Dow Stock Catches An Upgrade. How to Value Beaten Down Cyclical Shares.

The analyst wasn’t ready to recommend the stock just yet. (Bill Pugliano/Getty Images)

Shares of embattled commodity chemical producer Dow Inc. caught an upgrade. It’s good news, but the analyst isn’t ready to recommend Dow stock just yet.

Thursday, BofA Securities’ Salvator Tiano raised his rating to Hold from Sell. He left his price target unchanged at $25.

Dow shares rose 2%, closing at $23.37 after the upgrade, while the S&P 500 and Dow Jones Industrial Average finished close to flat. Thursday’s gain still left shares down about 42% this year.

Tiano’s logic is fairly simple. Before, he was worried about weakening earnings and a dividend cut. In July, with second-quarter earnings, Dow slashed its dividend in half to 35 cents a quarter from 70 cents. The company guided to third-quarter sales of $10.2 billion, about $300 million less than Wall Street was projecting, according to FactSet.

With the dividend and the outlook addressed, “we see valuation as more attractive,” wrote Tiano.

Valuing a cyclical commodity chemical company isn’t easy. Earnings before interest, taxes, depreciation, and amortization, or Ebitda, hit $12.4 billion in 2021. Ebitda is expected to be $3.2 billion in 2025.

Tiano’s target is based on 10 times estimated 2025 Ebitda, but he noted that Dow’s historic multiple has tended to be around seven times “average” Ebitda.

Average or normalized Ebitda is a good way to look at cyclical companies. Dow has averaged about $7.2 billion in Ebitda over the past few years, including 2025 estimates.

After adjusting for debt, seven times that number implies a market value of about $33 billion, or $47 a share. That’s a lot higher than the current $23.14 price.

The missing ingredient in Dow’s stock recipe is the prospect for improvement. The commodity chemical industry is plagued by overcapacity in China and slow economic growth in Europe—which also has high energy costs—chronic headaches for producers. None of that is going away soon, which is a reason he doesn’t rate the stock a Buy.

Only 16% of analysts covering Dow stock rate shares Buy, according to FactSet. The average Buy-rating ratio for stocks in the S&P 500 is about 55%.

The upgrade from Sell didn’t change the Buy-rating ratio, but it did change the Sell-rating ratio. Now, 8% of analysts rate shares Sell. That’s about average for the S&P 500.

The average analyst price target for Dow stock is about $28 a share. A year ago, it was closer to $58. Things haven’t been easy for Dow lately. Maybe Tiano’s upgrade is an early sign that things will improve.

Write to Al Root at allen.root@dowjones.com