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How Has Dow Chemical’s Free Cash Flow Improved?

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Stronger financial liquidity

Financial liquidity is a measure of a company’s financial ability to the meet its short-term obligations. Inability to pay short-term liabilities in time may have an adverse impact on a company’s operations as well as its share price. Therefore, although maintaining leverage is crucial, it is equally important to maintain liquidity.

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Increased free cash flow despite higher capex

The Dow Chemical Company’s (DOW) operating cash flow increased from $4.1 billion in 2010 to $6.5 billion in 2014, driven by improved earnings. Net profit increased to $3.9 billion in 2014, compared with $2.3 billion in 2010. With higher operating cash flow, Dow increased its free cash flow to $2.9 billion in 2014 from $1.9 billion in 2010. Dow’s free cash flow in 2013 improved significantly to $5.5 billion, compared with $1.5 billion in 2012, due to improved earnings and the drastic reduction in working capital. Dow has improved its free cash flow despite huge capital investments. The company’s capital expenditures rose from $2.1 billion in 2010 to $3.6 billion in 2014, due to significant investments in its US Gulf Coast projects and Sadara joint venture.

Improved liquidity

Dow’s liquidity rose from $10.0 billion in 2010 to $11.8 billion in 2014. Liquidity was higher due to the significant increase in revolving credit facilities from $3.0 billion in 2010 to $6.2 billion in 2014. However, Dow’s cash and cash equivalents fell to $5.7 billion in 2014 from $7.0 billion in 2010. Current ratio also improved, from 1.7 in 2010 to 2.1 in 2014.

Free cash flow comparison

Dow’s free cash flow improved significantly, rising by 84% YoY (year-over-year) to $2.4 billion in the first nine months of 2015 from $1.3 billion in the same period of 2014. Peers Eastman Chemical Company (EMN) and Monsanto (MON) reported free cash flows of $0.6 billion and $2.1 billion, respectively.

The Materials Select Sector SPDR ETF (XLB) and the iShares US Basic Materials ETF (IYM), which primarily focus on chemical stocks, are some alternatives for investing in the chemical industry. Dow, Monsanto, and Eastman make up 11%, 8%, and 2%, respectively, of XLB’s holdings.

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