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Dow Chemical (DOW) Q2 Earnings Preview: Will it Disappoint?

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Dow Chemical is scheduled to report its second-quarter 2017 results ahead of the bell on Jul 27.

The U.S. chemical kingpin topped earnings expectations in first-quarter 2017, helped by its cost-cutting and productivity actions and continued focus on consumer-driven markets. The company registered adjusted earnings of $1.04 per share for the quarter that zoomed past the Zacks Consensus Estimate of $0.99.

Dow raked in net sales of $13,230 million in the first quarter, up roughly 23% year over year, driven by the acquisition of Dow Corning’s silicones business. Sales also surpassed the Zacks Consensus Estimate of $12,367 million. The company witnessed sales gains across all geographic areas in the reported quarter.

Dow’s shares have rallied 23.7% over the past year, outperforming the 20.3% gain of the industry it belongs to.

Dow has beaten the Zacks Consensus Estimate in each of the trailing four quarters with an average beat of 10.77%. Let's see how things are shaping up for this announcement.

Factors to Watch For

Dow, in its last earnings call, said that it is witnessing signs of positive economic momentum globally amid sustained geopolitical risks and volatility. The company is also seeing early signs of gradual improvements in consumer-led markets in Latin America.

Dow is still facing challenges in its agriculture business, reflected by a decline in sales in this business in the first quarter, as volumes were affected by lower herbicide demand in North America. An expected shift in acreage driven by growers’ preference of soybeans over corn is affecting demand for corn seeds in North America. High channel inventories are also affecting demand for herbicides and insecticides in Asia-Pacific. The company sees flat year over year earnings in its agriculture business for first-half 2017.

Dow also faces feedstock cost pressure as reflected by higher raw material costs across a number of businesses in the first quarter. Higher feedstock costs led to margin compression across certain downstream businesses. Dow, in particular, is seeing a significant spike in prices for propylene, a key raw material. Raw material cost pressure is expected to continue in second-quarter 2017, thereby hurting downstream margins.

Moreover, the company sees increased start-up costs associated with the Texas cracker and planned maintenance costs related to the turnaround of the Terneuzen cracker in the second quarter, which may affect margins in its plastics business.

Nevertheless, Dow is gaining from its cost-cutting and productivity actions and continued focus on consumer-driven markets, which should continue to lend support to its results in the June quarter. The company is seeing strong demand across major consumer-focused markets such as packaging, infrastructure, transportation and consumer care, which is contributing to volume and earnings growth.

Dow remains on track to deliver $1 billion of cost reduction under its three-year productivity program. Dow achieved $313 million in productivity savings in 2016, thereby surpassing its cost savings goal for the year. The company has already achieved more than $750 million of cost savings since 2015.

Dow should also gain from the synergies associated with Dow Corning Silicones business. Dow has taken full control of Dow Corning – earlier a 50-50 joint venture between Dow and Corning Inc. Dow expects to achieve combined run rate annual cost and growth synergies of $500 million from the restructured ownership in Dow Corning. The company has already reached its targeted cost synergy run-rate of $400 million and remains on track to achieve $100 million in growth synergies.

Dow is moving ahead with its proposed merger with DuPont , which is expected to create significant synergies. The companies, last month, secured clearance from Canada's Competition Bureau for the merger after they agreed to sell certain assets and businesses. The companies also received the U.S. antitrust approval for the merger in June. Moreover, the European Commission conditionally approved the merger in Mar 2017.

Dow recently reached an agreement to divest part of its corn seed business in Brazil to CITIC Agri Fund for $1.1 billion. The asset sale is intended to satisfy the company's commitments to Brazil’s Administrative Council for Economic Defense (“CADE”) in connection with its conditional regulatory approval of the proposed merger with DuPont.

Dow and DuPont continue to work constructively with regulators in the remaining jurisdictions to obtain approval for the merger and continue to expect the closing of the merger to take place in Aug 2017. The merger is projected to deliver cost synergies of around $3 billion and growth synergies of roughly $1 billion. We expect Dow to provide an update on the merger in its second-quarter call.

Earnings Whispers

Our proven model does not conclusively show that Dow is likely to beat estimates this quarter. This is because a stock needs to have both a positive Earnings ESP  and a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) for this to happen. This is not the case here as you will see below:

Zacks ESP: The Earnings ESP for Dow is -1.98% as the Most Accurate Estimate stands at 99 cents while the Zacks Consensus Estimate is pegged at $1.01. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

Zacks Rank: Dow currently carries a Zacks Rank #4 (Sell). We caution against Sell-rated (Zacks Rank #4 or 5) stocks going into the earnings announcement, especially when the company is seeing negative estimate revisions momentum.

Stocks That Warrant a Look

Here are some other companies in the basic materials space you may want to consider as our model shows they have the right combination of elements to post an earnings beat this quarter:

Westlake Chemical Corporation (WLK - Free Report) has an Earnings ESP of +5.04% and a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

The Chemours Company (CC - Free Report) has an Earnings ESP of +4.44% and a Zacks Rank #1.

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