It has been a rough year for the commodity chemical giant Dow(NYSE: DOW). The stock is down about 23% year to date at the time of this writing -- and 13% in just the past month. In November, Dow was kicked out of the 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 sell-off in Dow's shares and why it may be a high-yield dividend stock worth buying now.
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Challenges are building up for Dow
Dow operates three segments: packaging and specialty plastics, industrial intermediates and infrastructure, and performance materials and coatings. Similar to oil and gas companies, gold miners, or any other businesses that deal in commodities, it can't control commodity prices, so it works to manage expenses and produce its products for the lowest cost possible.
Unfortunately, there is a global slowdown for commodity and specialty chemical companies, petrochemical companies, and refiners. As you can see in the following chart, major refining companies have given up gains made earlier this year, and other chemical companies have also sold off.
The three biggest factors driving the slowdown are weakening demand in Europe and China, higher competition out of China, and high interest rates. On its third-quarter 2024 earnings call, Dow said that its North American business was doing quite well; rather, it is Europe that's the main problem. CEO James Fitterling said the following on the call:
Current market dynamics are impacting Europe, including continued soft demand, coupled with a persistent lack of long-term regulatory policy. This ongoing absence of clear, consistent, and competitive regulatory policy in Europe has resulted in many challenges for our industry. These challenges have been acknowledged in statements by [European Union] government leaders, top economists, and our peers. And while a demand recovery in other parts of the world was expected to provide swift upside across the markets we serve, this alone is unlikely to be enough in Europe.
Since Dow is a global business, it is vulnerable to slowdowns in economies outside the U.S. As you can see in the following chart, the global slowdown has taken a sledgehammer to Dow's margins, which are at their lowest level since it was spun off from DowDuPont as an independent company in 2019.
It's hard to know for sure, but I would guess that part of the recent plunge in chemical companies over the last month is due to fears that the Federal Reserve may hold 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 rates can affect global manufacturing and production from companies that use a lot of the products Dow makes, like automakers. Many in the auto industry are experiencing a major slowdown due to weak demand, higher costs, and higher interest rates that make it harder for customers to finance a new car. Higher interest rates also mean that debt is more expensive, which affects capital-intensive companies like Dow and can increase interest expenses.
Dow's net long-term debt has increased, but its financial debt-to-equity and debt-to-capital ratios remain decent. It still has a credit rating of BBB from S&P Global, which is on the low end of the investment-grade range. According to S&P, a BBB rating means that the company has "adequate capacity to meet financial commitments, but [is] more subject to adverse economic conditions." That description nails the exact state Dow is in.
Why the stock is worth considering
With so many challenges, investors may wonder why Dow is worth a look. Admittedly, the business doesn't appear great now. But it has been through plenty of cycles and has what it takes to endure this one.
Because timing the cycle is a fool's errand, you should only consider buying Dow if you have at least a three- to five-year investment time horizon. Over time, its margins and earnings could improve, and then it could use excess cash to pay down debt.
But Dow has kept its dividend the same since the spinoff from DowDuPont and will probably keep it the same even as the business improves. Since the yield is already so high, simply maintaining the dividend would be highly appealing to income investors.
If you bought the stock at the current price of around $42 a 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 yield on cost of 33.3%. That's a compelling incentive to buy the stock even if the industry takes awhile to turn things around.
Dow hasn't made any drastic blunders. It's just an industry-leading business in a downturn. Buying leading companies on sale that are falling for self-inflicted reasons is one thing. However, it can be an excellent buying opportunity when the stock is selling off due to industrywide factors.
Add it all up, and Dow stands out as a high-yield stock worth a closer look for patient investors who can handle volatility.
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Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends S&P Global. The Motley Fool recommends Sherwin-Williams. The Motley Fool has a disclosure policy.
