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Buffett Vs. Loeb: A Guru Showdown For This Blue-Chip Company

Tuesday, June 17, 2014 - 10:15am

It stands to reason that companies that have been around for 100 years or more might have a pretty good chance of being around for another 100 years. These companies make the best buy-and-forget type of stocks that long-term shareholders look for in terms of stability, profits and dividends.

These are the types of companies Warren Buffett likes. However, it's not often that Dan Loeb and Buffett like the same stock. That's because Buffett tends to let management do their thing -- and Loeb usually wants to shake things up.

Although both Buffett and Loeb are owners of Dow Chemical (NYSE: DOW), they have different visions for the $62 billion company going forward.

Loeb sees Dow Chemical as extremely undervalued and wants the company to restructure its operations. Founded in 1897, Dow Chemical is the largest chemical company in the U.S. by sales and the second-largest position in Loeb's fund, Third Point Capital.

Loeb's Thesis
Loeb is not happy with the job CEO Andrew Liveris is doing. Loeb specifically cites the acquisition of Rohm & Haas as being an ill-timed purchase and wants the company split in two. Loeb says the company's integrated approach is costing shareholders billions of dollars and not generating the hoped-for synergies.

Loeb wants Dow to focus more on selling ethylene, propylene and other basic petrochemicals on the open market. He wants the company to get out of using these chemicals to make foams, glues and other consumer products.

If Dow Chemical were to do this, Third Point feels that the company could boost its EBITDA (earnings before interest, taxes, depreciation and amortization) by $2.5 billion. He also notes that Dow generates the same EBITDA in its chemical business as top competitor LyondellBasell Industries (NYSE: LYB), despite the fact that Dow has a much higher production capacity. Loeb wants Dow to focus on lowering costs.

Another critique that Loeb has is the way that Dow Chemical sells material between its units at cost. For example, if one of Dow Chemical's polyester resin plants buys ethylene from another Dow Chemical plant, it is sold at cost.

This is not how it's done elsewhere in the industry. Exxon Mobil (NYSE: XOM), for instance, sells chemicals in-house at market rates. What this allows for is better determination of a particular plant's profit and loss. A profitable plant could in effect be subsidizing a plant that's losing money.

If Dow Chemical were to sell material between divisions like Exxon Mobil does, it could make it easier for the company to identify (and sell) unprofitable divisions.

Warren Buffett is in the opposing corner, having provided Dow Chemical with $3 billion it needed back in 2009 to buy Rohm & Haas. Berkshire Hathaway (NYSE: BRK-B) got preferred shares in Dow Chemical through its investment.

Buffett supports Liveris and his vision, telling Dow's CEO that Berkshire is "an owner, and we like being an owner. And frankly, we think you've been running the company for the investors who will stay versus the investors who will leave."

Is DOW 'Dead Money'?
Even though shares of Dow Chemical are up 50% in the past year, they have lagged far behind the broader market over the past 15 years.

^SPX Chart

^SPX data by YCharts

Loeb loves to push companies to become more shareholder-friendly. During the first quarter, Dow repurchased $1.25 billion, and it plans on completing its remaining $3.25 billion repurchase program this year. Dow is also rightsizing its portfolio, and plans on bringing in between $4.5 billion and $6 billion by divesting non-core assets.

DOW pays a solid 2.9% dividend yield, but Loeb has been quick to note that that's below pre-recession levels. Trading at a trailing price-to-earnings (P/E) ratio of 13.1, Dow Chemical is one of the cheapest stocks in the industry. With a few tweaks per Loeb's recommendations, Dow Chemical might be able to boost margins and trade more in line with its peers.

Risks to Consider: Dow Chemical is reliant on and exposed to the broader economy, so any delay in a rebound could slow its sales growth. Also, Dow could well continue to trade at a discount to peers if Dow's management doesn't consider Loeb's recommendations.

Action to Take --> My price target for Dow is $65, representing upside of better than 20%. This would put shares trading at 16.8 times next year's earnings, which is in line with the average for the industry.

Stocks like DOW are similar to a special group of securities we call "Forever Stocks." These are world-dominating companies that pay investors a fat dividend, dig a deep moat around their business to fend off competitors and buy back massive amounts of stock. They're solid enough to buy, forget about and hold... forever. To learn more about these stocks -- including some of their names and ticker symbols -- click here.

Marshall Hargrave does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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