The chemical industry had a bumpy ride in 2013 as a weak
European economy, effects of sequestration in the U.S. along with
certain industry-specific challenges led to subdued demand for
chemicals for most of the year. Nevertheless, the December quarter
showed signs of life with improving trends across key industries,
raising hopes of a recovery.
Although the quarter showed continued recovery across commercial
construction and electronics end-markets, the industry is not out
of the woods. Questions about the emerging markets and a
still-challenging economic backdrop in Europe remain roadblocks.
But the industry is expected to fare relatively better in 2014,
aided by a shale gas boom in the U.S., healthy Chinese demand and
significant capital investment.
Chemical makers are ratcheting up investment on shale gas-linked
projects to take advantage of ample natural gas supplies which is
expected to boost capacity and export in 2014 and beyond.
Strength across agriculture and automotive markets and healthy
demand in emerging geographies represent tailwinds for the
industry. Strong agricultural market fundamentals in Latin America
and a gradual revival in the housing market bode well for recovery
prospects this year.
Industry at a Glance
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 roughly $770 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 employs nearly 800,000 people. It constitutes
roughly 12% of the nation's exports, aggregating $188 billion
annually. 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 had a 3.1% share of total earnings for the S&P
500 in 2013. 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. To learn more visit:
About Zacks Industry Rank
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
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
We have three chemicals related industries: Chemical Plastics,
Chemical Diversified and Chemical Specialty. The Chemical Plastics
industry currently retains a Zacks Industry Rank #10, placing it in
the top 1/3rd of the 260+ industry groups. Both Chemical
Diversified and Chemical Specialty industries lie in the middle
one-third with a Zacks Industry Rank #164 and #172, respectively.
Looking at the exact location of these industries, one could say
that the general outlook for the chemical industry as a whole is
Sector Level Earnings Trends
Looking at the overall results of the broader Basic Materials
sector, earnings shot up 20.7% in the fourth-quarter 2013, due
mostly to easy comparisons -- a marked improvement from a 2.2% rise
in the third. Total revenues were up 1.5% in the fourth quarter
versus a 1.1% rise a quarter ago. The sector racked up an earnings
beat ratio (the percentage of companies coming out with positive
surprises) of 66.7% and revenue beat ratio of 54.2% in the fourth
The earnings picture for the first quarter shows broad-based
weakness. Basic Materials is among the major sectors that are
expected to witness a decline in earnings in the first quarter,
with an expected 2.5% fall in earnings. Revenues, however, are
forecast to move up 2% in the quarter.
For 2014, earnings are expected to show a 9.8% increase. Revenues
are forecast to expand 2.4%.
For more details about earnings for this sector and others, please
read our latest '
Key Feedstock Price Trends
The chemical industry uses oil, naphtha and natural gas as energy
and feedstock inputs. According to chemical giant BASF SE (
), the price of Brent crude oil 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 $112 and a low of $104 so far this year, averaging at
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 Recovery Gathering Steam
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 manifested by
increase in building permits and a steady pick-up in home prices.
U.S. chemical exports are expected to rise 6.6% this year and 7.6%
in 2015, leading to continued generation of trade surplus. Trade in
chemicals is expected to rise with a recovery in global
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
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 revenues 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 was
flat year over year in Europe in 2013, modestly better than an
expected 0.5% decline. Weak demand across automotive and
construction markets remain as overhang, contributing to fragile
recovery. Nevertheless, CEFIC expects recovery in the European
chemicals industry to continue at a sluggish pace and sees a 1%
rise in output in 2014, aided by an uptick in exports.
Shale Boom Driving Chemical Investment
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
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
(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.
A recent ACC report indicated that 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 supplies.
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 Compelling Opportunity
Major chemical makers are increasingly shifting focus on businesses
that cater to agriculture 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.
A healthy start in the North American growing season, 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.
Mergers and acquisitions offer chemical companies another means to
shore up growth in a still challenging economic scenario. These
companies remain focused on exploring growth opportunities in the
fast-growing emerging markets, particularly in the lucrative
regions of Asia-Pacific and Latin America.
Moreover, cost-cutting measures implemented by chemical companies
including plant closures and headcount reduction should yield
industry-wide margin improvements. Cash flows derived through these
actions can be used for growth.
Recovery in Chinese Demand
China, a major market, is expected to see a recovery in 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. An improved demand outlook for China augurs
well for the chemical industry this year.
Stocks We Like
Chemical stocks that we like include
The Dow Chemical Company
PPG Industries Inc.
Eastman Chemical Company
). Dow and DuPont, in particular, are witnessing strong momentum in
agriculture, driven by higher demand for crop protection products.
Persistent weakness in Europe and its impact on global growth
remain sources of near-term uncertainty. Western Europe continues
to pose challenges on chemical stocks due to weak demand. Given the
industry's sensitivity to the global economy, any negative current
in the macro economy would be reflected in the prospects of the
In addition, weakness still persists in commercial construction,
which is among the key end-use markets. Demand from some of the
major manufacturing industries remains below the historic 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 Agrichemical Space
Agricultural chemicals and fertilizer makers face challenges
following the exit of world's largest potash maker Uralkali Group
from one of the biggest potash cartels -- the
Belarus Potash Company
) -- 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. This game-changing move has put
pressure on pricing.
Moreover, demand for potash and phosphate remains somewhat weak in
India, a key import market. Indian government's move to trim potash
subsidy levels coupled with local currency devaluation contributing
to lower demand for the nutrient in that country.
Stocks Warrant Caution
We hold a bearish view on
Air Products and Chemicals Inc.
The Sherwin-Williams Company
). We also steer clear of companies in the agricultural chemical
space. Companies that fit the bill include
CF Industries Holdings, Inc.
AGRIUM INC (AGU): Free Stock Analysis Report
AIR PRODS & CHE (APD): Free Stock Analysis
BASF SE (BASFY): Get Free Report
CELANESE CP-A (CE): Free Stock Analysis Report
CF INDUS HLDGS (CF): Free Stock Analysis Report
DU PONT (EI) DE (DD): Free Stock Analysis
DOW CHEMICAL (DOW): Free Stock Analysis Report
EASTMAN CHEM CO (EMN): Free Stock Analysis
METHANEX CORP (MEOH): Free Stock Analysis
POTASH SASK (POT): Free Stock Analysis Report
PPG INDS INC (PPG): Free Stock Analysis Report
SHERWIN WILLIAM (SHW): Free Stock Analysis
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