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

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.

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Maxx Chatsko has no position in any stocks mentioned. Check out his personal portfolio , CAPS page , previous writing for 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 .

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