Dow Chemical faces pressure as coffers swell

NEW YORK (Reuters) - Wall Street pressure is growing on Dow Chemical Co. (DOW.N) to reveal its plans for its growing cash pile, as investors hope that a dividend hike or share buyback could drive its shares above its current trading range.

Dow held roughly $2.5 billion in cash as of March 31 and some analysts say its coffers will swell as it generates between $7 billion and $8 billion of excess cash flow during the next two years.

But shares of the largest U.S. chemical maker have been stuck near $45 for the last three months after a 15 percent run-up in the first quarter.

The early 2007 move was fueled mainly by speculation that private equity investors were targeting Dow for a takeover. The shares have stagnated after Dow fired two executives it alleged were holding unauthorized talks to sell the company.

"I think the reason the stock really hasn't moved a ton is because people are just uncertain what they are going to do with the cash," said Tom Uutala, an analyst with Victory Capital management, which owns over 1 million Dow shares.

Dow has said that its policy remains to balance its use of cash between investing for growth and remunerating shareholders. It is buying back $2 billion of its own shares, and earlier this year it increased its dividend by 12 percent.

Analysts and investors are still hungry for more. Uutala argues that Dow's management must prove to the market it is confident about its strategy, either by raising its dividend or by announcing a large share buyback.

This month, a few top-tier brokerage firms have raised their earnings estimates or price targets for Dow. Lehman Brothers also raised its rating on Dow's shares, but the company's share price has barely budged.

The Standard & Poor's Chemicals Index, of which Dow is a component, boasts an average price-to-earnings ratio of about 19.5 times forward estimates. In comparison, Dow trades at 11.5 times expected 2007 earnings and also lags peer DuPont Co. (DD.N), whose shares trade at 16.2 times forward estimates.

ANALYSTS' UPSIDE

JPMorgan analyst Jeffrey Zekauskas, in a note to investors, said that the market undervalues Dow Chemical by $4.40 to $6.90 a share, or 10 to 15 percent of its current share price. In market capitalization terms, this means that the company is undervalued by $4.3 billion to $6.7 billion.

"We believe the stock represents reasonable value at the current share price due to a high and sustainable level of free cash flow," said Zekauskas.

Similarly, HSBC analyst Hassan Ahmed says that Dow shares have significant upside and argues Dow's shares could rise 20 percent. Ahmed has a 'buy' rating and a $55 price target on the shares.

Midland, Michigan-based Dow has opted to invest in and grow its specialty businesses, while adopting an 'asset light' joint venture strategy to grow its commodity chemicals businesses.

Commodity chemicals like ethylene are manufactured in bulk and typically have much smaller profit margins than specialty chemicals that are produced in smaller quantities.

Moreover, commodity chemical makers use natural gas and crude oil as their main raw materials, which puts North American commodity chemical makers at a cost disadvantage to those based in the energy-rich Middle East.

Dow has countered this threat by entering into joint ventures with oil and natural gas producers in cost-advantaged regions like the Middle East and North Africa.

It recently formed a joint venture with the National Oil Corp. of Libya to operate and expand the Ras Lanuf petrochemical complex and last month it announced a joint venture with Saudi Aramco to build a petrochemical plant at Ras Tanura.

However, the company has yet to announce any major deals or expansions on the specialties side of its business and patience on Wall Street is running thin.

"At the end of the day they need to do something about their cash. They have a ton of cash, they are going to generate a ton of cash, but till we know what they are going to do with it, I think people are generally going to stay on the sidelines," said Uutala.

"Until we see management commit to saying, 'we have faith in what we think we can do,'" said Uutala, "there is no reason investors should go out on a limb here."