Dow Maintains Rating on Positive Watch

A report from the Fitch Ratings states that it maintains Dow Chemical Company's (Dow) ratings on rating watch positive.

The positive watch reflects expected de-levering through earnings growth and scheduled repayment of debt. Earnings should grow with full year results of Dow Corning (50 percent acquired) and production ramp-up from projects.

Fitch believes Dow's funds from operations (FFO) net leverage could be below 2x by the end of 2018 will trend down through the intended merger and spin-off (see DowDuPont merger/spinoff).

The ratings watch will be resolved when Fitch has further clarity on the operating profile and capital structure of the successor to Dow.

Key rating drivers

DowDuPont merger/spin-off

Fitch placed Dow's ratings on rating watch positive on Dec 11, 2015, following the announcement of the proposed merger of equals between DuPont and Dow Chemical Company. The merger is to be a share-based transaction scheduled to close Aug 31, 2017. The merger is projected to deliver cost synergies of around $3 billion and growth synergies of roughly $1 billion.

Plastics provides profits

Dow is the largest ethylene and second-largest polyethylene producer in the world. Roughly 70 percent of its cracker capacity is located in the cost-advantaged Americas and Middle East. Fitch expects the performance plastics segment to continue to produce a significant share of Dow's profits given investments in US Gulf Coast (ethylene plant more than 95 percent mechanically complete) and at the company's 35 percent owned Sadara Chemical Company, which has achieved commercialization across the entire plastics franchise.

Sensitivity to hydrocarbons

Hydrocarbon feedstocks and energy comprise roughly 24% of Dow's production costs and operating expenses. These costs generally follow price trends in oil, and fluctuations in oil prices are generally reflected in selling prices of petroleum chemicals and plastics. Margins should improve on good demand supply fundamentals in end-markets, the company's cost cutting actions, improved throughput and elimination of start-up costs as projects complete, and moves toward greater value-added production.

Scale and market position

The ratings reflect Dow's position as the largest North American chemical company, patent-advantaged products representing more than 20 percent of revenues, and leading market positions in many commodity and speciality chemicals segments. The company has highly integrated production streams resulting in significant economies of scale and scope.

Structural considerations

Dow's senior unsecured notes do not benefit from upstream guarantees and are structurally subordinated to about $6.2 billion of subsidiary indebtedness.

Union Carbide is a wholly-owned subsidiary of Dow, and its rating is based on the high degree of financial, legal and business integration into Dow's operations. While the close integration would justify equalizing the rating, the one notch rating difference reflects Union Carbide's continuing exposure to asbestos litigation. Union Carbide has $472 million of notes outstanding.

The rating of the Rohm and Haas notes and debentures is based on the unconditional and irrevocable guarantee from Dow. Rohm and Haas have $1.2 billion in notes and debentures, of which, the 7.86 percent senior note due 2029 in the amount of $773.9 million is not guaranteed by Dow and not rated by Fitch.

Key assumptions

Fitch's key assumptions within our rating case for the issuer include:

Fitch assumes that Dow and DuPont will not provide cross guarantees, there will be no borrowing at the DowDuPont level, and that DowDuPont will not provide a guarantee of Dow or DuPont debt Fitch assumes the Material Science Company will succeed Dow and have a credit profile generally consistent with of Dow as of Dec 11 2015;-$1.7 billion in cash is assumed to be not readily available to repay debt The sale of the ethylene acrylic acid copolymers and ionomers business to SK Global Chemical Co Ltd occurs in 2017 and the sale of the Brazil corn seed business closes in 2018 Other top line growth at roughly 2 percent beyond 2017 EBITDA margins of 18 percent on average Capital expenditures trend toward depreciation expense Aggregate dividends to DowDuPont to be consistent with current levels adjusted for reduced share count Debt is repaid at maturity and there are no further capital changes.