />
Accrued Expenses & Liabilities Fed 4.41 0.0811 0.00358 2,215<br />
Income Tax Payable 10-K 35 0.0207 0.00725 569<br />
Total Current Liabilities 9,749<br />
Long-term Liabilities Estimate 4.8 0.312 0.01498 8,514<br />
Long-term Debt 10-K 6.7 0.2944 0.01972 8,036<br />
Deffered Income Tax Liability Fed 2.9 0.0366 0.00106 999<br />
Total L-T Liabilities 17,549<br />
1<br />
Total Liabilities 0.05893 27,298<br />
Kd=5.89%<br />
The following regression analysis information comes from using Dow chemical<br />
historic stock prices adjusted for dividends <strong>and</strong> comparing them to the St. Louis Fed<br />
FRED database information for T-bill interest rates.<br />
3 month 1 year 2 year 3 year<br />
X adj r 2 t-stat X adj r 2 t-stat X adj r 2 t-stat X adj r 2 t-stat<br />
72 month 1.0918 0.2628 5.1288 Ke 1.0895 0.2624 5.1246 1.0859 0.2617 5.1156 1.0841 0.2611 5.1081<br />
60 month 1.5005 0.3081 5.2226 0.1480 1.4985 0.3080 5.2212 1.4960 0.3072 5.2121 1.4949 0.3065 5.2033<br />
48 month 0.9629 0.1240 2.7660 0.9602 0.1235 2.7608 0.9570 0.1228 2.7534 0.9548 0.1222 2.7460<br />
36 month 0.8015 0.0654 1.8569 0.8023 0.0657 1.8609 0.8023 0.0660 1.8638 0.8023 0.0660 1.8640<br />
24 month 0.2973 -0.0244 0.6725 0.3015 -0.0238 0.6829 0.3045 -0.0233 0.6909 0.3056 -0.0231 0.6936<br />
5 year 7 year 10 year 20 year<br />
X adj r 2 t-stat X adj r 2 t-stat X adj r 2 t-stat X adj r 2 t-stat<br />
72 month 1.0817 0.2601 5.0948 1.0800 0.2593 5.0853 1.0792 0.2588 5.0787 1.0772 0.2577 5.0644<br />
60 month 1.4923 0.3047 5.1826 1.4897 0.3032 5.1651 1.4882 0.3022 5.1532 1.4844 0.3000 5.1270<br />
48 month 0.9503 0.1208 2.7309 0.9471 0.1198 2.7201 0.9445 0.1190 2.7113 0.9402 0.1177 2.6965<br />
36 month 0.8009 0.0656 1.8596 0.7996 0.0652 1.8556 0.7986 0.0650 1.8524 0.7968 0.0644 1.8465<br />
24 month 0.3058 -0.0231 0.6939 0.3058 -0.0231 0.6939 0.3060 -0.0231 0.6941 0.3065 -0.0230 0.6947<br />
After reviewing the above data sets, it has become clear that CAPM analysis for<br />
Dow will not yield reliable results. The 24-72 month regressions are used for a clear<br />
snapshot point in time to show the yield to maturity. While performing the regression<br />
Dow Chemical <strong>Analysis</strong> Page 93
analysis (in appendix), we determined to exclude the two <strong>and</strong> twenty year data sets.<br />
We excluded year two because the year one data set <strong>and</strong> the year three data set<br />
showed enough data we needed within that time span. The unreliable results are due<br />
to the instability of the beta calculations <strong>and</strong> the overall low r 2 that is the measure of<br />
how much of the overall risk can be explained by the company. Unfortunately, during<br />
recent years, the stock market has drifted away from high adjusted r2 confidence levels<br />
<strong>and</strong> the 30.81% that we have for our chosen beta is actually pretty good. The most<br />
reliable beta that we found turned out to be 1.5 based on the 5 year–3 month data set.<br />
This is almost twice of the published beta of .8 found on finance.yahoo.com. In<br />
reviewing the tables, we found that this beta comes from the 3 year–1 year data set.<br />
Looking ahead, the beta shows to stay consistent with possibilities with slight<br />
decreases. Oddly, this correlates with the lowest adjusted r 2 , above 0, instead of the<br />
highest. This would virtually eliminate all but the market risk, but not give an accurate<br />
view of the true company risk involved.<br />
In recent years, we have begun to see a trend in the stock market of lower<br />
adjusted r2 numbers being found. This leads to the conclusion, that as the financial<br />
world changes <strong>and</strong> become more global, the individual businesses have less control<br />
over their risk free rates.<br />
After finding Dow’s Ke, we can now plug in the other values to compute WACC. The<br />
weighted average cost of capital is comprised of the weights of both debt <strong>and</strong> equity<br />
with their respective discount rates.<br />
Weighted Average Cost of Capital<br />
WACC bt= (Vd/Vf) Kd + (Ve/Vf) Ke<br />
The first component, Vd/Vf, is the weight of debt financing that was acquired<br />
outside the firm at a discount rate of Kd. The weight of equity financing, Ve/Vf, is<br />
Dow Chemical <strong>Analysis</strong> Page 94
acquired at a rate of Ke. These 2 separate forms of financing are added together to<br />
form the cost of capital for a firm on a before tax-basis.<br />
WACC bt= (28,516/45,581) .0589 + (17,065/45,581) .148<br />
WACC bt=9.23%<br />
WACC AT= (Vd/Vf) (Kd(1-T)) + (Ve/Vf) Ke<br />
In calculating Dow’s WACC after-tax, we took our weighted average of portion of<br />
debt, <strong>and</strong> multiplied it by the corporate tax rate of 35%.<br />
WACC AT= (28,516/45,581) (.0589(.65)) + (17,065/45,581) .148<br />
WACC AT= 7.94%<br />
As you can see above we took the total market value of debt of the firm <strong>and</strong><br />
divided it by the market value of the firm (<strong>Equity</strong> + Debt), <strong>and</strong> then multiplied it by our<br />
Kd of .0589. From there we took the total value of equity over the total market value<br />
of the firm <strong>and</strong> multiplied it by our Ke of .148. Once we calculated this equation we got<br />
our before tax WACC of 9.23%. After we calculated the before tax WACC we went<br />
ahead <strong>and</strong> calculated our after tax WACC of 7.49% by subtracting (1-tax rate).<br />
Method of Comparables<br />
A quick screening tool that investors used when assessing whether or not a given<br />
stock is fairly value is the method of comparables. Essentially, this method compiles<br />
various stock value-based ratios of a company’s competitors to obtain an industry<br />
average. Once this average is found, we use that ratio to derive an expected value for<br />
the company. A few of Dow’s competitors that we used in method include Lyondell,<br />
DuPont, <strong>and</strong> Huntsman. It is important to note that some competitors where left out of<br />
certain ratios due to the fact that their ratios where too extreme in value <strong>and</strong> therefore<br />
where deemed as “outliers”.<br />
Dow Chemical <strong>Analysis</strong> Page 95
Trailing Price to Earnings<br />
To get this ratio, we first took the most recently reported share price for Dow<br />
<strong>and</strong> its competitors. When then took those given share prices <strong>and</strong> divided them by their<br />
respective past twelve-month earnings per share.<br />
P/E-<br />
EPS PPS Trailing<br />
HUN 0.986 18.97 19.25<br />
DD 3.39 48.71 14.73<br />
LYO 0.711 25.57 35.94<br />
INDUSTRY<br />
AVERAGE 23.19<br />
DOW 3.869 39.9 10.31<br />
EXPECTED<br />
PRICE 89.72<br />
ACTUAL PRICE 39.9<br />
Once an industry average of the competitors was computed (23.19), we<br />
multiplied that value to the Earnings per Share value of Dow <strong>and</strong> found an estimated<br />
share price of $89.72; an amount that is more than double the actual share price of<br />
$39.90. This led us to believe Dow is considerably undervalued. The reason why there<br />
is such an extraneous difference between the two values is likely attributable to Dow<br />
considerably higher Earnings per Share than its competitors.<br />
Forecasted Price to Earnings<br />
This method is similar to the Trailing Price to Earnings Ratio in the respect that is<br />
uses the currently listed share price. The difference in the two methods is that the<br />
Dow Chemical <strong>Analysis</strong> Page 96
Trailing method divides the given price per share (PPS) by the past twelve-month<br />
earnings while the Forecasted P/E divides the PPS by the expected earnings per share<br />
(which was found when we forecasted the income statement). It is important to note<br />
that Lyondell was not used in the industry average since its past earnings growth rate<br />
were negative for three consecutive years, making impossible to forecast their expected<br />
future earnings.<br />
P/E-<br />
EPS PPS Forecasted<br />
HUN 2.19 18.97 8.65<br />
DD 4.22 48.71 11.55<br />
LYO<br />
N/A<br />
INDUSTRY<br />
AVERAGE 10.1<br />
DOW 3.56 39.9 11.22<br />
EXPECTED 35.96<br />
ACTUAL 39.9<br />
Once we compare the results of both Dow Chemical share price ($39.90) <strong>and</strong> the<br />
expected price of $35.96, we see that the firm is fairly value due to the fact the<br />
difference between the due values is within 10% of the original stock price.<br />
Price to Book<br />
This method compares the market value of a given firm to its book value. This<br />
ratio is found by taking the currently listed share price <strong>and</strong> dividing that value by the<br />
company’s book value per share (found on the most recent 10-K).<br />
Dow Chemical <strong>Analysis</strong> Page 97
BVPS PPS P/B<br />
HUN 7.448 18.97 2.55<br />
DD 10.146 48.71 4.8<br />
LYO 12.19 25.57 2.1<br />
INDUSTRY<br />
AVERAGE 3.15<br />
DOW 17.73 39.9 2.25<br />
EXPECTED 55.86<br />
ACTUAL 39.9<br />
Once we derived an industry average of 3.15, we multiplied this value by Dow’s<br />
most recent Book Value per Share of (BVPS) to get an estimated price of $55.86. When<br />
this estimated price is compared with Dow’s most recent price per share of $39.90, we<br />
see that Dow is undervalued in this method.<br />
Dividend Yield<br />
In this ratio, we analyze how much a given share generates dividends relative to<br />
its market value. To find this ratio, we take a share’s dividend payout for a given year<br />
<strong>and</strong> divide that amount by the current price per share. It should be noted that<br />
Huntsman is a non-dividend paying firm; therefore, we did not include them in the<br />
industry average.<br />
Dow Chemical <strong>Analysis</strong> Page 98
DIVIDEND PPS D/P<br />
HUN<br />
N/A<br />
DD 1.48 48.71 0.0303<br />
LYO 0.9 25.57 0.0352<br />
INDUSTRY<br />
AVERAGE 0.0328<br />
DOW 1.5 39.9 0.0375<br />
EXPECTED 45.73<br />
ACTUAL 39.9<br />
Once we found the industry average, we took that value <strong>and</strong> divided it into<br />
Dow’s Dividend per Share <strong>and</strong> came up with an estimated value of $45.73. Once we<br />
compared this expected value with the actual share price of $39.90, we see that Dow<br />
Chemical is slightly undervalued according to this method.<br />
P.E.G.<br />
The Price Earnings Growth model (PEG) is used to estimate a given stock value<br />
while taking into account the expected future earnings of that stock. The PEG value is<br />
found by taking the current Price to Earnings Ratio (P/E) <strong>and</strong> dividing it by the<br />
estimated earnings per share (EPS) growth rate. When we try to apply the PEG to<br />
Dow’s competitors, we found that this method was a bit difficult. Lyondell has<br />
previously had negative earnings growth rate for consecutive years <strong>and</strong> Huntsman has<br />
(until recently) been operating with negative net income from the years of 2002 till<br />
2005, making it impossible to find the two companies earnings growth rate. Therefore,<br />
we are left with DuPont as the only source to find an industry average for the PEG ratio.<br />
Dow Chemical <strong>Analysis</strong> Page 99
GROWTH<br />
RATE P/E PEG<br />
HUN<br />
N/A<br />
DD 18% 14.73 0.8183<br />
LYO<br />
N/A<br />
INDUSTRY AVERAGE 0.8183<br />
DOW 7% 10.31 1.473<br />
EXPECTED 22.16<br />
ACTUAL 39.9<br />
We found an industry average (i.e. DuPont) of 0.8183 <strong>and</strong> multiplied that<br />
amount by Dow’s 7% growth rate. We then took that result <strong>and</strong> multiplied it by Dow<br />
EPS to get an estimated share price of $22.16. When this value is compared with Dow’s<br />
share price of $39.90, we observe the Dow is overvalued in regards to the PEG ratio<br />
method. However, due to the fact that DuPont is the only firm to represent the entire<br />
industry, this model does not prove to be a credible valuation in this example.<br />
Price to EBITDA<br />
This ratio is found by taking the stated share price of a firm <strong>and</strong> divide it by the<br />
earnings before interest, taxes, depreciation <strong>and</strong> amortization expenses to get an<br />
estimated share value of the company. To find Dow’s EBITDA, we used the information<br />
provided on the income statement of the most recent 10-K. To find Dow’s competitors<br />
PPS <strong>and</strong> EBITDA, we used the content listed on Yahoo! Finance. To simplify the data,<br />
we put all the companies EBITDA in decimals according to billions.<br />
Dow Chemical <strong>Analysis</strong> Page 100
EBITDA PPS P/EBITDA<br />
HUN 0.7365 18.97 25.76<br />
DD 3.789 48.71 12.86<br />
LYO 1.069 25.57 23.92<br />
INDUSTRY AVERAGE 20.85<br />
DOW 5.588 39.9 7.14<br />
EXPECTED 116.51<br />
ACTUAL 39.9<br />
After dividing the prices per share by their respective EBITDA’s, we took the<br />
industry average of 20.85 <strong>and</strong> multiplied it by Dow’s EBITDA of 5.588 (in billions) to get<br />
an estimated value of $116.51. Clearly, Dow is extremely undervalued. Due to the fact<br />
the Dow seems to be the only firm in the industry that is producing extraordinarily<br />
profits, the P/EBITDA ratio is flawed <strong>and</strong> therefore should not considered to be a<br />
reliable source of valuation (at least in this example).<br />
Price to Free Cash Flows<br />
This ratio is used to determine an estimated share price by dividing a firm’s price<br />
per share by the firm’s free cash flows of that year. Much like the P/EBITDA ratio<br />
previously mentioned, we put the companies Free Cash Flows (FCF) into decimals<br />
according to billions for simplicity. It is also important to note that Lyondell was not<br />
computed in the industry average since it had an outflow of free cash flows (a negative<br />
balance at years-end).<br />
Dow Chemical <strong>Analysis</strong> Page 101
FCF PPS P/FCF<br />
HUN 1.067 18.97 17.78<br />
DD 2.391 48.71 20.372<br />
LYO<br />
N/A<br />
INDUSTRY AVERAGE 19.076<br />
DOW 2.247 39.9 17.757<br />
EXPECTED 42.86<br />
ACTUAL 39.9<br />
Once we found an industry average of 19.076, we took that amount <strong>and</strong><br />
multiplied it by Dow’s FCF (2006 net cash provided by operations <strong>and</strong> investing) to get<br />
a value of $42.86. When we compare this result with Dow’s current market value of<br />
$39.90, we see that the P/FCF ratio list Dow as a fairly valued firm.<br />
Enterprise Value to EBITDA<br />
Our last <strong>and</strong> final method used to estimate a firms share value is the EV/EBITDA<br />
ratio. The Enterprise Value (EV) of a firm is “calculated as market capitalization plus<br />
debt, minority interest <strong>and</strong> preferred shares, minus total cash <strong>and</strong> cash equivalents”<br />
(Investopedia.com). The Enterprise Value’s of Dow’s competitors were found off of<br />
Yahoo! Finance on November 28 th , 2007 (note: both EV <strong>and</strong> EBITDA numbers are in<br />
billions). To find this ratio, we simply took the Enterprise Value of a firm <strong>and</strong> divided it<br />
by that firms Earnings before Interest, Tax, Depreciation <strong>and</strong> Amortization.<br />
Dow Chemical <strong>Analysis</strong> Page 102
EBITDA EV EV/EBITDA<br />
HUN 0.7365 7.233 9.821<br />
DD 3.789 36.086 9.524<br />
LYO 1.069 7.377 6.901<br />
INDUSTRY AVERAGE 8.749<br />
DOW 5.588 44.9 8.035<br />
EXPECTED 48.89<br />
ACTUAL 39.9<br />
Once we had found the industry average, we took that amount <strong>and</strong> multiplied it<br />
by Dow’s EBITDA to get a value of $48.89. When we compare this result with the<br />
stated share price of $39.90, we see that the EV/EBITDA ratio list Dow as an<br />
undervalued firm.<br />
Method of Comparables Overview<br />
Relative to the<br />
<strong>Mark</strong>et Value<br />
Price ($39.90/share)<br />
Trailing Price to Earnings $89.72 Under<br />
Forecasted Price to Earnings $35.96 Fair<br />
Price to Book $55.86 Under<br />
Dividend Yield $45.73 Slightly Under<br />
Price Earnings Growth $22.16 Over<br />
Price to EBITDA $116.51 Extremely Under<br />
Price to Free Cash Flows $42.86 Fair<br />
Enterprise Value to EBITDA $48.89 Under<br />
Dow Chemical <strong>Analysis</strong> Page 103
When we averaged out the rankings of the comparable stock prices (excluding<br />
the P/EBITDA outlier), we see that this firm falls between the ranges of undervalued<br />
<strong>and</strong> slightly undervalued. As the table above indicates, the comparables valuation<br />
method has proven the Dow Corporation as an undervalued firm; therefore, this<br />
appraisal technique would advise any interested party to buy shares of this firm<br />
immediately.<br />
Intrinsic Model <strong>Valuation</strong>s<br />
A significant drawback the Method of Comparables is that they rely on an<br />
industry average to benchmark their valuation. This valuation does not access the true<br />
value of a firm if the company’s performance exceeds or under performs the industry<br />
benchmark: therefore, instead of getting a true value of a firm, we get a number that<br />
would perform on pair with industry st<strong>and</strong>ards. It is for this reason that Intrinsic<br />
<strong>Valuation</strong>s give a better overall picture of a single firm’s performance because it ignores<br />
the industry benchmarking principle of the Comparables Method. In addition, these<br />
valuations dissect a company from different angle in order to gain a better perspective<br />
of the true value of the firm. The methods used were the discounted dividends model,<br />
the free cash flows model, the residual income model, <strong>and</strong> the abnormal growth model.<br />
Now, we will discuss each model used, <strong>and</strong> their importance in valuing Dow Chemical.<br />
Discounted Dividends<br />
The discounted dividends model values a firm by using the “firm’s equity as the<br />
present value of forecasted future dividends” (Palepu). This means that shareholders<br />
receive payoffs in the form of dividends, <strong>and</strong> the value of their equity is the present<br />
value of the future dividends. In order to value the firm with this model, we must<br />
discount the future dividends back to the present value. In order to compute this<br />
model, the two essential elements needed are the forecasted dividends from the<br />
Dow Chemical <strong>Analysis</strong> Page 104
financial statement, <strong>and</strong> a calculated cost of equity. This model, however, does not<br />
prove to be reliable in regards of accurately valuing the equity because it is unknown<br />
how a firm’s dividends will change over time.<br />
Growth Rate<br />
0 0.03 0.05 0.07 0.1<br />
11.00% $ 39.72 $ 49.80 $ 62.12 $ 86.76 $ 308.52<br />
Ke 13.00% $ 35.47 $ 42.52 $ 50.17 $ 62.91 $ 113.89<br />
14.80% $ 32.53 $ 37.94 $ 43.40 $ 51.65 $ 76.92<br />
17.00% $ 29.70 $ 33.83 $ 37.73 $ 43.18 $ 57.22<br />
19.00% $ 27.65 $ 31.00 $ 34.02 $ 38.06 $ 47.47<br />
ub<br />
$43.89 Undervalued<br />
lb $ 35.91 Overvalued<br />
To find the present value of dividends on a year-to-year basis, we multiplied<br />
dividends by their corresponding present value factor, which we then totaled to find the<br />
present value annual dividends. The terminal value of the perpetuity was then found<br />
<strong>and</strong> dividing this number by one plus the cost of equity raised to the ten twelve’s, which<br />
brought it back to its present value. The estimated price was the total present value of<br />
the annual dividends plus the present value of the terminal perpetuity. To make this<br />
value time consistent, the estimated price per share was multiplied by one plus the cost<br />
of equity raised to the ten twelve’s. The sensitivity analysis reveals that the company is<br />
overvalued using the cost of equity of .148 <strong>and</strong> a growth rate of zero. There are also<br />
growth rates that cause the estimated prices to spike, especially with smaller cost of<br />
equity. Since dividends, growth rates, treasury repurchases, <strong>and</strong> stock issuances are<br />
impossible to determine, this valuation model losses it explanatory powers.<br />
Discounted Free Cash Flows<br />
The discounted free cash flows model uses the present value of future cash<br />
flows by discounting them using the weighted average cost of debt. Unlike the<br />
Dow Chemical <strong>Analysis</strong> Page 105
discounted dividends model, this model uses cash flows instead of dividends to<br />
determine the value of the firm’s equity.<br />
This first step for this evaluation model is to find the free cash flows for the<br />
company. This can be done by taking the forecasted cash from operations <strong>and</strong><br />
subtracting them from the cash from investing. Then we found the total present value<br />
of annual free cash flows by multiplying the annual free cash flows by their present<br />
value factor <strong>and</strong> summing them together. After finding the continuing value of the<br />
perpetuity, we multiplied it by the present value factor to find the terminal value of the<br />
perpetuity. The value of the firm was the present value of the terminal perpetuity that<br />
was just found plus the total present value of the annual free cash flows. Estimated<br />
market value of equity was then found by subtracting total liabilities for the value of the<br />
firm, which was then divided by the number of shares outst<strong>and</strong>ing to get the estimated<br />
price per share.<br />
Growth Rate<br />
0 0.02 0.03 0.04 0.05<br />
0.05 $ 80.72 $ 135.16 $ 203.21 $ 407.36 N/A<br />
0.07 $ 44.32 $ 63.64 $ 80.54 $ 108.71 $ 165.06<br />
WACC BT 0.09 $ 24.64 $ 33.55 $ 40.24 $ 49.61 $ 63.66<br />
0.0923 $ 22.95 $ 31.19 $ 37.30 $ 45.74 $ 58.18<br />
0.1 $ 17.90 $ 24.31 $ 28.89 $ 35.00 $ 43.55<br />
0.12 $ 8.03 $ 11.60 $ 13.98 $ 16.96 $ 20.78<br />
ub<br />
$43.89 Undervalued<br />
lb $ 35.91 Overvalued<br />
The sensitivity analysis allows us to look at Dow’s share prices using different<br />
before tax weighted cost of capital <strong>and</strong> growth rates. This model showed that Dow was<br />
overvalued at their before tax WACC of .0923 with a 0 perpetuity growth. However,<br />
with a .03 growth rate firm is fairly valued.<br />
Residual Income<br />
Dow Chemical <strong>Analysis</strong> Page 106
Out of all of the intrinsic valuation models, the residual income method proves to<br />
be the most accurate <strong>and</strong> reliable. Due to the fact that its values are based on the<br />
expected rate of return on future earnings, it proves to be a more credible model than<br />
the other methods that base their evaluations on perpetuity amounts. Moreover, this<br />
model places the largest emphasis of its share price on the current book value of<br />
equity. It is for this reason that the residual model has the highest degree of<br />
explanatory values. By forecasting out our net income for the next 10 years, we were<br />
able to calculate our actual earnings per share. We then found our normal earnings per<br />
share by taking our previous year book value of equity <strong>and</strong> multiplying it out by the cost<br />
of equity. By subtracting our actual earnings by our expected earning, we found our<br />
annual residual income. In order the discount them back to their present value, we<br />
multiplied this number by its related present value factor, <strong>and</strong> then totaled them up.<br />
The next step was to find the continuing terminal value of the perpetuity, which was<br />
our RI year eleven divided by the cost of equity minus the growth rate. We then took<br />
this number <strong>and</strong> multiplied it by the present value factor of year ten to find the terminal<br />
value of the perpetuity. Then to find Dow’s estimated price per share, we added the<br />
book value of liabilities plus the present value of the terminal perpetuity plus the total<br />
present value of residual income <strong>and</strong> divided that number by our number of shares<br />
Negative Growth Rate<br />
0% -10% -15% -30% -50%<br />
11.0% $ 39.36 $ 35.40 $ 34.00 $ 33.28 $ 32.55<br />
13.0% $ 30.02 $ 28.62 $ 28.29 $ 27.77 $ 27.46<br />
Cost of <strong>Equity</strong> 14.8% $ 24.20 $ 23.95 $ 23.89 $ 23.79 $ 23.72<br />
17.0% $ 19.15 $ 19.57 $ 19.69 $ 19.88 $ 20.00<br />
19.0% $ 15.85 $ 16.52 $ 16.71 $ 17.04 $ 17.26<br />
ub<br />
$43.89 Undervalued<br />
lb $ 35.91 Overvalued<br />
outst<strong>and</strong>ing, which we found to be 962.3 million on November 1, 2007.<br />
Dow Chemical <strong>Analysis</strong> Page 107
The above chart shows the sensitivity analysis of Dow’s share price based on the<br />
residual income model. This sensitivity analysis shows how price would change at<br />
various costs of equities <strong>and</strong> growth rates. This model assumes a negative growth rate<br />
because of the theory that residual income converges to zero. As you can see our firm<br />
is undervalued using this model since our observed share price was 39.90 on November<br />
1, 2007, <strong>and</strong> there is only one number that is within 10 percent of this value.<br />
Abnormal Earnings Growth<br />
AEG can be found by using forecasted earnings or net income, as well as, annual<br />
dividends paid. The next step would be to find a dividend reinvestment plan (DRIP)<br />
income, which is found by multiplying the previous year’s dividends by the cost of<br />
equity. From here, we added the earnings <strong>and</strong> DRIP to get cumulative dividend<br />
earnings. Normal earnings were found by multiplying the previous year’s net income<br />
with the cost of equity. By subtracting the cumulative dividends earnings by normal<br />
earning, abnormal earnings were found. We knew these earnings were correct because<br />
they matched the residual income check figures. To find the present value of the AEG,<br />
we multiplied the AEG by the corresponding present value, <strong>and</strong> later totaled them up<br />
<strong>and</strong> added them to the present value of the terminal perpetuity. Finally, we added this<br />
number to the core earnings to find the total average earnings. The intrinsic value per<br />
share was then found by dividing this number by the cost of equity, <strong>and</strong> then<br />
multiplying this number by one plus the cost of equity raised to the ten twelve’s to find<br />
the time consistent price.<br />
Sensitivity <strong>Analysis</strong><br />
Growth Rate<br />
0% -10% -20% -30% -40%<br />
0.11 $ 45.48 $ 44.21 $ 43.90 $ 43.54 $ 43.40<br />
0.13 $ 33.86 $ 33.81 $ 33.78 $ 33.77 $ 33.77<br />
Cost of <strong>Equity</strong> 0.148 $ 27.21 $ 27.54 $ 27.68 $ 27.76 $ 27.80<br />
0.17 $ 21.81 $ 22.26 $ 22.47 $ 22.59 $ 22.66<br />
0.19 $ 18.46 $ 18.90 $ 19.11 $ 19.24 $ 19.31<br />
ub<br />
$43.89 Undervalued<br />
lb $ 35.91 Overvalued<br />
Dow Chemical <strong>Analysis</strong> Page 108
This sensitivity analysis was used to show how price would change if the cost of<br />
equity <strong>and</strong> growth rate were altered. AEG is similar to the residual income model in<br />
that it uses a negative growth rate, so it can move towards zero. After viewing the<br />
results, it became clear that Dow Chemical is an overvalued company. By taking a look<br />
at cost of equity <strong>and</strong> noticing that the smaller the number got, the closer Dow moved to<br />
their actual share price, which further proves that they are overvalued.<br />
Growth Rate<br />
0.11 0.12 0.13 0.14 0.15<br />
ROE =.187 0.125 $ 100.42 $ 262.14 N/A N/A N/A<br />
0.135 $ 60.70 $ 88.03 $ 224.66 N/A N/A<br />
Ke 0.148 $ 40.31 $ 47.61 $ 63.00 $ 116.88 N/A<br />
0.155 $ 34.22 $ 38.28 $ 45.59 $ 62.65 $ 147.97<br />
0.165 $ 28.20 $ 29.99 $ 32.80 $ 37.86 $ 49.68<br />
ub<br />
$43.89 Undervalued<br />
lb $ 35.91 Overvalued<br />
Growth Rate<br />
0.11 0.12 0.13 0.14 0.15<br />
Ke = .148 0.23 62.83 78.16 110.53 223.82 N/A<br />
0.21 52.36 63.95 88.42 174.08 N/A<br />
ROE 0.19 41.88 49.74 66.32 124.34 N/A<br />
0.17 31.41 35.53 44.21 74.61 N/A<br />
0.15 20.94 21.32 22.11 24.87 N/A<br />
ub<br />
$43.89 Undervalued<br />
lb $ 35.91 Overvalued<br />
ROE<br />
0.15 0.17 0.19 0.21 0.23<br />
Growth = .13 0.125 N/A N/A N/A N/A N/A<br />
0.135 $ 70.93 $ 157.66 $ 236.48 $ 315.32 $ 394.14<br />
Ke 0.148 $ 22.11 $ 44.21 $ 66.32 $ 88.42 $ 110.53<br />
0.155 $ 16.00 $ 31.99 $ 47.99 $ 63.98 $ 79.98<br />
0.165 $ 11.51 $ 23.02 $ 34.53 $ 46.04 $ 57.54<br />
ub<br />
$43.89 Undervalued<br />
lb $ 35.91 Overvalued<br />
Dow Chemical <strong>Analysis</strong> Page 109
To find the long run return of equity, we first found the ROE for next ten years<br />
by dividing the net income by the previous year’s book value of equity. We then<br />
averaged this number out, which was the long run return on equity.<br />
Book Value of <strong>Equity</strong> 19353 21919.9 24793.8 28005.3 31588 35578.5 40017 44947.3 50417.4 56479.7<br />
Ending BVE = Beginning BVE + Earning – Dividend<br />
ROE= Net Income current / BVE of the previous year<br />
ROE 0.2196 0.2111 0.2032 0.1958 0.1889 0.1826 0.1767 0.1712 0.1662 0.1615<br />
Then to find the growth rate, we simply took the current BVE minus the previous BVE<br />
<strong>and</strong> then divided by the previous BVE. We assumed that Dow’s ROE would hit a<br />
plateau at around 15%.<br />
Growth Rate = BVE current –BVE previous / BVE Previous<br />
Growth of <strong>Equity</strong> 13.26% 13.11% 12.95% 12.79% 12.63% 12.48% 12.32% 12.17% 12.02%<br />
After viewing the results above, we noticed the decreasing growth rates of Dow’s book<br />
value of equity. We assumed that it would on average hit a plateau at 11%.<br />
Now that we had the long run return on equity <strong>and</strong> the long run growth rate of equity,<br />
we were able to plug these numbers into the following equation<br />
Value of Firm = BVE ( 1 + ((LR Return on <strong>Equity</strong> – Ke / (Ke – LR Growth Rate)))<br />
Then, we divided this number by the number of shares outst<strong>and</strong>ing (962.3) to<br />
get the price per share. This gave us a share price of $18.64, which we to November 1,<br />
to be $20.94. This shows that Dow is clearly overvalued. The only way Dow could be<br />
Dow Chemical <strong>Analysis</strong> Page 110
fairly valued would be to have a ROE of 19 percent. Since the trend seems to be<br />
headed to for a much smaller percentage, which does not seem feasible. Overall, the<br />
sensitivity analysis showed that Dow Chemical is an overvalued firm.<br />
Analyst Recommendation<br />
After careful research of Dow Chemical, including a five forces analysis, industry<br />
analysis, accounting analysis, financial analysis, forecasting models, valuation models,<br />
<strong>and</strong> future financial statements it is in our opinion that we are slightly overvalued. From<br />
this opinion we would advise to sell.<br />
We came to theses conclusions from past financial statements, Dow’s 10-k, along<br />
with three other competitors’ financial statements. These competitors include<br />
Huntsman, DuPont, <strong>and</strong> Lyondell. Seeing that the chemical industry is highly<br />
concentrated this requires key success factors that each competitor must follow in order<br />
to gain a competitive advantage. Some of these include economies of scale, operating<br />
efficiency, low input cost, efficient production, <strong>and</strong> most important research <strong>and</strong><br />
development.<br />
According to our accounting ratios Dow is one of the leading competitors in the<br />
industry. Besides working capital Dow holds the bar high for any competitor that exists<br />
or chooses to enter the industry. However, where Dow falls short is the disclosure of<br />
their financial information. In effect this created misleading numbers throughout their<br />
financial statements as well as GAP. For Dow their disclosure has become worse where<br />
as their competitors do a fair job of disclosing their financial information. Overall, for<br />
their financial ratios Dow has had a positive outlook in the market when calculating<br />
these.<br />
When we looked at forecasting the statements we took a below average growth<br />
rate of the past five years to determine future values. Looking back at the previous<br />
Dow Chemical <strong>Analysis</strong> Page 111
trends it is in our opinion this was a good rate to use. Overall, we feel this was the best<br />
rate we could get by getting the most accurate look into the company’s future.<br />
Looking back in the past five years of the company there seems to be no real<br />
evidence of any problems that have occurred. However, when looking at our residual<br />
income model <strong>and</strong> our AEG model we came to the conclusion of the firm being<br />
overvalued. Along with all other models there was a consistency of overvaluations.<br />
Through much research it is in the opinion of the group that anyone holding Dow<br />
stock to sell. As of November 1, 2007 the stated stock price was $39.90. After looking<br />
at our valuation models the stock price stated for Dow should be $20.94. Comparing<br />
these stock prices it is our opinion to sell this stock because of a prime selling<br />
opportunity.<br />
Dow Chemical <strong>Analysis</strong> Page 112
Net Sales/Cash from sales<br />
2002 2003 2004 2005 2006<br />
DOW 1.0091 1.0142 1.0302 1.0081 0.9972<br />
DD 0.9992 1.0141 1.0252 0.9644 1.0159<br />
HUN 0.9934 1.337 1.0536 0.9896 0.9785<br />
LYO 1.0137 1.0142 1.2321 1.0058 1.0226<br />
Net Sales/Net A/R<br />
2002 2003 2004 2005 2006<br />
DOW 5.0335 5.5029 5.4589 5.8424 6.1039<br />
DD 6.1807 6.4002 5.5921 6.8183 6.3255<br />
HUN 5.2644 6.2827 5.9943 7.1656 8.4811<br />
LYO 8.2374 8.4209 3.7897 11.095 10.253<br />
Net Sales/Inventory<br />
2002 2003 2004 2005 2006<br />
DOW 6.5611 8.0573 8.1019 8.706 8.1089<br />
DD 5.4448 6.5732 6.0904 5.6165 5.5497<br />
HUN 4.4447 11.606 7.5819 8.0742 6.9362<br />
LYO 9.4823 10.896 3.6726 11.229 9.8398<br />
Appendix<br />
Screening Ratio’s<br />
Asset Turnover<br />
2002 2003 2004 2005 2006<br />
DOW 0.6979 0.779 0.8753 1.0081 1.0777<br />
DD 0.6934 0.7289 0.7673 0.8002 0.8629<br />
HUN 0.4946 0.7929 1.0089 1.1917 1.2485<br />
LYO 0.438 0.4953 0.3733 1.2331 1.2455<br />
CFFO/OI<br />
2002 2003 2004 2005 2006<br />
DOW -3.389 2.1588 0.7034 0.6992 0.8355<br />
DD 1.0396 2.0499 1.1814 0.6149 0.8723<br />
HUN 0.7808 1.2585 0.6877 1.3547 1.2126<br />
LYO 1.6609 -103 3.6381 0.8257 0.7549<br />
Pension Expense / SGA<br />
2002 2003 2004 2005 2006<br />
DOW 3.5413 3.6412 3.8933 3.0829 2.6581<br />
DD 1.8921 1.6658 1.391 1.9358 1.7869<br />
HUN 1.1662 1.0878 0.7454 0.9232 0.834<br />
LYO 2.6875 2.7294 0.8571 0.3849 0.3613<br />
CFFO/NOI<br />
2002 2003 2004 2005 2006<br />
DOW 0.1528 0.2659 0.1931 0.3305 0.3027<br />
DD 0.1836 0.2617 0.316 0.2466 0.3559<br />
LYON 0.1219 0.0375 0.0491 0.2441 0.1336<br />
HUNT 0.0288 0.0444 0.0211 0.2086 0.22<br />
Dow Chemical <strong>Analysis</strong> Page 113
Core Financial Ratios<br />
2002 2003 2004 2005 2006 Average<br />
Industry<br />
LIQUIDITY<br />
Current Ratio 2.10 1.56 1.78 1.65 1.61 1.74<br />
Quick Asset Ratio 0.83 0.81 0.96 0.87 0.79 0.85<br />
A/R Turnover 7.68 7.91 6.01 8.14 8.42 7.63<br />
A/R Days 49.52 48.03 65.14 47.71 46.38 51.35<br />
Inventory Turnover 5.55 6.92 5.39 7.12 6.39 6.27<br />
Inventory Days 72.19 58.28 73.67 55.81 61.91 64.37<br />
Working Capital Turnover 7.14 6.97 5.23 7.67 8.03 7.01<br />
PROFITABILITY<br />
Gross Profit Margin 15.26% 11.46% 14.33% 15.26% 15.20% 0.14<br />
Operating Expense Ratio 0.07 0.07 0.07 0.06 0.06 0.07<br />
Net Profit Margin -2.81% -1.04% 3.00% 5.07% 5.53% 0.02<br />
Asset Turnover 0.58 0.69 0.75 1.03 1.09 0.83<br />
Return on Assets 2.29% -0.78% 2.40% 4.64% 5.35% 0.03<br />
Return on <strong>Equity</strong> -8.93% 43.26% 24.99% 16.95% 18.58% 0.19<br />
CAPITAL STRUCTURE<br />
Debt to equity ratio 6.56 -8.05 -3.57 3.38 3.11 0.29<br />
Times interest earned 2.71 1.25 2.94 5.47 5.28 3.53<br />
Debt service margin 0.12 0.17 0.22 0.34 0.39 0.25<br />
IGR 2.28% 3.51% 4.22%<br />
Dow Chemical<br />
LIQUIDITY<br />
Current Ratio 1.28 1.38 1.51 1.63 1.62 1.49<br />
Quick Asset Ratio 0.53 0.63 0.76 0.84 0.75 0.70<br />
A/R Turnover 8.86 9.13 8.45 9.04 9.85 9.07<br />
A/R Days 41.19 39.98 43.20 40.39 37.06 40.36<br />
Inventory Turnover 5.65 6.96 6.91 7.20 6.85 6.71<br />
Inventory Days 64.59 52.46 52.84 50.72 53.25 54.77<br />
Working Capital Turnover 10.96 9.12 7.46 6.87 7.43 8.37<br />
PROFITABILITY<br />
Gross Profit Margin 13.87% 13.65% 14.73% 17.34% 15.47% 0.15<br />
Operating Expense Ratio 0.06 0.04 0.04 0.03 0.03 0.04<br />
Net Profit Margin -1.22% 5.30% 6.96% 9.75% 7.58% 0.06<br />
Asset Turnover 0.70 0.78 0.88 1.01 1.08 0.89<br />
Return on Assets -0.95% 4.37% 6.68% 9.84% 8.11% 0.06<br />
Return on <strong>Equity</strong> -4.43% 18.86% 22.80% 29.46% 21.82% 0.18<br />
CAPITAL STRUCTURE<br />
Debt to equity ratio 4.19 3.57 2.74 2.00 1.67 2.83<br />
Times interest earned 3.14 3.19 6.16 10.36 9.07 6.39<br />
Debt service margin -0.04 0.05 0.23 0.49 0.52 0.25<br />
IGR 3.55% 6.88% 4.93%<br />
SGR 0.04 0.15 0.24 0.33 0.25 0.20<br />
Dupont<br />
LIQUIDITY<br />
Current Ratio 1.90 1.42 1.92 1.67 1.62 1.70<br />
Quick Asset Ratio 1.13 0.58 1.06 0.89 0.89 0.91<br />
A/R Turnover 6.18 6.40 5.59 5.55 5.28 5.80<br />
A/R Days 59.05 57.03 65.27 65.78 69.19 63.27<br />
Inventory Turnover 3.79 4.27 4.62 4.39 3.98 4.21<br />
Inventory Days 96.21 85.52 78.93 83.12 91.63 87.08<br />
Working Capital Turnover 3.77 4.98 3.76 5.34 5.56 4.68<br />
PROFITABILITY<br />
Gross Profit Margin 26.98% 23.10% 23.82% 26.11% 25.46% 0.25<br />
Operating Expense Ratio 0.12 0.11 0.11 0.12 0.12 0.12<br />
Net Profit Margin -4.59% 3.60% 6.51% 7.72% 11.48% 0.05<br />
Asset Turnover 0.69 0.73 0.77 0.80 0.86 0.77<br />
Return on Assets -2.74% 2.81% 4.81% 5.77% 9.46% 0.04<br />
Return on <strong>Equity</strong> -12.17% 9.95% 15.65% 22.94% 33.41% 0.14<br />
CAPITAL STRUCTURE<br />
Debt to equity ratio 2.55 2.74 2.03 2.66 2.33 2.46<br />
Times interest earned 6.92 1.41 4.98 7.88 8.24 5.89<br />
Debt service margin 0.43 0.58 0.58 0.37 0.62 0.52<br />
IGR 1.02% 1.73% 5.32%<br />
Lyondell<br />
LIQUIDITY<br />
Current Ratio 1.85 1.94 1.94 1.68 1.60 1.80<br />
Quick Asset Ratio 1.15 1.27 1.04 0.88 0.82 1.03<br />
A/R Turnover 9.59 9.77 4.00 10.82 10.08 8.85<br />
A/R Days 38.04 37.35 91.19 33.74 36.21 47.31<br />
Inventory Turnover 8.42 10.35 3.37 9.95 8.75 8.17<br />
Inventory Days 43.33 35.27 108.15 36.67 41.70 53.02<br />
Working Capital Turnover 6.06 5.40 2.69 9.74 10.78 6.94<br />
PROFITABILITY<br />
Gross Profit Margin 11.16% -0.67% 6.18% 2.44% 5.37% 0.05<br />
Operating Expense Ratio 0.05 0.05 0.05 0.03 0.03 0.04<br />
Net Profit Margin -4.54% -8.47% 0.93% 3.14% 0.89% -0.02<br />
Asset Turnover 0.44 0.47 0.36 1.12 1.17 0.71<br />
Return on Assets -2.21% -4.05% 0.71% 3.33% 1.23% 0.00<br />
Return on <strong>Equity</strong> -12.55% -26.12% 1.92% 17.65% 5.83% -0.03<br />
CAPITAL STRUCTURE<br />
Debt to equity ratio 5.32 5.60 4.67 4.04 4.60 4.85<br />
Times interest earned 0.45 -0.04 0.20 1.95 1.69 0.85<br />
Debt service margin 0.07 0.02 0.05 0.27 0.15 0.11<br />
IGR -0.96% 1.94% -0.24%<br />
Huntsman<br />
LIQUIDITY<br />
Current Ratio 3.37 1.49 1.74 1.64 1.61 1.97<br />
Quick Asset Ratio 0.53 0.77 1.00 0.86 0.73 0.78<br />
A/R Turnover 6.10 6.32 5.99 7.17 8.48 6.81<br />
A/R Days 59.79 57.75 60.89 50.94 43.04 54.48<br />
Inventory Turnover 4.31 6.10 6.67 6.92 5.98 5.99<br />
Inventory Days 84.62 59.88 54.75 52.73 61.08 62.61<br />
Working Capital Turnover 7.77 8.38 7.00 8.75 8.34 8.05<br />
PROFITABILITY<br />
Gross Profit Margin 9.02% 9.74% 12.59% 15.13% 14.49% 0.12<br />
Operating Expense Ratio 0.06 0.06 0.07 0.06 0.07 0.06<br />
Net Profit Margin -0.89% -4.62% -2.40% -0.33% 2.18% -0.01<br />
Asset Turnover 0.49 0.79 1.01 1.19 1.25 0.95<br />
Return on Assets -0.43% -6.23% -2.61% -0.37% 2.59% -0.01<br />
Return on <strong>Equity</strong> -6.57% 170.38% 59.61% -2.28% 13.23% 0.47<br />
CAPITAL STRUCTURE<br />
Debt to equity ratio 14.19 -44.11 -23.73 4.82 3.85 -9.00<br />
Times interest earned 0.34 0.42 0.43 1.68 2.10 0.99<br />
Debt service margin 0.03 0.04 0.03 0.22 0.26 0.11<br />
IGR 0.00% -0.49% 2.43%<br />
Dow Chemical <strong>Analysis</strong> Page 114
Altman Z-score<br />
2002 2003 2004 2005 2006<br />
Z-score = 1.2 Working Capital 2519 3,578 5,384 6,741 6,608<br />
Total Assets 39,562 41,891 45,885 43,934 45,581<br />
(+)<br />
1.4Retained Earnings 9,520 9,994 11,527 14,719 16,987<br />
Total Assets 39,562 41,891 45,885 43,934 45,581<br />
(+)<br />
3.3 EBIT 2,433 2,642 4,604 7,270 5,588<br />
Total Assets 39,562 41,891 45,885 43,934 45,581<br />
(+)<br />
0.6 MV of <strong>Equity</strong> 27,041.9 38,194.5 46,544.4 42,207.4 42,273.8<br />
BV of Liabilities 31,936 32,716 33,615 30,610 28,516<br />
(+)<br />
1 Sales 27,609 32,632 40,161 46,307 49,124<br />
Total Assets 39,562 41,891 45,885 43,934 45,581<br />
2002 2003 2004 2005 2006<br />
Raw 0.0764 0.1025 0.1408 0.1761 0.174<br />
0.3369 0.334 0.3517 0.4486 0.5218<br />
0.2029 0.2081 0.3311 0.5223 0.4046<br />
0.5081 0.7005 0.8308 0.8273 0.8895<br />
0.6979 0.779 0.8753 1.008 1.0777<br />
Weighted 2002 2003 2004 2005 2006<br />
1.82 2.12 2.53 2.98 3.07<br />
Dow Chemical <strong>Analysis</strong> Page 115
Regression <strong>Analysis</strong><br />
3 Month<br />
SUMMARY OUTPUT<br />
72 month<br />
Regression Statistics<br />
Multiple R 0.522630544<br />
R Square 0.273142686<br />
Adjusted R Square 0.26275901<br />
St<strong>and</strong>ard Error 0.062363058<br />
Observations 72<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.10230415 0.10230415 26.30501 2.48628E-06<br />
Residual 70 0.272240566 0.00388915<br />
Total 71 0.374544716<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0%Upper 95.0%<br />
Intercept 0.00556246 0.007389837 0.7527176 0.454144 -0.009176104 0.020301 -0.0091761 0.02030102<br />
X Variable 1 1.091787102 0.212872095 5.12884088 2.49E-06 0.667227102 1.5163471 0.6672271 1.5163471<br />
SUMMARY OUTPUT<br />
60 Month<br />
Regression Statistics<br />
Multiple R 0.565553759<br />
R Square 0.319851054<br />
Adjusted R Square 0.308124348<br />
St<strong>and</strong>ard Error 0.057818637<br />
Observations 60<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.09118165 0.09118165 27.27544 2.49541E-06<br />
Residual 58 0.193893696 0.00334299<br />
Total 59 0.285075345<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0%Upper 95.0%<br />
Intercept 0.003122317 0.007750746 0.40284088 0.688546 -0.012392486 0.0186371 -0.0123925 0.01863712<br />
X Variable 1 1.500548991 0.287318972 5.22258931 2.5E-06 0.925417586 2.0756804 0.9254176 2.0756804<br />
SUMMARY OUTPUT<br />
48 Month<br />
Regression Statistics<br />
Multiple R 0.377625976<br />
R Square 0.142601378<br />
Adjusted R Square 0.123962277<br />
St<strong>and</strong>ard Error 0.051023884<br />
Observations 48<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.019918003 0.019918 7.650658 0.008143283<br />
Residual 46 0.119758089 0.00260344<br />
Total 47 0.139676092<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0%Upper 95.0%<br />
Intercept 0.002164357 0.00761353 0.28427777 0.777473 -0.013160883 0.0174896 -0.0131609 0.0174896<br />
X Variable 1 0.962856865 0.34810667 2.76598223 0.008143 0.262154492 1.6635592 0.2621545 1.66355924<br />
Dow Chemical <strong>Analysis</strong> Page 116
SUMMARY OUTPUT<br />
36 Month<br />
Regression Statistics<br />
Multiple R 0.303440599<br />
R Square 0.092076197<br />
Adjusted R Square 0.065372556<br />
St<strong>and</strong>ard Error 0.055256898<br />
Observations 36<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.010528097 0.0105281 3.448076 0.072006621<br />
Residual 34 0.103813043 0.00305332<br />
Total 35 0.11434114<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0%Upper 95.0%<br />
Intercept -0.00063504 0.009521801 -0.0666936 0.947216 -0.01998567 0.0187156 -0.0199857 0.01871558<br />
X Variable 1 0.801510538 0.431639114 1.85689969 0.072007 -0.075685675 1.6787068 -0.0756857 1.67870675<br />
SUMMARY OUTPUT<br />
24 Month<br />
Regression Statistics<br />
Multiple R 0.141919467<br />
R Square 0.020141135<br />
Adjusted R Square -0.0243979<br />
St<strong>and</strong>ard Error 0.043382824<br />
Observations 24<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.000851096 0.0008511 0.452213 0.508287888<br />
Residual 22 0.041405527 0.00188207<br />
Total 23 0.042256624<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0%Upper 95.0%<br />
Intercept 0.000302795 0.009332888 0.03244382 0.974411 -0.019052431 0.019658 -0.0190524 0.01965802<br />
X Variable 1 0.297271458 0.442060452 0.67246789 0.508288 -0.619505803 1.2140487 -0.6195058 1.21404872<br />
Dow Chemical <strong>Analysis</strong> Page 117
1 Year<br />
SUMMARY OUTPUT<br />
72 Month<br />
Regression Statistics<br />
Multiple R 0.52231823<br />
R Square 0.27281633<br />
Adjusted R Square 0.26242799<br />
St<strong>and</strong>ard Error 0.06237706<br />
Observations 72<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.102181915 0.102181915 26.2617877 2.52703E-06<br />
Residual 70 0.272362801 0.003890897<br />
Total 71 0.374544716<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.00582068 0.007386456 0.788021267 0.43334471 -0.008911138 0.02055251 -0.0089111 0.02055251<br />
X Variable 1 1.089495 0.212599921 5.124625612 2.527E-06 0.665477832 1.51351216 0.66547783 1.51351216<br />
SUMMARY OUTPUT<br />
60 Month<br />
Regression Statistics<br />
Multiple R 0.56544947<br />
R Square 0.31973311<br />
Adjusted R Square 0.30800437<br />
St<strong>and</strong>ard Error 0.05782365<br />
Observations 60<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.091148026 0.091148026 27.2606537 2.50841E-06<br />
Residual 58 0.19392732 0.003343574<br />
Total 59 0.285075345<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.00345008 0.007734848 0.446043594 0.65722651 -0.012032901 0.01893306 -0.0120329 0.01893306<br />
X Variable 1 1.49846148 0.286997062 5.221173593 2.5084E-06 0.92397445 2.07294851 0.92397445 2.07294851<br />
SUMMARY OUTPUT<br />
48 Month<br />
Regression Statistics<br />
Multiple R 0.3770192<br />
R Square 0.14214348<br />
Adjusted R Square 0.12349443<br />
St<strong>and</strong>ard Error 0.05103751<br />
Observations 48<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.019854046 0.019854046 7.62202062 0.0082546<br />
Residual 46 0.119822046 0.002604827<br />
Total 47 0.139676092<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.00239629 0.007595451 0.315489574 0.75381687 -0.012892564 0.01768513 -0.0128926 0.01768513<br />
X Variable 1 0.96020364 0.347798967 2.760800721 0.0082546 0.26012064 1.66028664 0.26012064 1.66028664<br />
Dow Chemical <strong>Analysis</strong> Page 118
SUMMARY OUTPUT<br />
36 Month<br />
Regression Statistics<br />
Multiple R 0.30403661<br />
R Square 0.09243826<br />
Adjusted R Square 0.06574527<br />
St<strong>and</strong>ard Error 0.05524588<br />
Observations 36<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.010569496 0.010569496 3.46301593 0.071421637<br />
Residual 34 0.103771644 0.003052107<br />
Total 35 0.11434114<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept -0.0005036 0.009501034 -0.05300321 0.95803956 -0.019812009 0.01880484 -0.019812 0.01880484<br />
X Variable 1 0.80227758 0.431119246 1.860918034 0.07142164 -0.073862136 1.67841729 -0.0738621 1.67841729<br />
SUMMARY OUTPUT<br />
24 Month<br />
Regression Statistics<br />
Multiple R 0.14407725<br />
R Square 0.02075825<br />
Adjusted R Square -0.0237527<br />
St<strong>and</strong>ard Error 0.04336916<br />
Observations 24<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.000877174 0.000877174 0.46636243 0.501794128<br />
Residual 22 0.04137945 0.001880884<br />
Total 23 0.042256624<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.00029837 0.009318134 0.032020152 0.97474471 -0.019026259 0.019623 -0.0190263 0.019623<br />
X Variable 1 0.30154821 0.441565345 0.682907333 0.50179413 -0.614202261 1.21729869 -0.6142023 1.21729869<br />
Dow Chemical <strong>Analysis</strong> Page 119
3 Year<br />
SUMMARY OUTPUT<br />
72 Month<br />
Regression Statistics<br />
Multiple R 0.521091747<br />
R Square 0.271536609<br />
Adjusted R Square 0.261129989<br />
St<strong>and</strong>ard Error 0.062431919<br />
Observations 72<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.101702602 0.101703 26.092681 2.693E-06<br />
Residual 70 0.272842114 0.003898<br />
Total 71 0.374544716<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.006308106 0.007384397 0.854248 0.3958817 -0.0084196 0.0210358 -0.00841961 0.02103582<br />
X Variable 1 1.084063661 0.21222446 5.1081 2.693E-06 0.6607953 1.507332 0.66079533 1.50733199<br />
SUMMARY OUTPUT<br />
60 Month<br />
Regression Statistics<br />
Multiple R 0.564132568<br />
R Square 0.318245554<br />
Adjusted R Square 0.306491167<br />
St<strong>and</strong>ard Error 0.057886837<br />
Observations 60<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.090723961 0.090724 27.074619 2.678E-06<br />
Residual 58 0.194351384 0.003351<br />
Total 59 0.285075345<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.003956358 0.00771958 0.51251 0.6102408 -0.0114961 0.0194088 -0.01149606 0.01940878<br />
X Variable 1 1.494857376 0.287288723 5.203328 2.678E-06 0.9197865 2.0699282 0.91978652 2.06992823<br />
SUMMARY OUTPUT<br />
48 Month<br />
Regression Statistics<br />
Multiple R 0.3752868<br />
R Square 0.140840182<br />
Adjusted R Square 0.122162795<br />
St<strong>and</strong>ard Error 0.051076261<br />
Observations 48<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.019672006 0.019672 7.540679 0.0085797<br />
Residual 46 0.120004086 0.002609<br />
Total 47 0.139676092<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.002654832 0.007580819 0.350204 0.7277843 -0.0126046 0.0179142 -0.01260456 0.01791423<br />
X Variable 1 0.954757536 0.347686532 2.74603 0.0085797 0.2549009 1.6546142 0.25490086 1.65461422<br />
Dow Chemical <strong>Analysis</strong> Page 120
SUMMARY OUTPUT<br />
36 Month<br />
Regression Statistics<br />
Multiple R 0.304487347<br />
R Square 0.092712545<br />
Adjusted R Square 0.066027619<br />
St<strong>and</strong>ard Error 0.05523753<br />
Observations 36<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.010600858 0.010601 3.4743416 0.0709817<br />
Residual 34 0.103740282 0.003051<br />
Total 35 0.11434114<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept -0.0004737 0.009494807 -0.04989 0.960502 -0.0197695 0.0188221 -0.01976947 0.01882207<br />
X Variable 1 0.80234831 0.430453939 1.863959 0.0709817 -0.0724393 1.677136 -0.07243934 1.67713596<br />
SUMMARY OUTPUT<br />
24 Month<br />
Regression Statistics<br />
Multiple R 0.146276129<br />
R Square 0.021396706<br />
Adjusted R Square -0.02308526<br />
St<strong>and</strong>ard Error 0.04335502<br />
Observations 24<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.000904153 0.000904 0.4810198 0.4952189<br />
Residual 22 0.041352471 0.00188<br />
Total 23 0.042256624<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.000234007 0.009330535 0.02508 0.9802175 -0.0191163 0.0195844 -0.01911634 0.01958435<br />
X Variable 1 0.305600924 0.440629126 0.693556 0.4952189 -0.6082079 1.2194098 -0.60820795 1.2194098<br />
Dow Chemical <strong>Analysis</strong> Page 121
5 Year<br />
SUMMARY OUTPUT<br />
72 Month<br />
Regression Statistics<br />
Multiple R 0.5200989<br />
R Square 0.2705028<br />
Adjusted R Square 0.2600814<br />
St<strong>and</strong>ard Error 0.0624762<br />
Observations 72<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.101315402 0.10132 25.95651 2.8352E-06<br />
Residual 70 0.273229314 0.0039<br />
Total 71 0.374544716<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.006695 0.007383658 0.90673 0.367661 -0.0080313 0.0214212 -0.008031 0.021421215<br />
X Variable 1 1.0816882 0.212314179 5.09475 2.84E-06 0.65824097 1.5051355 0.658241 1.505135511<br />
SUMMARY OUTPUT<br />
60 Month<br />
Regression Statistics<br />
Multiple R 0.5625978<br />
R Square 0.3165163<br />
Adjusted R Square 0.3047321<br />
St<strong>and</strong>ard Error 0.0579602<br />
Observations 60<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.090230998 0.09023 26.85938 2.8894E-06<br />
Residual 58 0.194844347 0.00336<br />
Total 59 0.285075345<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.004423 0.007708555 0.57378 0.568332 -0.0110073 0.0198534 -0.011007 0.019853395<br />
X Variable 1 1.4923465 0.287953058 5.1826 2.89E-06 0.91594582 2.0687472 0.9159458 2.068747159<br />
SUMMARY OUTPUT<br />
48 Month<br />
Regression Statistics<br />
Multiple R 0.373504<br />
R Square 0.1395052<br />
Adjusted R Square 0.1207988<br />
St<strong>and</strong>ard Error 0.0511159<br />
Observations 48<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.019485547 0.01949 7.457618 0.00892574<br />
Residual 46 0.120190545 0.00261<br />
Total 47 0.139676092<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.0028711 0.007570536 0.37924 0.706252 -0.0123676 0.0181098 -0.012368 0.018109776<br />
X Variable 1 0.950284 0.347979257 2.73086 0.008926 0.2498381 1.6507299 0.2498381 1.650729909<br />
Dow Chemical <strong>Analysis</strong> Page 122
SUMMARY OUTPUT<br />
36 Month<br />
Regression Statistics<br />
Multiple R 0.3038443<br />
R Square 0.0923214<br />
Adjusted R Square 0.0656249<br />
St<strong>and</strong>ard Error 0.0552494<br />
Observations 36<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.01055613 0.01056 3.458191 0.07160997<br />
Residual 34 0.10378501 0.00305<br />
Total 35 0.11434114<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept -0.000416 0.009490546 -0.04387 0.965265 -0.0197035 0.0188708 -0.019703 0.018870758<br />
X Variable 1 0.8008947 0.430676224 1.85962 0.07161 -0.0743447 1.6761341 -0.074345 1.676134068<br />
SUMMARY OUTPUT<br />
24 Month<br />
Regression Statistics<br />
Multiple R 0.0086847<br />
R Square 7.542E-05<br />
Adjusted R Square -0.041588<br />
St<strong>and</strong>ard Error 0.0477816<br />
Observations 26<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 4.13308E-06 4.1E-06 0.00181 0.96641409<br />
Residual 24 0.054793994 0.00228<br />
Total 25 0.054798127<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.0048132 0.009720153 0.49518 0.62498 -0.0152482 0.0248746 -0.015248 0.024874588<br />
X Variable 1 0.0199105 0.467956588 0.04255 0.966414 -0.9459044 0.9857254 -0.945904 0.985725402<br />
Dow Chemical <strong>Analysis</strong> Page 123
7 Year<br />
SUMMARY OUTPUT<br />
72 Month<br />
Regression Statistics<br />
Multiple R 0.5193968<br />
R Square 0.269773<br />
Adjusted R Square 0.2593412<br />
St<strong>and</strong>ard Error 0.0625074<br />
Observations 72<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.101042058 0.101042 25.8606 2.93977E-06<br />
Residual 70 0.273502658 0.003907<br />
Total 71 0.374544716<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.0069602 0.007383676 0.942643 0.349105 -0.007766104 0.0216864 -0.0077661 0.02168645<br />
X Variable 1 1.0800329 0.212381966 5.085332 2.94E-06 0.656450399 1.5036153 0.656450399 1.50361534<br />
SUMMARY OUTPUT<br />
60 Month<br />
Regression Statistics<br />
Multiple R 0.5612943<br />
R Square 0.3150513<br />
Adjusted R Square 0.3032418<br />
St<strong>and</strong>ard Error 0.0580223<br />
Observations 60<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.089813345 0.089813 26.67787 3.08102E-06<br />
Residual 58 0.195262 0.003367<br />
Total 59 0.285075345<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.0047599 0.007702401 0.617976 0.53901 -0.010658133 0.0201779 -0.01065813 0.02017793<br />
X Variable 1 1.4897076 0.288420056 5.165062 3.08E-06 0.912372103 2.067043 0.912372103 2.06704303<br />
SUMMARY OUTPUT<br />
48 Month<br />
Regression Statistics<br />
Multiple R 0.3722344<br />
R Square 0.1385584<br />
Adjusted R Square 0.1198314<br />
St<strong>and</strong>ard Error 0.051144<br />
Observations 48<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.019353298 0.019353 7.398862 0.00917947<br />
Residual 46 0.120322794 0.002616<br />
Total 47 0.139676092<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.0030284 0.007563207 0.40041 0.690708 -0.012195564 0.0182523 -0.01219556 0.01825233<br />
X Variable 1 0.9471257 0.348197103 2.720085 0.009179 0.246241271 1.6480101 0.246241271 1.64801008<br />
Dow Chemical <strong>Analysis</strong> Page 124
SUMMARY OUTPUT<br />
36 Month<br />
Regression Statistics<br />
Multiple R 0.303242<br />
R Square 0.0919557<br />
Adjusted R Square 0.0652485<br />
St<strong>and</strong>ard Error 0.0552606<br />
Observations 36<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.010514323 0.010514 3.443108 0.07220234<br />
Residual 34 0.103826817 0.003054<br />
Total 35 0.11434114<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept -0.0003568 0.009485825 -0.03761 0.970219 -0.019634279 0.0189208 -0.01963428 0.01892075<br />
X Variable 1 0.7995779 0.430908874 1.855562 0.072202 -0.076134271 1.6752901 -0.07613427 1.67529011<br />
SUMMARY OUTPUT<br />
24 Month<br />
Regression Statistics<br />
Multiple R 0.1463393<br />
R Square 0.0214152<br />
Adjusted R Square -0.0230659<br />
St<strong>and</strong>ard Error 0.0433546<br />
Observations 24<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.000904933 0.000905 0.481444 0.495030778<br />
Residual 22 0.041351691 0.00188<br />
Total 23 0.042256624<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.0002383 0.009328079 0.025548 0.979848 -0.019106936 0.0195836 -0.01910694 0.01958357<br />
X Variable 1 0.3058135 0.440741187 0.693862 0.495031 -0.608227795 1.2198548 -0.6082278 1.21985475<br />
Dow Chemical <strong>Analysis</strong> Page 125
10 Year<br />
SUMMARY OUTPUT<br />
72 Month<br />
Regression Statistics<br />
Multiple R 0.5188987<br />
R Square 0.2692558<br />
Adjusted R Square 0.2588166<br />
St<strong>and</strong>ard Error 0.0625296<br />
Observations 72<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.100848348 0.100848 25.79276 3.01617E-06<br />
Residual 70 0.273696369 0.00391<br />
Total 71 0.374544716<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.0071862 0.007383426 0.973282 0.333765 -0.00753962 0.0219119 -0.0075396 0.02191194<br />
X Variable 1 1.0792325 0.212503519 5.078657 3.02E-06 0.655407618 1.5030574 0.65540762 1.50305742<br />
SUMMARY OUTPUT<br />
60 Month<br />
Regression Statistics<br />
Multiple R 0.5604099<br />
R Square 0.3140593<br />
Adjusted R Square 0.3022327<br />
St<strong>and</strong>ard Error 0.0580643<br />
Observations 60<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.089530553 0.089531 26.55541 3.21769E-06<br />
Residual 58 0.195544793 0.003371<br />
Total 59 0.285075345<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.0050739 0.007694653 0.659407 0.512244 -0.01032861 0.0204764 -0.0103286 0.02047643<br />
X Variable 1 1.488239 0.288799337 5.153194 3.22E-06 0.910144365 2.0663337 0.91014436 2.06633372<br />
SUMMARY OUTPUT<br />
48 Month<br />
Regression Statistics<br />
Multiple R 0.3711964<br />
R Square 0.1377868<br />
Adjusted R Square 0.119043<br />
St<strong>and</strong>ard Error 0.0511669<br />
Observations 48<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.019245519 0.019246 7.351072 0.009391495<br />
Residual 46 0.120430573 0.002618<br />
Total 47 0.139676092<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.0031905 0.007554773 0.422322 0.674757 -0.01201642 0.0183975 -0.0120164 0.01839752<br />
X Variable 1 0.9445255 0.348368082 2.711286 0.009391 0.243296976 1.6457541 0.24329698 1.64575411<br />
Dow Chemical <strong>Analysis</strong> Page 126
SUMMARY OUTPUT<br />
36 Month<br />
Regression Statistics<br />
Multiple R 0.3027736<br />
R Square 0.0916718<br />
Adjusted R Square 0.0649563<br />
St<strong>and</strong>ard Error 0.0552692<br />
Observations 36<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.010481862 0.010482 3.431406 0.072665753<br />
Residual 34 0.103859278 0.003055<br />
Total 35 0.11434114<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0%Upper 95.0%<br />
Intercept -0.0002829 0.009478665 -0.02984 0.976368 -0.01954582 0.0189801 -0.0195458 0.01898011<br />
X Variable 1 0.7986022 0.431116346 1.852405 0.072666 -0.0775316 1.674736 -0.0775316 1.67473604<br />
SUMMARY OUTPUT<br />
24 Month<br />
Regression Statistics<br />
Multiple R 0.1463834<br />
R Square 0.0214281<br />
Adjusted R Square -0.0230525<br />
St<strong>and</strong>ard Error 0.0433543<br />
Observations 24<br />
ANOVA<br />
df SS MS F Significance F<br />
Regression 1 0.000905479 0.000905 0.481741 0.494899387<br />
Residual 22 0.041351145 0.00188<br />
Total 23 0.042256624<br />
Coefficients St<strong>and</strong>ard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%<br />
Intercept 0.0002507 0.009322103 0.026895 0.978786 -0.01908214 0.0195836 -0.0190821 0.01958358<br />
X Variable 1 0.3060237 0.440908438 0.694075 0.494899 -0.6083644 1.2204119 -0.6083644 1.22041186<br />
Dow Chemical <strong>Analysis</strong> Page 127
References<br />
1. Yahoo Finance: http://finance.yahoo.com<br />
2. MSN Money: http://moneycentral.msn.com<br />
3. Dow Chemical Website: www.Dow.com<br />
4. Securities <strong>and</strong> Exchange Commission Website: http://www.sec.gov<br />
5. Wikipedia: www.wikipedia.org<br />
6. Palepu <strong>and</strong> Healy, Business <strong>Analysis</strong> <strong>and</strong> <strong>Valuation</strong>, Ohio: Thomson<br />
Southwestern, 4 th Edition, 2008.<br />
7. Wall Street Journal Online: www.WSJ.com<br />
8. Chemical Processing: www.chemicalprocessing.com/bluebook.pdf<br />
9. John Bolte, BDP Chief Operating Officer: www.BDPoint.com<br />
10. In-Class Ratio’s H<strong>and</strong>out (Alamo Distributing Co.)<br />
11. InvestoPedia: www.investopedia.com<br />
12. Dow Chemical 10-K (2002,2003,2004,2005,2006)<br />
13. Huntsman Chemical 10-K (2002,2003,2004,2005,2006)<br />
14. DuPont 10-K (2002,2003,2004,2005,2006)<br />
15. Exxon Mobil 10-K (2002,2003,2004,2005,2006)<br />
16. Lyondell Chemical Co. 10-K (2002,2003,2004,2005,2006)<br />
Dow Chemical <strong>Analysis</strong> Page 128