Dow Chemical Puts Hit Four-Year Low on Asset-Sale Plan: Options

The cost of hedging against losses in Dow Chemical Co. shares has fallen to a four-year low as the company considers selling assets, such as its chlorine-related businesses, to boost profitability.

Puts protecting against a 10 percent drop in the stock cost 3.60 points more than calls betting on a 10 percent rally, according to three-month data compiled by Bloomberg. The price relationship known as skew fell to 2.95 on Dec. 5, the lowest since March 2009. Dow Chemical shares have climbed 12 percent this month, beating all other 30 raw-materials producers in the Standard & Poor’s 500 Index.

The largest U.S. chemical maker by revenue is shifting its focus to more profitable businesses as competitors such as DuPont Co. and Ashland Inc. face pressure from activist investors to increase shareholder returns. Chief Executive Officer Andrew N. Liveris said in October that he’s seeking to generate as much as $4 billion from asset sales over the next two years. Analysts forecast the company’s profit margin will improve every year through 2015 to reach the highest level in a decade.

Dow Chemical (DOW) “is a great find for those people that are looking for reasonably priced stocks with potential,” Peter Morris, chief investment officer at Arlington, Virginia-based National Rural Electric Cooperative Association, said in a Dec. 11 phone interview. He helps manage $12 billion in NRECA and Homestead funds, including Dow Chemical shares. “Pricing is pretty good in the business. Earnings in the cycle can go higher.”

Excess Capacity

Dow Chemical said earlier this month that it plans to separate chlorine-related assets, including the unit that makes epoxy, a material used in plywood and can linings. The company’s third-quarter earnings missed analyst estimates by the most in a year after excess capacity in China hurt sales in the epoxy unit.

The Midland, Michigan-based company said it’s holding on to businesses that use chlorine as a raw material to make value-added products, such as 2,4-D, an herbicide tolerated by Dow’s genetically modified crops. Chlorine is also used to make products including polyvinyl chloride, a plastic known as PVC.

Chemicals producers have taken steps this year to sell assets after Nelson Peltz’s Trian Fund Management LP bought a stake in DuPont and activist investor Jana Partners LLC became the second-largest shareholder in Ashland.

‘Next Target’

“If you’re a major competitor and you see activists in two of your major competitors, anyone with half a brain is going to say you’re the next target,” Alec Levine, an equity-derivatives strategist at Newedge Group SA in New York, said in a telephone interview. “Dow is trying to get ahead of it so they don’t become prey to an activist.”

Analysts forecast Dow’s gross margin, a gauge of profitability as measured by earnings as a percentage of sales, will increase for a seventh straight year in 2015 to reach 17 percent, the highest level since 2005, estimates and financial data compiled by Bloomberg show.

Implied volatility, used to gauge the cost of options, for three-month contracts with an exercise price 10 percent below Dow shares rose 14 percent to 30.30 in the past two months, data compiled by Bloomberg show. During that time, the measure for calls 10 percent above the shares jumped 21 percent to 26.69.

Rebecca Bentley, a Dow Chemical spokeswoman, did not return a phone call or e-mail requesting comment on the company’s options trading.

Trailing Peers

Dow shares will trail the rest of the industry in the coming years because the stock is expensive and earnings may not keep pace with peers because of high costs and a concentration in commodity chemicals, according to Matt Arnold, a St. Louis-based analyst with Edward Jones & Co. He recommends selling the stock.

“More attractive investment opportunities exist in the materials sector,” Arnold wrote in wrote in a Dec. 4 note. “In light of our unfavorable long-term view of the company’s fundamentals, we do not find the valuation compelling.”

Shares of Dow traded at 22.3 times reported earnings, up 28 percent this year and compared with a multiple of 19.3 for the S&P 500 Materials Index. DuPont, the biggest U.S. chemicals maker by market value, had a price-to-earnings ratio of 20.4, according to data compiled by Bloomberg.

The Chicago Board Options Exchange Volatility Index, a gauge of S&P 500 option prices known as the VIX (VIX), declined 5.4 percent to 13.04 yesterday. Its European counterpart, the VStoxx Index, slipped 1.3 percent to 15.81.

Bullish Options

Traders held more bullish options on Dow than bearish ones. The ratio of outstanding calls giving the right to buy the stock versus puts to sell was 2.38-to-1, according to data compiled by Bloomberg. All seven most-owned options were bullish. January $40 calls had the largest open interest, followed by January $45 calls, which had an exercise price 2.6 percent above yesterday’s close, the data show.

Dow’s chlorine-related assets that it plans to separate from the business account for as much as $5 billion of annual sales. CEO Liveris said on Dec. 2 that the company has already received expressions of interest from potential buyers.

“In the options world, you could see there’s a vote of confidence in this aggressive Liveris strategy to restructure the company,” Newedge’s Levine said. “They’re in a massive major restructuring and obviously the market is looking at this positively.”

To contact the reporters on this story: Callie Bost in New York at cbost2@bloomberg.net; Lu Wang in New York at lwang8@bloomberg.net

To contact the editor responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net

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