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No. of Recommendations: 7

Question: does this information allay some of the concern or only create more?

Any undefunded pension program needs to be watched carefully. If the primary plan to fully fund the program is to use the markets I would be very nervous. What got many pension plans in deep water were pie in the sky growth estimates that only work during the best years. I seriously doubt DOW CFO staff rivals that of Goldman Sachs or some of the better hedge funds. If they were that good a great deal more money can be made elsewhere.

I personally believe the picture you paint is of the DOW from 2007

No, the financial picture I painted is based mostly off of the last 4 quarters using an eye on the past for guidance. There are a serious issues with their CapEx and Depreciation. The reason I reached back to 2007 is because that was the last rational CapEx number used by this 100 year old company. Their business model did not change that dramatically with the acquisition of a specialties chemicals firm. An increase in depreciation can be understood. They acquired another firm therefore more assets to depreciate. It is also not unusual for a firm, if given the opportunity, to accelerate depreciation. I assumed an accelerated depreciation schedule and then smoothed it via averaging.

Here is the problem, DOW is not fully funding its own infrastructure, the very things it uses to take raw inputs and add value to them for wholesale. How long can we expect them to add value at reasonable margins while their facilities decay? At what point are they forced to expend the money they did not expend over the last 3 years?

In a fully mature business like DOW we can anticipate Depreciation and CapEx to be about equal. If they are expanding CapEx may be larger than depreciation; depreciation would lag as the new equipments was first purchased and then the next qtr or year they would begin depreciating it. Depreciation may be larger if they are acquiring or phasing out specific units. Over all the two numbers should be relatively close to each other.

The concept is relatively simple, as soon as we buy a new car we are on the path to buying the next one. As soon as we roll off the lot the car has depreciated by 10% or more. For each year we own the car it continues to lose value. Each year we own the car we must perform basic maintenance on the car or it will fail long before its expected life span is over. After X number of years, depending on use, the useful life of the car is gone and it begins to become more expensive to maintain then to purchase new and must be replaced. As a business we can claim that loss in value using depreciation and we either need to budget monthly or annually for its replacement or find the lump sum at the end of its usefulness in another account or obtain debt.

Right now DOW is barely putting oil and windshield fluids in their vehicle.

I dont really know where you get the -6.9% negative growth figure from - is that revenue, EPS or another metric?

The formula is ROIC * Reinvestment Rate
6.6% * - 105.85% = - 6.98%

This is a direct reflection of their failure to invest in themselves via CapEx. Change the CapEx to a historic average rate and the estimated growth rate goes marginally positive. Right now, today, the past 3 years they are not reinvesting adequately enough to anticipate growth.

When I look at their books and the cut dividend what I see is a company that is choking on its last acquisition. The synergies may make sense but it does not look like they could afford what they took on. In order to generate the cash needed to keep basic functions rolling and to pay for their new division they are robbing their future. Their current cash flow is not sustainable. If I was a rating agency I would have them on credit watch.

Currently this is not a healthy company. Maybe they can get ahead of this mess and turn a corner but it will take a fair amount of time and it will be painful. I would not buy this for $10/share, the risk reward scenario is weighted too heavily toward risk.

Good luck

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