What the Dow Chemical Company's $20 Billion Growth Project Means to Investors

By Markets Fool.com

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Dow Chemical CEO Adam Liveris is interviewed by March Gunther in 2012. Image Source: Fortune Live Media/ Flickr.

To earn big, you have to spend big. When it comes to an industry as massive and globally competitive as petrochemicals, the definition of "big" can reach unparalleled heights. In the case of Sadara, the joint venture between Dow Chemical Company and Saudi Aramco, that meant cutting checks totaling $20 billion to build the world's largest petrochemical complex. While Dow Chemical has talked about the growth Sadara will enable for several years now, the first manufacturing units will finally come online in 2015.

That's good news, but, uh, what does that really mean?

Sure, investors have heard about millions of metric tons of production of chemicals with funny names and the long-term earnings estimates for the JV. But you still may be wondering what it really means to individual investors like you. With that in mind, let's dig a little deeper and discuss, in simple language, what you need to know about one of Dow Chemical's largest growth projects.

Sadara by the numbers
The joint venture will operate the world's largest chemical complex ever assembled in a single construction phase. So, if you think Sadara will be accompanied by gaudy stats and facts, you would be right. Here are a few that demonstrate the size, value creation, and global importance of the JV.

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  • $20 billion: total investment in project
  • 35/65: equity split between Dow Chemical and Saudi Aramco
  • 26: number of integrated world-scale manufacturing plants
  • 14: number of the project's manufacturing plants bringing production of specific chemicals to Saudi Arabia for the first time
  • 3 million: metric tons of annual manufacturing capacity
  • 100%: amount of initial production already sold
  • 60%: amount of total production expected to be sold to the fast-growing Asia Pacific region
  • 1 year: time of full operations required to become a Fortune 500 company

One of the most important aspects of Sadara that often gets overlooked is what the manufacturing complex means to the surrounding region. And since that region (the Middle East or, more specifically, Saudi Arabia) happens to be at the center of many existing global trade routes for petroleum and petrochemicals, the effects will be even more profound.

Consider that Sadara will allow several important petrochemicals to be produced for the first time in Saudi Arabia. Those chemicals will become the raw materials used to create important everyday products often craved by the growing global middle class, especially in China, which figures to be a strategic long-term destination for end-uses of the JV's output.

Knowing how important Asian Pacific markets will be to future trade, Saudi Arabia didn't waste any time utilizing its newfound manufacturing abilities. A separate world-class industrial park, called PlasChem Park, will be constructed next to Sadara. The 12-square kilometer complex will use chemical products created from Dow Chemical and Saudi Aramco's venture to manufacture additional chemicals and consumer-ready products, such as those listed below:

Chemical Group
(Sadara production)

Everyday Product Applications
(PlasChem production)

Amines

Textile fibers, dyes, pharmaceuticals

Glycol ethers

Solvents, biodegradable paints

Isocyanates*

Car seats, pesticides

Polyether polyols*

Foam mattresses, furniture, various foams

Polyethylene

Food packaging, plastic bottles

Polyolefin elastomers

Automobile interiors (dashboard), footwear

Propylene Glycol

Toothpaste, food additives

*First manufacturing capacity in Saudi Arabia. Source: Dow Chemical, Sadara.

PlasChem Park will ensure a baseload demand for Sadara's output and bolster its value to Saudi Arabia and maturing economies such as China. In other words, the joint venture represents a relatively low-risk, long-term growth opportunity for investors. That's great news considering the large impact it's expected to have on Dow Chemical's financial performance.

What drives the economics for Sadara?

Image source: Dow Chemical.

Despite the hefty price tag, Dow Chemical expects Sadara to become an earnings and cash flow machine relatively quickly. The chemical leader's 35% stake in the JV will generate an average of $500 million in annual earnings for the first 10 years of operations, in addition to achieving positive cash flow within the first five years of operations. Keep in mind, this financial windfall will arrive after new all-time highs for annual EBITDA ($9.3 billion) and annual cash from operations ($6.5 billion) were established in 2014.

What drives Sadara's favorable economics? Cheap inputs.

Saudi Arabia is home to some of the most cost competitive petroleum production in the world. Since Dow Chemical and Saudi Aramco will utilize regional petroleum derivatives (naphtha, for example) and natural gas derivatives (ethane), the JV will achieve some of the lowest production costs possible. When coupled with high selling prices realized from selling into high-demand (Asia Pacific) or production-challenged (Europe) markets, investors can expect very healthy profit margins.

What about falling oil prices?
On Dow Chemical's last conference call some analysts wondered aloud if the competitive advantages were washed away given recent developments in the global energy markets. After all, the recent drop in oil prices forced several other global joint ventures to shelve or cancel plans for new construction. For instance, Qatar Petroleum and Royal Dutch Shell abandoned a $6.5 billion petrochemical manufacturing facility citing that falling oil prices rendered it "commercially unfeasible."

Deutsche Bank analyst David Begleiter asked Dow Chemical CEO Adam Liveris and CFO Howard Ungerleider about the potential risks to long-term earnings. Liveris acknowledged the drawbacks of making long-term predictions, but asserted that the ability to utilize multiple raw materials provided opportunities to maintain profit margins in low price oil environments.

Ungerleider took a different approach, by simply reverting the analyst back to the company's long-term focus:

David I would also add, this is Howard, that $500 million [in equity earnings] with a 10-year average run rate is over the first 10 years, so we're not stepping away from that number.

Admittedly, Sadara was likely too far along in development to step away from in late 2014. But investors should be encouraged that Dow Chemical management has their eye on the future rather than short-term volatility. That fact is integral to the company's plans to create an additional $2.7 billion in annual EBITDA from growth projects coming online in the next few years, including Sadara.

What does Sadara really mean for investors?
The $20 billion growth project really will be an earnings and cash flow machine for Dow Chemical investors for years to come. While it's impossible to predict movements in global energy markets, Sadara can counter volatility with feedstock flexibility, direct sales to PlasChem Park next door, and the continually growing demand for consumer goods China's middle class. When coupled with increasingly efficient existing operations that enabled record EBITDA and cash flow in 2014, it's difficult to argue that now is a bad time to be a Dow Chemical shareholder.

The article What the Dow Chemical Company's $20 Billion Growth Project Means to Investors originally appeared on Fool.com.

Maxx Chatsko has no position in any stocks mentioned. Check out hispersonal portfolio,CAPS page,previous writingfor The Motley Fool, and follow him on Twitter to keep up with developments in the synthetic biology field.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.