Dow Inc. (NYSE:DOW) is a diversified global chemicals company focusing on several critical business segments. In addition, it’s exposed to broad consumer and industrial tailwinds, including automotive applications. As such, assessing the operating performance of Dow could be telling for investors looking for insights into the underlying health of the global economy.
However, it’s also important to understand that the market is a forward-discounting mechanism. Hence, while Dow reported a mixed Q3 release in October, Wall Street analysts panicked, as they marked down Dow’s forward estimates significantly.
Despite the indifferent results and Wall Street pessimism, DOW still formed its bottom in September/October (pre-Q3 earnings) and has continued to march upward.
As such, DOW has significantly outperformed the S&P 500 (SPX) (SPY), to the surprise of the bears. Moreover, relative to its all-time total return CAGR of 10%, DOW recovered nearly 40% from its recent lows to its highs last week.
Savvy investors who picked its bottom likely anticipated a COVID-zero pivot by the Chinese government, even as it looked bleak in October after the 20th CPC National Congress concluded.
Despite that, Dow management remained optimistic in its earnings call, suggesting that investors should look ahead. Hence, high-conviction investors who concurred with management’s optimistic outlook have been well-rewarded, as China has reopened fully, reintegrating with the world.
Furthermore, the IMF appeared less pessimistic about the global economic outlook, suggesting that the US economy could dodge a debilitating recession. While the major US banks formed their consensus around a “mild recession” in their recent Q4 earnings commentaries, we believe it has already been reflected in DOW’s September/October bottom.
Moreover, Europe could also avoid a hard landing, as it managed to avert a significant energy crisis, given warmer winter weather, demand rationing, and robust storage capacity. As such, it demonstrated the resolve of the EU policymakers to nurse the Eurozone economy back to health, even as it battles elevated inflation rates.
Hence, the macroeconomic outlook has not deteriorated significantly, lifting the gloom over the pessimistic outlook of fund managers in 2023.
Accordingly, Wall Street analysts have also revised their estimates upward to reflect a more constructive macro outlook. However, they still project for Dow to post a revenue decline of 9.3% in FY23, with significant operating deleverage as its adjusted EBITDA is estimated to fall by nearly 24%.
Hence, we assessed the bar remains relatively low for Dow to cross, as it’s scheduled to report its Q4 earnings release on January 26. Investors should continue to parse for clues from management on its China outlook.
We gleaned that “China” was mentioned more than 20 times in its Q3 commentary between analysts and management. As such, investors will likely parse the recovery momentum in China’s industrial, housing, and consumer activity and whether the company’s outlook could be better than expected.
Given DOW’s rapid recovery from its September/October lows, we assessed that market operators have likely anticipated an improved 2023 outlook from management.
As such, DOW’s NTM EBITDA multiple of 8.1x has also normalized above its average and its peers’ median of 7.2x. Hence, the dislocation that proffered astute investors a fantastic opportunity to add exposure is likely over for now.
Still, investors are reminded that the Fed could still be far from done with its rate hikes. Given the market’s expectations of an earlier-than-expected easing, Powell & his FOMC could provide a potential negative surprise that patient investors could capitalize on subsequently.
Hence, we move to the sidelines from here, as DOW’s valuations seem more well-balanced now.
Rating: Hold (Revise from Buy).