Title: Should You Grab This High Dividend Stock, Offering a 23% Drop and a 6.7% Yield, in December?
In the past year, shares of the renowned commodity chemical giant, Dow (DOW -0.85%), have taken a beating, losing approximately 23% overall and 13% just in the past month. This unfortunate turn of events led to Dow's removal from the prestigious Dow Jones Industrial Average and its replacement by Sherwin-Williams. The recent tumble has pushed Dow's dividend yield up to an enticing 6.7%. Let's dissect the underlying forces driving this sell-off and explore whether Dow's current predicament makes it an appealing high-yield dividend stock worth considering.
Tests that Dow is weathering
Dow can be categorized under three operating segments: packaging and specialty plastics, industrial intermediates and infrastructure, and performance materials and coatings. Companies in this realm, such as oil and gas firms, gold miners, and other commodity dealers, are at the mercy of commodity prices, relentlessly striving to control costs and optimize their product output.
Regrettably, the market for commodity and specialty chemical companies, petrochemical firms, and refiners has been on a downward spiral due to factors like weakening demand in Europe and China, hardened competition steepening from China, and elevated interest rates. As the following chart illustrates, major refining businesses have forfeited gains amassed earlier in the year, and chemical companies have followed suit:
The voice from the top tier
On its third-quarter 2024 earnings call, Dow's CEO James Fitterling explained briefly why the company is facing headwinds:
Europe is the primary area of concern, plagued by enduring soft demand and an unequivocal lack of long-term regulatory policy. The continuing absence of a clear, consistent, and competitive regulatory environment in Europe has resulted in numerous challenges for our industry. These challenges have been articulated by European Union leaders, top economists, and industry peers. Even though a demand rebound was anticipated in other regions, Europe remains a significant concern[4].
Dow, being a multinational entity, is not immune to global economic fluctuations. This can be seen in the following chart, which illustrates that the overall global slowdown has had a crushing impact on Dow's margins since the company spun off from DowDuPont and became an independent entity in 2019:
Fears of a Fed-driven slowdown
There's mounting speculation that the Fed may continue to keep interest rates high to rein in stubbornly persistent inflation. This potential prolonged high-interest rate environment could have severe consequences for manufacturers relying on extensive production, like Dow, which could depend on automakers most heavily. With a growing number of automakers grappling with weak demand, sky-high costs, and higher interest rates that hinder car financing, Dow's circumstances could deteriorate even further.
On top of this, increased interest expenses pose challenges for capital-intensive businesses like Dow. As a result, the company's net long-term debt has risen, and though its financial debt-to-equity and debt-to-capital ratios remain relatively stable, its credit rating of BBB issued by S&P Global sits precariously on the cusp of the investment-grade range. Analysts from S&P Global indicate that a BBB rating implies a company possesses "adequate capacity to meet financial commitments but may be more subject to adverse economic conditions."
Why should you take a closer look at Dow?
Despite its numerous challenges, it's compelling to examine why Dow could be an intriguing high-yield dividend stock opportunity for patient investors who can manage volatility.
- Enduring the cycle: Timing the business cycle is a losing proposition. However, if you embrace a long-term investment horizon of at least 3 to 5 years, Dow might be a suitable candidate for you. Employing this investment strategy could enable Dow to weather its current hardship, gradually bouncing back and potentially improving its margins and earnings in the long run.
- Dividend During Challenges: Dow has kept its dividend unaltered since its separation from DowDuPont and is likely to maintain it even as the company's fortunes take an upward turn. With its dividend yield already sky-high, the mere act of maintaining it would serve as a significant draw for income investors.
If you purchased the stock now at around $42 and held onto it for a five-year term, assuming that the dividend remained unchanged at $0.70 per share per quarter, you'd collect $14 in dividends, resulting in a yield on cost of 33.3% - a tantalizing proposition to buy the stock, even if it takes some time for the industry to turn around.
- Leading the pack under distressed circumstances: Dow isn't merely a chemical combination company trying to survive a hardship; it's an industry-leading powerhouse experiencing a downturn. Buying top-notch companies on deep discounts when they're undergoing self-inflicted struggles can be a great buying opportunity. On the other hand, packages faced with problems due to broader market factors might present another type of buying prospect.
Merits of Sticking to Dow
- High Yield: Dow's lofty 7.0% dividend yield makes it an appealing choice for income investors seeking higher returns[4].
- Long-term potential: Despite the industry's cyclical nature, Dow's scale, low-cost feedstock position, and diversified portfolio better position it to defend its dividend, making it a potential long-term investment[4].
- Defensive Income Investment Appeal: Dow's attractive dividend yield, regulated earnings, and sturdy balance sheet appeal to defensive income investors looking to forgo some short-term dividend growth in favor of the stability and reliability of the dividend payments[4].
- In light of the current market conditions, some investors might consider diversifying their portfolios by investing in Dow, given its strong position in the commodity chemical industry and the attractive yield it offers.
- If one is interested in pursuing an investment strategy centered around value and income, Dow's current financial situation, with its high dividend yield, could present a compelling investment opportunity for those willing to weather potential volatility and focus on the long term.
