DOW Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
October 20, 2021

There are 17 speakers on the call.

Operator

Welcome to Dow's Third Quarter 2021 Earnings Call. Also, today's call is being recorded. At this time, I would like to turn the call over to Mr. Pankaj Gupta. Please go ahead, sir.

Speaker 1

Good morning. Thank you for joining Dow's 3rd quarter earnings call. This call is available via webcast and we have prepared slides to supplement our comments today. They are posted on the Investor Relations section of Dow's website and through the link to our webcast. I am Pankaj Gupta, Dow Investor Relations' Vice President.

Speaker 1

And joining me on the call today are Jim Fitterling, Dow's Chairman and Chief Executive Officer and Howard Underleiter, President and Chief Financial Officer. Please read the forward looking statement disclaimer contained in the earnings news release and slides. During our call, we will make forward looking statements regarding our expectations or predictions about the future. Because these statements are based on current assumptions and factors that involve risks and uncertainties, Our actual performance and results may differ materially from our forward looking statements. Dow's Forms 10Q and 10 ks include detailed discussions of principal risks and uncertainties, which may cause such differences.

Speaker 1

Unless otherwise specified, all financials, where applicable, exclude significant items. We will also refer to non GAAP measures. A reconciliation of the most directly comparable GAAP financial measure and other associated disclosures is contained in the Dow earnings release, in the slides that supplement our comments today and on the Dow website. On Slide 2, you will see our agenda for the call. Jim will begin by reviewing our Q3 highlights and operating segment performance, Howard will share our modeling guidance and outlook, and then Jim will recap our strategy for disciplined value growth that we outlined at our Investor Day earlier this month, and why Dow continues to be a compelling investment opportunity.

Speaker 1

Following that, we will take your questions. Now let me turn the call to Jim.

Speaker 2

Thank you, Pankaj, and thanks everyone for joining us today. Starting on Slide 3, in the Q3, Dow achieved Top and bottom line growth both year over year and sequentially. I'm incredibly proud of the Dow team for delivering these results and doing so safely Despite industry supply disruptions from hurricanes on the U. S. Gulf Coast, our proactive storm preparations enabled us to maintain the safety of our team and community and recover quickly.

Speaker 2

We delivered a 53% sales increase year over year with double digit gains in every segment, business and region. We also recorded a 7% increase in sales over the prior quarter. We captured strong price momentum driven by tight supply demand balances across our key value chains, and we achieved volume growth of 2% both year over year and sequentially, supported by continued strong end to market demand despite supply and logistics constraints. We increased operating EBIT by more than $2,100,000,000 year over year with improvements in all segments and businesses and $58,000,000 higher sequentially. Key contributors included year over year margin expansion of 11 70 basis points, driven by price momentum and demand growth and increased equity earnings up $189,000,000 And our balanced, disciplined capital allocation enabled us to deliver cash flow from operations of $2,700,000,000 up $958,000,000 year over year driven by margin expansion from price momentum and key value chain.

Speaker 2

We returned a total of $918,000,000 to shareholders through our industry leading dividend of $518,000,000 Plus $400,000,000 in share repurchases and we also reduced gross debt by more than $1,100,000,000 in the quarter. Our proactive liability management actions to tender existing notes have resulted in no long term debt maturities due until 2026, And we've reduced annual interest expense by more than $60,000,000 Overall, Dow continues to deliver on its priorities We see further strength ahead as we benefit from a favorable macro backdrop and execute our disciplined strategy to decarbonize our footprint and grow earnings, driving significant value for all stakeholders. Moving to our segment performance on Slide 4. In the Packaging and Specialty Plastics segment, operating EBIT was $2,000,000,000 compared to $647,000,000 in the year ago period. Sequentially, operating EBIT was down $60,000,000 Price gains in both businesses and in all regions led to margin improvement in the core business and increased equity earnings.

Speaker 2

On a sequential basis, Operating EBIT margins declined by 300 basis points on higher feedstock and energy costs. The Packaging and Specialty Plastics business reported a net sales increase year over year led by local price gains in industrial and consumer packaging and flexible food and beverage packaging applications. Volumes declined year over year due to lower polyethylene supply as a result of planned maintenance turnarounds and weather related outages in the quarter. Compared to the prior quarter, The business delivered price and volume gains on strong demand in industrial and consumer packaging applications, which were partly offset by hurricane related outages. Moving to the Industrial Intermediates and Infrastructure segment, Operating EBIT was $713,000,000 up $609,000,000 year over year, primarily due to continued tight supply and demand in both Businesses.

Speaker 2

Sequentially, operating EBIT was up $65,000,000 and operating EBIT margins expanded by 50 basis points on volume and price gains in both businesses. The polyurethanes and construction chemicals business increased net sales compared to the year ago period with price gains in all regions on tight supply demand balances. Volume declines year over year, primarily reflect Sequentially, the business delivered sales growth due to increased local price and volume from additional supply availability to meet resilient demand. The Industrial Solutions business delivered a net sales improvement compared to the year ago period with local price gains in all regions. Volume increased year over year on strong demand for materials in Industrial Manufacturing and Energy Applications.

Speaker 2

Net sales also increased sequentially driven by volume growth, primarily in coatings and industrial applications from increased supply and local price gains in all regions. And finally, the Performance Materials and Coatings segment Reported operating EBIT of $284,000,000 up $209,000,000 versus the same quarter last year as margins increased 7 50 basis points due to strong price momentum and robust demand recovery for silicones and industrial coatings offerings. Sequentially, operating EBIT was up $59,000,000 on price gains, leading to margin expansion of 210 basis points. The Consumer Solutions business achieved higher net sales year over year with price gains in all regions. Volume increased over the prior year on stronger consumer demand for personal care, mobility and electronics offerings.

Speaker 2

Sequentially, sales were down as price increases in all regions were more than offset by volume declines as a result of planned maintenance and third party supply and logistics constraints. The coatings and performance monitors business Delivered increased net sales year over year as higher raw material costs and tight supply demand balances led to price gains in all regions. Volumes were down year over year as demand recovery for industrial coatings was more than offset by weather related outages and 3rd party supply and logistics constraints. Sequentially, the business delivered local price gains in all regions, supported by increased volume due to continued strong demand for acrylic monomers and architectural coatings and increased supply availability. Now let me turn it over to Howard to review the modeling guidance.

Speaker 3

Thank you, Jim, and good morning, everyone. Turning to Slide 5. In the Q4, we see a continuation of robust demand growth across our packaging, infrastructure, consumer and mobility end markets. Brand owner inventory levels remain low and as a result, we anticipate higher seasonal demand continuing into the holiday season this year. In Packaging and Specialty Plastics, we continue to see resilient demand for packaging applications and for our differentiated functional polymers.

Speaker 3

Global polyethylene supply remains constrained as the industry completes higher turnaround activity and supply chains recover from weather events on the U. S. Gulf Coast. We exited the 3rd quarter experiencing higher raw material and energy costs, which we anticipate will likely persist through the 4th quarter. We expect these costs to be an approximately $350,000,000 headwind sequentially.

Speaker 3

Dow will continue to utilize our broad geographic and best in class feedstock flexibility to help mitigate these impacts. We also anticipate $175,000,000 tailwind from turnarounds in the quarter as we completed our planned maintenance on our cracker in Canada. In Industrial Intermediates and Infrastructure, Continued consumer demand for furniture and bedding, appliances, pharma and home care are expected to keep supply tight in our key value chains. Due to the weather related outages in the 3rd quarter, some of our planned turnaround activity was moved to the 4th quarter. Sadara will also turnaround at its isocyanates facility in the 4th quarter as well.

Speaker 3

Altogether, we anticipate $100,000,000 in this segment from turnaround impacts. Short term increased energy costs in the U. S. Gulf Coast and Europe are expected to be an additional $100,000,000 headwind in the quarter. We continue to see sequential recovery in industrial activity, particularly for energy applications.

Speaker 3

We anticipate this recovery will continue at least through the 4th quarter As industrial production continues to ramp up from very low inventory levels to meet demand. In Performance Materials and Coatings, demand for electronics, Mobility, building and construction continues to outpace supply. Demand for architectural coatings is also expected to remain elevated due to low inventory levels across the value chain. Global production for silicones has been impacted by the recent dual control policy enforcement actions in China, with silicon metal prices almost 3 times their previous highs. We intend to pull forward a scheduled turnaround at a siloxane facility in Zhang Zhigang, China to coincide with government actions to curtail power usage.

Speaker 3

Our current estimate for the quarter includes $125,000,000 from increased raw material costs and turnaround impacts. We'll continue to work on mitigating the impacts of rising raw material costs through our integrated position in both businesses. Despite higher raw material and energy costs in the 4th quarter, Dow will continue to leverage its advantaged global footprint, structural cost and feedstock advantages, as well as our broad suite of differentiated products to meet growing demand. On Slide 6, as we look ahead, we expect robust economic growth to continue. With the Delta variant slowing the reopening of economies around the world, there remains significant pent up demand globally, particularly across our industrial and consumer end markets.

Speaker 3

Many industries continue to see elevated order backlogs Which will certainly prolong the ability to restock inventories across most value chains. As a result, we expect tighter than forecasted market conditions to continue. A view strengthened by China's recent dual control policy that has impacted both coal to olefins and methanol to olefins based capacity, which represent more than 30% of China's total polyethylene production. 2022 GDP growth forecasts are well above historical averages in most areas of the world as industries ramp up to match the robust consumer demand With further upside as global chip shortages continue to extend the recovery in manufacturing. Collectively, G7 countries have not yet fully recovered to pre pandemic GDP.

Speaker 3

This points to additional upside as economies return to more normalized consumption levels with degree of vaccination increasing, particularly in Asia, where levels remain low relative to the rest of the world. Moving to Slide 7. Our Investor Day earlier this month, we outlined how our differentiated portfolio and our focus on sustainability driven innovation will enable more than $3,000,000,000 in underlying EBITDA improvement across the cycle. Our restructuring program and digital investments will yield $600,000,000 in increased EBITDA. Both are in progress and our restructuring program is on track to achieve its $300,000,000 run rate by year end.

Speaker 3

We also have a suite of higher return, lower risk and faster payback capital and operating investments that will enable an additional $2,000,000,000 in EBITDA in the near term And our investments to decarbonize and grow at our Fort Saskatchewan site in Alberta, Canada are also expected to deliver approximately $1,000,000,000 in increased EBITDA. And as we've already shared, we're executing against a favorable macro backdrop that we expect will continue to support constructive market fundamentals for our key value chains. Turning to Slide 8, you'll see the detailed list of these low risk growth investments. Our capital investments are expected to generate $1,000,000,000 in EBITDA through incremental capacity expansions, debottlenecking and enhance feedstock flexibility across our operating segments. We're already making good progress.

Speaker 3

For example, in Packaging and Specialty Plastics, our Fort Saskatchewan expansion to add ethylene capacity of 65,000 metric tons per year to support growing polyethylene demand is now complete and will ramp by the end of the Q4. Our FCDH pilot plant in Louisiana will start up in 2022, featuring 20% to 40% lower CapEx and 5% to 7% lower OpEx, while reducing CO2 emissions by up to 20% compared to other PDH technologies. In Industrial Intermediates and Infrastructure, our debottlenecking project to add 60,000 metric tons per year of Aniline will be fully online by year end. And earlier this year, we signed an MOU for a new South China hub to advance local supply and formulating capabilities to serve the fast growing Asia Pacific market. In Performance Materials and Coatings, we recently completed a capacity expansion at 1 of our silicone polymer plants And by year end, we will complete a new silicone sealant compounding unit to enable sustainable solutions for high performance building and infrastructure applications.

Speaker 3

And we are progressing our 50 kt methylacrylate investment on the U. S. Gulf Coast to support global end markets such as inks, resins and packaging materials, which is scheduled to come online in the first half of next year. In addition, our operating investments are also expected to generate another $1,000,000,000 in EBITDA as we improve We're increasing capabilities and shifting our mix toward higher margin polyurethane systems for mobility and consumer applications. Our Industrial Solutions business is increasing capabilities to supply differentiated materials into the textile market.

Speaker 3

Our EcoFast collaboration with Ralph Lauren lowers energy usage by 40% and water usage by 50% in the fabric dyeing process. And by 2025, the brand aims to incorporate this technology in more than 80% of its solid cotton products. In Performance Materials and Coatings, we're expanding our ability to formulate differentiated silicones for a number of attractive markets, Including silicone adhesives for foldable displays and consumer electronics, thermal conductive silicone solutions for electric vehicles And silicone solutions for 5 gs where the market is expected to more than double over the next 10 years. And we recently partnered with customers on high value innovations like paper barrier coating applications that use our award winning Robar polyolefin dispersion technology And Callaway's super soft golf balls, which feature a new hybrid cover made with Dow's Paralloid impact modifier. In Packaging and Specialty Plastics, we're enhancing our extensive conversion and testing capabilities to commercialize resin through packaging design, Speeding the innovation process and expanding the addressable market for higher margin and more sustainable products.

Speaker 3

For example, we're already benefiting We're also making investments to improve asset reliability, to accelerate catalyst development for new resins and processes like FCDH, where we can typically be 100 times more efficient than conventional experimentation. Collectively, our slate of near term investments will generate an increase of approximately $2,000,000,000 in underlying EBITDA, And we intend to deliver this growth with a disciplined and balanced approach, maintaining our top quartile performance in cash flow,

Speaker 2

Thank you, Howard. Turning to Slide 9. The strategy we outlined at our Investor Day builds on our long history of industry leadership. Our plan enables us to capture demand from sustainability drivers, achieve 0 scope 1 and 2 carbon emissions and deliver meaningful underlying earnings and cash flow growth for years to come. Our path to decarbonize our footprint and grow earnings is while also expanding our capacity.

Speaker 2

This plan will deliver a 30% reduction in our CO2 emissions between 2,005 2030 through a disciplined approach that manages timing based on affordability, macro and regulatory drivers around the world. Our Texas 9 cracker proves that we can do this and do it well. Texas 9 is 60% lower carbon intensity than any asset in our fleet, and that's without any specific design for carbon capture Overall, the project has a 65% lower conversion cost, is running consistently at more than 110% of nameplate capacity and has delivered greater than 15% return on invested capital since start up. We will leverage key learnings from Texas 9 As we plan to build the world's 1st ever net zero carbon emissions ethylene cracker and derivatives complex in Fort Saskatchewan, Alberta, delivering approximately $1,000,000,000 in EBITDA as Howard outlined earlier. This project will more than triple our ethylene and downstream derivative capacity at the site while decarbonizing emissions for 20% of our global ethylene capacity.

Speaker 2

We selected this site due to the availability of carbon capture infrastructure, advantaged feedstocks And supportive government policies and incentives. On Slide 10, as we capture these attractive growth opportunities, We'll maintain our balanced and disciplined financial approach since spin. We are committed to keeping CapEx at or below D and A, well below pre spin levels, while targeting return on invested capital above 13% across the economic cycle. We will continue to align our capital spend to the macroeconomic environment, our affordability and return targets. Our investments align to 3 categories.

Speaker 2

First, we'll maintain our foundation and maximize the return of our existing assets while ensuring safe and reliable operations. 2nd, we'll execute our pipeline of faster payback, lower risk incremental growth projects for downstream and sustainability driven applications growing faster than GDP and will invest approximately $1,000,000,000 per year to decarbonize our footprint and grow earnings. These investments enable us to capture increasing demand for low carbon footprint products, while de risking the enterprise with lower emissions assets. In closing, on Slide 11, Dow is well positioned to deliver significant long term value for shareholders. We have actions in place to both decarbonize our footprint and grow the enterprise as we achieve an additional $3,000,000,000 in underlying EBITDA, Our balanced capital allocation approach targets more than 13% return on invested capital, keeps CapEx within D and A and return 65% of net income to shareholders across the economic cycle.

Speaker 2

All of this is underpinned by our industry leading portfolio, cost position and strong track record of innovation With that, I'll turn it back to Pankaj to open the Q and A.

Speaker 1

Thank you, Jim. Now let's move on to your questions. I would like to remind you that our forward looking statements apply to both our prepared remarks and the following Q and A. Operator, please provide the Q and A instructions.

Operator

And we'll take our first question from Hassan Ahmed with Alembic Global.

Speaker 3

Good

Speaker 1

Jim, as I take a look at your guidance, sequentially you seem to be guiding to a $500,000,000 downtick in EBITDA. So $3,600,000,000 comes down to 3.1 But just reading through the guidance, you don't break out the impact of EIDA. So is it fair to assume that you guys are guiding To sort of north of $3,100,000,000 in EBITDA for Q4?

Speaker 2

Thanks, Hassan. That's a great question. The impact, the total impact of Ida was about $100,000,000 and split 3rd quarter, 4th quarter. So that's how you should look at that. Most of the rest of the guide was just impact on feedstock costs or raw material costs that we I'd like to see going into the Q4.

Speaker 2

Having said that, I think demand is going to continue to be strong And I expect our operating rates will be stronger than they were in the Q3 because of the impact of Ida. And I don't We're going to have a chance to build much inventory, but our intent is to run hard through the end of the year because our customers need the demand And we need to get out in front of this a little bit.

Operator

Next, we'll go to Vincent Andrews with Morgan Stanley.

Speaker 2

Thanks. Good morning, everyone. Maybe just a little more color within the Packaging and Specialty Plastics sales guidance In particular, what you're expecting for volume sequentially? And then is there any sort of impact on the top line From feedstocks or hydrocarbons, you can obviously tell I'm trying to back out your polyethylene price assumptions. Good morning, Vince.

Speaker 2

I expect volumes will be better. We had St. Charles obviously out in the month of September, and it came back here earlier in October. So I expect Q4 will have a strong run. And remember, we had the turnaround in the Fort that was happening in the 3rd quarter as well, and we're out of that.

Speaker 2

So the fort will be back. We'll see some additional ethylene out of the fort because the back half of that expansion started up. And I think you'll see higher volumes for the year. We're looking at volume increases for plastics like 8%, 9% for the industry. I think for Q4, we managed 2% in the quarter.

Speaker 2

In Q3, I think for Q4, it will be higher than that. I do expect prices will moderate at some point. I don't know exactly when that's going to be because right now inventories are low, but I don't think it's going to fall as precipitously as some of the forecast estimate.

Operator

Next question will come from P. J. Juvekar with Citi.

Speaker 4

Yes. Good morning, Jim and Howard. Can you talk about siloxins and downstream silicone demand? What's happening in siloxane merchant market? And how is this chain impacted by raw materials?

Speaker 4

I think, Jim, you said, Silicon costs came up in China, so you shut down some shut down a plant. Can you expand on that? And finally, What happens to the new siloxane capacity that was announced in China with these recent dual control policies? Thank you.

Speaker 2

Yes. P. J, good question. I'm going to walk through several things. I would say in the near term, the impact on silicon metal He has been in China due to the restrictions from dual control.

Speaker 2

And as you know, that was driven by the higher coal prices Really pushing up the costs for the electricity producers and the electricity producers are capped On their electricity prices, so some of them didn't run and that forced the industry curtailment. Typically, as you're going into cold weather months, industry takes the hit versus homeowners and consumers, you try to keep your people warm. And so that hit silicon metals. For that reason, things became tight. We've moved some silicon metals from Brazil Over to China to offset that and we'll run through the Q4, but we decided to pull a turnaround in Zhongjiang Into the Q4, we had originally planned it for Q1.

Speaker 2

We decided to do it now. That takes a little pressure off the dual control situation. That turnaround will cost us, I think on Slide 5, it's in there, dollars 75,000,000,000 in the 4th quarter. I expect we're going to see About $50,000,000 higher cost, but both downstream G3 silicones demand And siloxanes demand are very strong and siloxanes prices have gone up significantly. And so I think we're going to be in that situation for all of 4th quarter and I would expect into 1st quarter as well.

Operator

All right. Next question will come from Jeff Zekauskas with JPMorgan.

Speaker 5

Hi, good morning. I have a 2 part question. The first part has to do with your expansion in Alberta in the late decade. That seems to be your sole large ethylene polyethylene expansion. And By my calculation, what that means is that over the next 10 years or so, your capacity will expand 1% to 2% per year.

Speaker 5

And presumably the industry grows faster than that. And so is this approach an example of your disciplined capital approach where you really only want to have high return projects and what you'll do is you'll sacrifice volume growth In service of that higher return. 2nd part is for Howard. The net debt to EBITDA, You say we'll go to 2 to 2.5 times. That makes a difference because if your EBITDA is $10,000,000,000 that's a $5,000,000,000 difference.

Speaker 5

So is it because if what you're going to do is lever up by another, I don't know, dollars 9,000,000,000 or $10,000,000,000 to buy back stock or increase dividends, How quickly are you going to get there? Is it 2022 or 2025 or somewhere in between? Thanks.

Speaker 2

Good morning, Jeff. The first part of the Alberta expansion comes on in 2,007. That brings on most of the new cracker capacity, the cracker will be expandable. And it also brings on the derivatives. And then we retrofit the existing cracker, so we can tie the back end into the auto thermal reformer and that will come on in 2,009.

Speaker 2

So that will be the largest mega project that we do. We do have investments in the near term on debottlenecking existing assets That will help us between now and 2,007. And we have the ethylene capacity To add some downstream capacity as well. So there will be a little bit more than 1% to 2% growth. But Our focus on Alberta is obviously to take advantage of the situation there, to decarbonize and have a good carbon capture location and take that whole Howard, do you want to get net debt to EBITDA?

Speaker 3

Yes, sure. Good morning, Jeff. Your point about discipline and balance on the capital Allocation side, it goes to the debt as well. I mean, when you think about what we did in the Q3, it was very balanced. It was more than $500,000,000 in dividends.

Speaker 3

It was doing another $400,000,000 of stock buyback and then we took out $1,100,000,000 To your point on the 2% to 2.5% ratio, I would say some of our peers have a 1% swing Between the low and the high. So we're already giving you a better than peer view with saying our range is only a half a turn. But if you'd like me to narrow that further, I would say use the midpoint. So our long term average is 2 to 2.5. I would say, through the economic cycle, if you want to use 2.25, that's a reasonable proxy for where we want to be, but we have the corridor there to recognize that it's a long term target.

Speaker 3

Punctually today using the rating agency methodology through the end of 3rd quarter, we're probably around 2.4, 2.5. So we have about a quarter of a turn left to go to hit that midpoint of the 2 to 2.5.

Operator

All right. Next question will come from the line of Bob Koort with Goldman Sachs.

Speaker 6

Good morning. This is Mike actually sitting in for Bob. Just wondering, you guys made a couple of comments about inventory still being tight. And I guess from a polyethylene perspective, could you perhaps maybe quantify what you're seeing in terms of days of inventory and how perhaps that may compare to

Speaker 2

Yes, industry, Mike, good morning. Industry inventory and DDI fell. Industry inventory in September fell down £120,000,000 and so days in inventory had dropped, demand is obviously Strong and export demand exceeded domestic and export exceeded the production. Obviously, storms had an impact on that as well. We saw inventory declines in high density and linear low and a little bit of inventory build in low density, but it isn't A significant number.

Speaker 2

So when you look at the 5 year trends and I think what we put in the slide deck to show you earlier is that The order backlog is off about 30% above normal and the inventory to sales ratio is down About 10%. I think that's going to stay in that band for the most of the 4th quarter. And as the capacity comes back from the hurricanes, we have still supply and logistics issues. So there are bottlenecks everywhere, It's a little hand to hand combat right now. If a truck driver doesn't show off, shipment gets delayed.

Speaker 2

So I think we're going to be in that situation for

Speaker 3

the rest of the year and into the Q1. Just giving you some down numbers, our DSI was down 7 days In the Q3 versus a year ago and our overall cash conversion cycle was better by a day sequentially. We're tightly managing our working capital.

Operator

And next we'll go to David Begleiter with Deutsche Bank.

Speaker 7

Thank you. Good morning. Jim, the consultants have a pretty sharp decline in ethylene chain margins through February.

Speaker 1

Do you agree with

Speaker 2

that or are they being

Speaker 7

a little too bearish given the tightness right now in the marketplace?

Speaker 2

Good morning, David. I think A little bit, Barish. The way I would categorize it, I think they're underestimating the demand that's going to be there because There still is a significant inventory restock and continued strong demand that we see coming. And I think they're overestimating how much Supply is coming in. And if I go back to the China situation, remember that about half of the CTO, MTO capacity is out of the money Right now, 60% of all the new capacity coming on in the world is in Northeast Asia, Which will still be on that importer for a long time and it's all naphtha or higher cost base.

Speaker 2

And so I think Those things are going to soften this. I do expect prices to moderate a bit, but I think we could see a pretty strong 2022 with Higher volumes yet slightly lower prices, operating rates were always going to be in the high 80s to low 90s for the full year, so I don't see a change there. And remember that the U. S. Structural advantage, Canadian Structural Advantage, our position in Argentina, our positions in the Middle East are still going to remain strong.

Speaker 3

Thank you.

Operator

Next we'll go to Frank Mitsch with Fermium Research.

Speaker 1

Hey, good morning and nice results. You did sequentially tick up your buybacks here to that $400,000,000 level in the 3rd quarter. How should investors think about the pace of buybacks in 4Q 2022?

Speaker 6

Howard, do you want to

Speaker 3

take that? Yes. Thanks, Frank. Good morning. So the guidance we gave for the Q4 is 745,000,000 shares Outstanding.

Speaker 3

So if you look at where we ended the Q3 or the average for the Q3, that's about a 5,000,000 share reduction, which That said, look, we continue to be disciplined and balanced in the capital allocation and we will continue to be opportunistic. We're staying true to our 65% Of our net income going back to shareholders, long term 45% of the earnings growth will and the net income will go in the form of dividends, And then we'll use stock buyback to top that up to 65%.

Operator

All right. Next question will go to John Roberts with UBS.

Speaker 3

Thank you. We see all the container ships out in the harbors and all the containers stacked up on the docks and The warehouses are full with drivers waiting to take product to the final customers. Your earlier comment was about polyethylene producer inventories. Do you worry about Contain product downstream where it would seem like there's a lot of inventory in the channel downstream of the converters.

Speaker 2

Hey, good morning, John. Yes, it's the visibility is hard to track right now. I do think that Some of the moves that the government made recently to get the big ports, 20 fourseven operation is going to help the backlog. What happens is typically when those ports get backlogged, it spills over into other ports. We don't use Long Beach as much, but When traffic spills over into other ports, it hits us.

Speaker 2

I would say that almost every value chain Has some impact from that. And where we see the biggest impact is being able it's kind of blocking Material getting out. And so we're starting to see some congestion and some competing demand product coming in. Sometimes it's faster to reload an empty container to get it back to China. And so that competes with other materials going out.

Speaker 2

We don't see that in every port, but certainly on the West Coast, we're seeing that right now. I would say almost Every value chain we have, every application we have is short product. And I don't think there's enough material tied up in All of that floating inventory or in the warehouses that, that is going to alleviate the demand or fill the demand that's out there right now. I still think the Consumer is strong and we still got other economies that are coming back from COVID that are going to add to that demand.

Operator

Next we'll go to Michael Sison with Wells Fargo.

Speaker 8

Hey guys, good morning. Nice quarter. Just curious when you think about 2022 and you tend to have that nice little market fundamentals for your 3 base segments. And Just curious, Amy, I know you think demand is strong, but any thoughts on natural gas pricing, feedstock costs, Oil is going up. Just curious how you're baking in those type of inflation numbers in that outlook?

Speaker 2

Yes. So we're starting to see some improvement in production, drilling and Completion of wells, we're going to bring more NGLs as we move out of the winter season. I believe what we're seeing short term here It is a knock on effect as coal really ratcheted much higher in China. The first Fuel that you go to that could replace coal in the fuel grid is natural gas and then LNG obviously went right up After coal. And then the next fuel is oil and oil came right up and so that took us up to $80 a barrel.

Speaker 2

I think we're going to see things will stabilize a little bit. As we go into winter, Inventories are a little light of the 5 year average going into winter, but you've seen Price is on line a little bit in the forward market by about $1,000,000 Btu because weather plays a Significant factor. So if you have a warmer fall, that's going to take a little bit of staying out of the natural gas prices. Even with that, the oil to gas ratio, but more importantly, the oil to gas spreads are good. And so I think that's going to continue.

Speaker 2

And if we get through winter without a really, really cold snap, Then I think you're going to see prices to moderate. Long term or medium term, I would say 2.50 to 4.50 For U. S. Production and long term about 275,000,000 BTU for natural gas.

Operator

And your next question will come from Duffy Fischer with Barclays.

Speaker 9

Great. Thanks. Good morning. This is Mike Leithead on for Duffy. Maybe 2 part question for Howard.

Speaker 9

I guess one, Just a clarification on Jeff's earlier question, is that 2 to 2.5 debt target a gross debt to EBITDA metric net debt? Because if I heard your response correctly, It sounds like you still want to pay down slightly more debt from here. And second, if we stay in this call it $6,000,000,000 or so annualized Operating cash flow range from the past, say, 24 months or so, we roughly know what CapEx will be next year. And it seems like there should still be a decent amount of excess cash. I know you stress a balanced approach, but just how should we think about the priority of that excess cash?

Speaker 9

I guess that's the gold bar in your chart, but are buybacks the flywheel here? Thanks.

Speaker 3

Yes. On the 2 to 2.5 debt to EBITDA ratio, that's a rating agency adjusted net debt to EBITDA target. That's over a long term. Typically, the rating agencies will look at 2 years back, current year and then come up with Forward 2 year forecast. So when we think about that 2 to 2.5 range or as I target the midpoint in answering to Jeff's questions of 2.25, that's over a 5 to a 10 year period.

Speaker 3

So as I mentioned to Jeff, we're slightly we're at the higher end of that range today. So you will You should expect over the next several years, we'll continue to titrate that number down to the midpoint to 2.25 And depending on how things go, we might go to the lower end of that range, we'll see. In terms of the capital allocation priorities, It is we intend to continue what you've seen from us, which is disciplined and balanced approach. The number one priority for us is to safely and reliably operate our plants. And then the next is organic investment.

Speaker 3

So where we have low risk, high return, fast payback projects that helps us continue to get Through the cycle average return on capital of the enterprise of 13% or more, we will do that. Dividends would be next. So as the net income increases, that dividend should increase in line with the 45% of net income over the cycle And then share repurchases. And like I said earlier, we'll use share repurchases to at least cover dilution, but then we will also be opportunistic And compares opportunistic share buyback to any other use of cash. And over the long run, our goal is to do the value maximizing thing.

Operator

Next we'll go to John McNulty with BMO Capital Markets.

Speaker 10

Hi, good morning, James. This is Bhavesh for John. A question on your equity earnings from the JVs. It looks like each of your II and I and P and SP Segment is on track to deliver around $500,000,000 of earnings. Now quite a few unique regional dynamics and feedstock arrangements at play here, but Broadly, could you discuss where these businesses are in the cycle and perhaps any color on where you see the earnings of these businesses for the next year?

Speaker 10

Thanks.

Speaker 2

Yes. Good question. On IINI and polyurethanes, I do believe that the demand and the operating rates Rice, the cyanates will continue to stay strong into next year. Maybe a little bit lower operating rates on polyols, but The key demand drivers and value drivers are going to be those systems and solutions that are going into things like mobility, Like construction, like appliances and some extent furniture and bedding and things that are driven by consumer Growth and that will continue to remain strong. The only thing that we've got coming that would be a detractor Those earnings would be we've got a turnaround in this quarter on isocyanates in Sadara, but that's been planned And they'll manage that.

Speaker 2

They've been running very well. I expect to see them in good shape next year. And as you know, Their fixed costs are quite low. And so I think they'll be a very good source for us to fulfill that demand.

Speaker 3

Just one point on maybe on the cash flow side on the equity earnings, if you recall that our dividends usually come from the prior year earnings. So with this year's equity earnings up, as you pointed out, and that will drive a cash flow tailwind for us next year, probably in the range of At least $200,000,000 to $300,000,000 as we sit here today, possibly more.

Operator

And next we'll go to Laurence Alexander with Jefferies.

Speaker 11

Good morning. Two questions. In the period with sort of the tighter supply constraints. Have you seen a mix be a net Positive or negative across the portfolio? In other words, how do you see things playing out when the supply constraints ease?

Speaker 11

And secondly, with respect to decarbonization, We're integrating in decarbonization platforms.

Speaker 2

On the mix, I think Anytime you get a tight situation like this, there's a natural gravitation for the mix to move up. I would also say though that We've been trying customers are in close communication and we're trying obviously to keep everybody running. There's a lot of juggling going on. There are some specialty grades where it's hard to shift the mix up because things are so tight right now, especially in some of our elastomeric products. On decarbonization, I think it's just going to depend on The situation in the geographies that we're looking at the investments in Canada, we don't need to do the back investment into CO2 capture and sequestration.

Speaker 2

And I think And to CO2 capture and sequestration. And I think there are a lot of players that are out there that have capabilities to do that. So if we can keep our investments focused on assets that generate revenue for us and generate growth for us And our 0 carbon emitting, I think there's plenty of room for 3rd parties and others to play to help us to handle the CO2.

Speaker 1

Thank you.

Operator

Next, we'll go to Alex Yefremov with KeyBanc.

Speaker 12

Thank you. Good morning, everyone. I have a question about Slide 8, where you detail in flight investments For $1,700,000,000 $2,100,000,000 EBITDA contribution. In my math, this implies fairly high High single digit growth versus your base EBITDA. So can you at a high level explain why investors confidence in this target.

Speaker 12

What are you doing differently from sort of traditional DAS growth rate here? So anything that can sort of at a higher level explain why this growth is achievable?

Speaker 2

Yes. I'll start and I'll ask Howard to fill in a little bit. But I'm going to start with silicones Because that's an area that grows at 2x GDP. And if you look at mobility and if you look at electronics If you look at consumer applications, they're going to continue to grow as well as we've got expansions coming For silicones products into construction sealants for glass glazing for big skyscraper buildings. So that is high GDP growth and that's going to continue in Industrial Solutions, Not only Hyatt's value return to ethylene, but also high value downstream growth, driven primarily by consumer applications.

Speaker 2

To some extent, oil and gas, which we see recovering, we have many, many cases where our oil and gas products help people Reduce CO2 emissions in the midstream production. And then things like EcoFast which is the partnership with Ralph Lauren where we just open sourced that technology to use that product, which would get textile mills that use cotton To switch over to a product that is uses 90% less chemicals, 50% less water, 50% less energy, I think that's a huge driving force towards more sustainability in an area that's a tough environmental aspect. And then if you go to PM and C, we've got continued growth in our downstream systems, which have been growing at greater than 11% per year. For a long time, we'll continue those investments. We've got high growth targets for our downstream coatings business To continue to keep up with the demand, specifically traffic demand, Howard mentioned paper demand for Paper cups replacing others with our roll bar dispersions and also architectural demand, which is our growth leader in that space.

Speaker 2

And then you get back to Packaging and Specialty Plastics, which is continuing to grow above GDP, about 1.4 times GDP in our forward forecast. It's very dispersed. So when we talk about $3,000,000,000 Of EBITDA growth over that time period is pretty evenly split between all three segments. And you're going to see about $200,000,000 to $300,000,000 of it come on next year and that is projects that are already completed and will be finished by the end

Operator

All right. Your next question comes from Arun Viswanathan with RBC Capital Markets.

Speaker 13

Great. Thanks for taking my question. Congrats on a strong quarter. So I just wanted to get back to the polyethylene discussion. I guess we're hearing some conflicting things because we saw an ACC number on inventories of Mid-40s on days of supply, maybe 47.

Speaker 13

And then it appears that the September, October increase on polyethylene has Has stalled as well. So is that are those correct characterizations? Or would you say that the market is really tight and You do expect further increases as we go through the year. Thanks.

Speaker 2

I think mid-40s number on days of inventory It's kind of an average number. But remember, sometimes the inventory numbers are things that are locked up and can't get shipped out. And so I think that's the main delta in some of the data that I shared with you. I would say demand in production, I think are both going to be strong in the 4th quarter. I also think some of the shipment delays are going to moderate as we get through the quarter, and I think that will help.

Speaker 2

But, 40 to 45 days of inventory is not much inventory for the polyethylene business.

Operator

Your next question will be from Christopher Parkinson with Mizuho.

Speaker 14

Hi, this is Kieran on for Chris. I was just wondering if you can touch a little bit between II and I and PM and C, you mentioned 3rd party supply constraints. Can you just talk about what you're seeing in terms of those 3rd party supply constraints and whether you see them easing into the 4th

Speaker 2

They are primarily the 3rd party supply constraints are primarily industrial gas suppliers. They were wrecked pretty hard earlier in the year from the Texas freeze and then they got hit again from the hurricanes in Louisiana. It is improving. I expect it will continue to improve through the quarter. And I think they're working hard.

Speaker 2

I know they're working hard to work on reliability and get the assets back up. And we're working hard as well to make sure that we've got Redundancy in those supplies. So we'll take actions like we do after events like this and make sure that we've got redundancy on supply as well. But that was the primary impact.

Operator

All right. Next we'll move on to Steve Byrne with Bank of America.

Speaker 15

Thanks everyone. It's Matt Deo on for Steve. Just a question on polyurethanes. I think you touched a little bit on this, but do you think we are in the cycle? Because even earlier this year, we had some of your peers talking about over earning.

Speaker 15

I know we've had a lot of outages, but demand is still really Strong inventories are light. So how does this shake out into 2022? And then As you push downstream into systems, what do you expect the margin uplift to be and how is the business may be different from like a SG and A intensity perspective?

Speaker 2

I think supply demand balances are pretty favorable through 2026, because durables demand has been out The supply growth in durables pull a lot on MDI and TDI operating rates. And so I think you're going to see an earnings ridge in the business that we haven't seen. There's also been a fair number of delays or rationalizations of And we've also seen obviously margin uplift in that segment for polyurethane systems.

Operator

All right. And we'll take our final question from the line of Matthew Blair with Tudor, Pickering, Holt.

Speaker 16

Hey, good morning. Thanks for squeezing me in here. Howard, I

Speaker 1

think you highlighted the feedstock flexibility

Speaker 16

in your crackers. Just given these volatile energy markets, do

Speaker 1

you have any So big examples of the kind

Speaker 16

of changes you've been making. For example, are you switching away from propane either in the U. S. Or in Europe? And then also if you have any thoughts on the recent widening of the ethane to natural gas spread, I think it's about $0.08 a gallon.

Speaker 16

Do you see that as kind of a short term blip or perhaps something maybe a little bit more medium term? Thanks.

Speaker 2

No, go ahead, Howard. Jim is looking at me, so

Speaker 3

I will take that. Look, I would just say this, our feedstock flexibility is really a Key enabler of our consistent outperformance versus our peers as you've seen in the last several years of our annual benchmarking. It includes what I would say is unmatched Speed stock flexibility for most of our feed. So we've got the ability to max ethane on the U. S.

Speaker 3

Gulf Coast. We also have Propane, we can do minimum naphtha if we need to. In Europe, we also have the ability to do max LPG. To your point, I mean, propane is not necessarily in the slate right now. So you're not doing that in Europe.

Speaker 3

But then you also look at the point that Jim made earlier, which is we've got our Canadian advantage, we've got the feedstock We've got the Argentinian advantage and we also have the Middle East. And I also think when you talk a lot of people talk about feedstock flexibility, But most of the time what that means is they have 3 furnaces that can crack this feed, 2 furnaces that can crack this feed. When we talk feedstock flexibility in furnace Flexibility. So we have the ability to switch within the furnace and we can do it frankly, we can do it day by day. Typically, we do it every week.

Speaker 3

Do you have anything to add? I would only

Speaker 2

add 2 things. It isn't always a linear equation when you switch from cracking ethane to propane. At these propane prices, some might The propane was out of the crack slate. And actually, we've been cracking a fair amount of propane because we're generating a lot more byproducts out of that And we need them all. And so it has been in the slate more than you might expect.

Speaker 2

And I think as the natural gas prices moderate going into the year, We're going to see that ethane and propane advantage in the U. S. Gulf Coast is going to be there.

Speaker 1

Very good. I think that's all the time we have for Q and A. Thank you everyone for joining our call. We appreciate your interest in Dow.

Operator

And again, that does conclude today's conference. We thank you all for your participation. You may now disconnect.

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DOW Q3 2021
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