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On Oct 29, we reaffirmed our Neutral recommendation on Dow Chemical (DOW - Analyst Report). While the company should gain from strong momentum in its agriculture business, feedstock strength and cost-cutting measures, we remain cautious factoring in a still challenging European market, sustained softness in some key end-markets and pension headwinds   

Why Neutral?

The U.S. chemical kingpin’s profit climbed 20% in third-quarter 2013, reported on Oct 24, on strength across agriculture, coatings and plastics businesses and healthy gains from emerging markets. However, both revenues and adjusted earnings miss Zacks Consensus Estimates. Dow said that it will continue to focus more on attractive end-user markets and cut its exposure in non-strategic markets amid a challenging business environment.

Dow, a Zacks Rank #3 (Hold) stock, is benefiting from strong fundamentals in agriculture and food markets. A string of innovative products in its pipeline adds to its strength. Moreover, Dow is seeing significant feedstock advantage in North America. The company’s investments in the U.S. Gulf Coast and Middle East are focused on boosting this advantage.

Dow also remains committed to optimize its portfolio by selectively divesting its assets. The company continues to pursue its cost reduction and efficiency programs.

In addition, Dow remains focused on offering incremental returns to its shareholders leveraging its healthy cash flows. It also continues debt repayments having reduced its debt by $2.4 billion so far in 2013, resulting in a meaningful decline in interest expenses.

However, Dow continues to face challenges in Western Europe due to soft economic conditions in the region. While electronics and construction end-markets have stabilized of late, they are still not out of the woods.

In the Performance Materials segment, the Epoxy business is struggling with underperformance amid tough competition and industry overbuilding. The company is considering selling the Epoxy business.

Moreover, Dow is exposed to significant pension headwinds. The company expects pension costs to increase roughly $275 million year over year in 2013.

Other Stocks to Consider

Other companies in the chemical industry with favorable Zacks Rank are E. I. du Pont de Nemours and Company (DD - Analyst Report), PPG Industries Inc. (PPG - Analyst Report) and Praxair Inc. (PX - Analyst Report). All of them carry a Zacks Rank #2 (Buy).

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