It has been a difficult year for the raw materials chemicals giant Dow(NYSE: DOW). The stock, at the time of writing, is down about 23% this year – and down 13% in the past month alone. In November, Dow was evicted Dow Jones Industrial Average and replaced by Sherwin Williams. The downward moves have pushed the chemical maker’s dividend yield up to 6.7%.
Here’s what’s driving the Dow stock sell-off and why it could be a high-yield dividend stock worth buying now.
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Image source: Getty Images.
Dow operates in three segments: packaging and specialty plastics, industrial intermediates and infrastructure, and performance materials and coatings. Like oil and gas companies, gold miners and other companies that trade in commodities, it cannot control commodity prices, so it works to control expenses and produce its products at the lowest possible cost.
Unfortunately, there is a global slowdown in growth for raw material and specialty chemical companies, petrochemical companies and refineries. As you can see in the following chart, major refiners have given up the gains they made earlier this year, and other chemical companies have also been sold.
MPC data by YCharts.
The three biggest factors driving the slowdown are weaker demand in Europe and China, increased competition from China and high interest rates. On its third-quarter 2024 earnings call, Dow said its North American operations were doing quite well; rather, it is Europe that is the biggest problem. CEO James Fitterling said the following during the call:
Current market dynamics are impacting Europe, including continued weak demand, coupled with a continued lack of longer-term regulatory policies. This continued lack of a clear, consistent and competitive regulatory policy in Europe has led to many challenges for our industry. These challenges have been recognized in statements from [European Union] government leaders, top economists and our colleagues. And while a recovery in demand in other parts of the world was expected to deliver a rapid upward movement for the markets we serve, it is unlikely that this will be sufficient in Europe.
Because Dow is a global company, it is vulnerable to slowdowns in economies outside the US. As you can see in the following chart, the global slowdown has taken a sledgehammer to Dow’s margins, which are at their lowest levels since the spin-off from DowDuPont. as an independent company in 2019.
DOW operating margin (TTM) data by YCharts; TTM = after 12 months.
It’s hard to know for sure, but I suspect that some of the recent decline in chemical companies over the past month is due to fears that the Federal Reserve will keep interest rates higher. Last week, Fed Chairman Jerome Powell commented on the surprisingly strong economy and higher-than-expected inflation, which could slow the pace of rate cuts.
Higher tariffs could affect global production and production by companies that use many of the products Dow makes, such as automakers. Many in the auto industry are experiencing a major slowdown due to weak demand, higher costs and higher interest rates making it more difficult for customers to finance a new car. Higher interest rates also mean that debt becomes more expensive, which affects capital-intensive companies like Dow and can increase interest costs.
Dow’s net long-term debt has increased, but financial debt-to-equity and debt-to-capital ratios remain decent. It still has a credit rating of BBB S&P Globalwhich is at the lower end of the investment-grade range. According to S&P, a BBB rating means that the company has “sufficient capacity to meet its financial obligations, but [is] more subject to adverse economic conditions.” This description precisely reflects the situation in which Dow finds itself.
With so many challenges, investors may be wondering why Dow is worth a look. Admittedly, the company doesn’t look great right now. But it has been through many cycles and has what it takes to weather them.
Since timing the cycle is a folly, you should only consider buying Dow Jones if you have an investment horizon of at least three to five years. Over time, margins and profits could improve, and then it could use excess cash to pay down debt.
But Dow has kept its dividend the same since the DowDuPont spinoff and will likely keep it the same even as business improves. Because the yield is already so high, simply maintaining the dividend would be very attractive to income investors.
If you bought the stock at the current price of about $42 per share and held it for five years and the dividend stayed the same at $0.70 per share per quarter, you would end the five years with $14 per share in dividends for a return on costs of 33.3%. That’s a compelling incentive to buy the stock, even if it takes a while for the sector to turn things around.
Dow has not made any drastic blunders. It’s just a leading company in a recession. Buying leading companies that are on sale and going under for self-inflicted reasons is one thing. However, it can be an excellent buying opportunity when stocks are selling off due to industry-wide factors.
Put it all together, and Dow stands out as a high-yield stock worth watching for patient investors who can handle volatility.
Consider the following before buying shares of Dow:
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Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool holds positions in and recommends S&P Global. The Motley Fool recommends Sherwin-Williams. The Motley Fool has a disclosure policy.
A drop of 23% with a return of 6.7%. Is this high-dividend stock too cheap to ignore and worth buying in December? was originally published by The Motley Fool
