The most unglamorous businesses often toss up the best values. Richard Earnest, portfolio co-manager of HighMark Value Momentum fund, thinks he's spotted a bargain in old-line Dow Chemical, the big ($46 billion sales) maker of plastics and chemicals.
Chemicals are a highly cyclical industry -- but that's what attracts Earnest. "For the first time in a long time, we have a unified, global economic recovery, which is great for big, cyclical multinationals," he explains. Overseas, where Dow (symbol DOW) generates 62% of its revenues, emerging economies such as China and India are booming. Growth in even the large, mature consumer markets of Japan and Western Europe is perking up.
The second plank of Earnest's case for Dow turns on the price of natural gas, the principal feedstock for the Michigan-based company's chemicals and plastics. Natural gas prices have risen, but not nearly as much as world oil prices. Dow's big European competitors such as BASF and Bayer depend on naphtha, an oil derivative, for their feedstock. Advantage Dow.
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Buoyed by strong free-cash flow, the company is rapidly reducing debt and cleaning up its balance sheet. Earnest reckons it may start buying back its low-priced shares soon. Meanwhile, Dow's stock currently yields 3.7%, one of the better returns available apart from the utility and banking sectors.
At $41, the stock sells for just eight times the average of analysts' 2006 earnings estimates of $4.89 a share, according to Thomson First Call. Earnest thinks the company could earn in excess of $5 a share next year and sell on a P/E multiple of 10, implying a $50 price. Plastics and chemicals may not be pretty, but the total return on venerable Dow shares could be handsome.
--Andrew Tanzer
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