The chemical industry started the year on a positive note
following a bumpy 2013. With the U.S. economy getting its groove
back, the first two quarters of 2014 showed encouraging demand
trends for chemicals and continued recovery across end-use markets
such as commercial construction and electronics after being in a
rut for the most part of 2013.
The chemical industry also saw a pick-up in consolidation
activities so far this year. Although some industry-specific
challenges and slow economic recovery in Europe remain roadblocks,
the industry is expected to continue to recuperate through the
balance of 2014, backed by cost benefits from a shale gas boom in
the U.S. and significant capital investment.
Chemical makers are ramping up investment on shale gas-linked
projects to take advantage of abundant natural gas supplies which
is expected to beef up capacity and export in 2014 and beyond.
Strength across agriculture and automotive markets in North America
and healthy demand in emerging geographies represent tailwinds for
the industry. A gradually convalescing housing market also augur
well for recovery prospects this year and the next.
The Industry in a Nutshell
Chemicals are used to make consumer goods and are also used in the
agriculture, manufacturing, construction and service industries. In
fact, the chemical industry -- a roughly $5 trillion global
business - itself consumes 26% of its own output. Major industrial
consumers include rubber and plastic, textiles, apparel, petroleum
refining, pulp, paper and primary metals.
The chemical industry is among the biggest industries in the U.S.,
a more than $800 billion enterprise. It is cyclical by nature and
heavily linked to the overall condition of the U.S. and world
economies. The chemical industry touches 96% of manufactured goods,
making the manufacturing industry the biggest consumer of chemical
The U.S. chemical industry represents more than 15% of the global
chemical output and constitutes roughly 12% of the nation's
exports. Roughly 6 million additional jobs are backed by the
purchasing activity of the chemical industry. The U.S. chemical
industry supports around 25% of the nation's gross domestic product
Zacks Industry Rank
Within the Zacks Industry classification, the chemical industry
falls under the broader Basic Materials sector (one of 16 Zacks
sectors) which is expected to have a 2.8% share of total earnings
for the S&P 500 in 2014. We rank all of the more than 260
industries in the 16 Zacks sectors based on the earnings outlook
for the constituent companies in each industry.
The way to look at the complete list of 260+ industries is that the
outlook for the top one-third of the list (Zacks Industry Rank of
#88 and lower) is positive, the middle 1/3rd or industries with
Zacks Industry Rank between #89 and #176 is neutral while the
outlook for the bottom one-third (Zacks Industry Rank #177 and
higher) is negative.
We have three chemicals related industries: Chemical Specialty,
Chemical Plastics and Chemical Diversified. Both Chemical Specialty
and Chemical Plastics industries lie in the middle one-third with a
Zacks Industry Rank #90 and #110, respectively. The Chemical
Diversified industry currently retains a Zacks Industry Rank #225,
placing it in the bottom 1/3rd of the 260+ industry groups.
Looking at the exact location of these industries, one could say
that the general outlook for the chemical industry as a whole is
leaning toward 'Neutral.'
Sector Level Earnings Trends
Looking at the overall results of the broader Basic Materials
sector, earnings for 95.2% of the sector participants in the
S&P 500 index reported so far are up 11.9% in second-quarter
2014, a marked turn around from a 2.4% fall in the first.
Total revenues for these companies are up 3.7% in the second
quarter versus a 1.4% rise a quarter ago. The sector racked up a
healthy earnings beat ratio (the percentage of companies coming out
with positive surprises) of 70% and revenue beat ratio of 50% in
the second quarter.
The earnings momentum is expected to continue into the third
quarter with a projected rise of 9.7%. Revenues are forecast to
move up 1.5% in the quarter.
For 2014, earnings are expected to show an 8.3% increase, further
accelerating to a 19.4% rise next year. Revenues are forecast to
expand 2.1% this year and 5.2% in 2015.
Key Feedstock Price Trends
The chemical industry uses oil, naphtha and natural gas as energy
and feedstock inputs. According to chemical giant BASF SE (
), Brent crude
averaged $109 per barrel in 2013, below 2012 average of $112.
Brent crude prices touched a nine-month high of $119 in Feb 2013,
triggered by geopolitical tension in the Middle East, exacerbated
by Iran's nuclear program. Prices eased to below $100 in Apr 2013
on weak demand outlook for oil. Brent crude has hovered between a
high of roughly $116 and a low of $104 so far this year, averaging
at around $110. Prices crossed $115 in Jun 2014 on concerns over
possible supply disruption stemming from violence in Iraq.
The price of the other key raw material, naphtha, which is produced
from oil, ranged between $985 per metric ton and $820 per metric
ton in 2013, based on the BASF report. Naphtha prices averaged $902
last year, lower than the 2012 average of $937. The average annual
price of natural gas in the U.S. was $3.73 per million British
thermal units (MMBtu) in 2013, higher than $2.75 in 2012.
Chemical Industry on the Mend
The chemical industry is poised for a recovery this year and the
next. The American Chemistry Council (ACC), an industry trade
group, foresees national chemical output (excluding pharma) to rise
2.5% in 2014 (up from a 1.6% increase in 2013) and further improve
to a 3.5% gain next year. Growth will be backed by strong
agricultural market fundamentals, healthy demand from light
vehicles market and a recovery in the housing market.
U.S. chemical exports are expected to cross $200 billion this year
and rise roughly 8% annually through 2018, leading to continued
generation of trade surplus. Trade in chemicals is expected to rise
with a recovery in global manufacturing activities.
On the global front, ACC sees production to move up 3.8% in 2014
and 4.1% in 2015 with healthy gains expected across North America
and emerging markets.
The ACC expects strong capital spending in the coming years,
stemming from new investments in petrochemicals and derivatives. It
envisions U.S. capital spending to reach $61.2 billion by 2018.
The shale gas boom is expected to drive investment on plants and
equipment in the U.S. The ACC expects U.S. chemical shipment value
to surpass $1 trillion and the industry to rake in record trade
surpluses by 2018, partly boosted by significant share gas-driven
According to the European Chemical Industry Council (CEFIC), which
represents the European chemicals industry, chemical output will
rise 2% this year following a 0.2% fall in 2013. The gain will be
driven by increasing demand from customer industries (especially
automakers) and stabilization in construction markets. While CEFIC
expects continued growth in production in 2015, it expects output
to rise at a slower pace (of 1.5%) next year. Pace of growth is
expected to be stymied by high-energy prices that place European
chemical makers at considerable disadvantage versus their North
Shale Bounty Driving Chemical Spending
According to the ACC, emerging market growth and favorable
oil-to-gas price ratios resulting from abundant shale gas
production are driving U.S. chemical exports. A string of factors
are driving growth in the export markets, including favorable
energy costs stemming from the abundance of shale gas and healthy
demand from the emerging markets.
Affordable natural gas and ethane (derived from shale gas) offer
U.S. producers a compelling cost advantage over their global
counterparts who use a more expensive, oil-based feedstock. New
methods of extraction such as horizontal drilling and hydraulic
fracturing are boosting shale production, bringing down prices of
ethane in the process.
Leveraging the abundant natural gas supply and cost advantage,
chemical companies are investing billions of dollars for setting up
facilities (crackers) that produce ethylene from ethane. The U.S.
has emerged as an attractive investment location and chemical
makers are aggressively expanding capacity in the country.
According to an ACC report, potential domestic chemical investment
related to share gas has reached as high as $100 billion, more than
50% of which are from firms outside of the U.S. Already 148
projects -- backed by Federal government support -- have been
announced by chemical makers to take advantage of ample natural gas
These projects may lead to $81 billion in new chemical industry
output annually and 637,000 permanent new jobs by 2023. Such
investments are expected to boost capacity and export over the next
Agriculture: A Lucrative Prospect
Major chemical makers are increasingly shifting their focus on
businesses that cater to agriculture and health and nutrition
markets in an effort to cut their exposure on other businesses that
are grappling with weak demand and input costs pressure. In
particular, agriculture is emerging as a lucrative market as
evident from recent trends.
Strong planting activity by growers across North and Latin America,
solid order book and healthy supply of seeds and crop protection
products represent driving factors.
Strategic Measures: M&A Heating Up
Chemical companies remain actively focused on mergers and
acquisitions to diversify and shore up growth in a still
challenging economic environment. These companies continue to
explore growth opportunities in the fast-growing emerging markets,
particularly in the lucrative regions of Asia-Pacific and Latin
The chemical industry is expected to witness high levels of
consolidation activities in 2014 with some major deals have already
been announced this year including Albemarle Corp.'s (
) proposed buyout of Rockwood Holdings, Inc. (
) for $6.2 billion. Chemical makers are also divesting non-core
assets as they shift their focus on high margin businesses.
Moreover, cost-cutting measures implemented by chemical companies
-- including plant closures and headcount reduction -- are expected
to yield industry-wide margin improvements. Cash flows derived
through these actions could be directed for growth initiatives.
Recovery in Chinese Demand
Recovery in China, a major market, is expected to continue through
the balance of 2014. Government stimulus actions coupled with
efforts to stem inflation appear to bear fruit and exports to the
U.S. and other key markets are regaining momentum. Strength in the
automotive market represents another positive. An improved demand
outlook for China bodes well for the chemical industry this year.
Stocks We Like
Chemical stocks that look good in the prevailing operating backdrop
include LyondellBasell Industries NV (
), Celanese Corp. (
), The Dow Chemical Company (
), PPG Industries Inc. (
), The Sherwin-Williams Company (
) and Eastman Chemical Company (
While there have been some signs of improvement of late, the
European economy is still not out of the woods. Western Europe
continues to pose challenges on chemical stocks due to weak demand,
thus remaining a source of near-term uncertainty. In addition,
given the chemical industry's sensitivity to the global economy,
any negative current in the macro economy would be reflected in the
prospects of the chemical makers.
In addition, demand from some of the major manufacturing industries
remains below their historic highs. While non-residential
construction activities are improving, the market remains way below
its peak levels.
Pricing, FX Pressure
Commodity prices, though subsiding of late, still remain a concern
for many of the U.S. chemical producers. Their ability to pass
these costs on to end consumers is not always easy, given the
competitive pressures at play. As a result, margins for a number of
producers may be under pressure.
In addition, chemical companies generate a major chunk of their
revenues outside the U.S., and therefore are exposed to foreign
exchange fluctuations. Currency exchange translation remains a
headwind for these companies.
A Still-Cloudy Fertilizer Space
Fertilizer and agricultural chemicals makers continue to face
challenges from weak pricing, affecting their margins. Prices for
potash have been under pressure following the exit of world's
largest potash maker Uralkali Group from one of the biggest potash
cartels -- the Belarus Potash Company (BPC) -- that influence
potash pricing by controlling the production and supply. Uralkali's
Board decided to end export sales through BPC and direct all potash
export through its Switzerland-based trade arm Uralkali Trading.
Moreover, demand for potash and phosphate remains somewhat weak in
India, a key import market. Potash subsidy cuts by the Indian
government coupled with a weak local currency contributing to
depressed demand for the nutrient in that country. Moreover, the
demand environment for phosphate will remain uncertain in India in
second-half 2014 due to monsoon rainfall.
Stocks Warrant Caution
We hold a bearish view on FMC Corp. (
), DuPont (
), Methanex Corp. (
) and Air Products and Chemicals Inc. (
). We steer clear of certain companies in the fertilizer space.
Companies that fit the bill are The Mosaic Company (
) and CF Industries Holdings, Inc. (
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