The September quarter essentially mirrored the conditions
witnessed in the first two quarters of the year. A feeble economic
recovery in the U.S. and persistent recessionary conditions in
Europe continue to lead to depleted demand for chemical products.
Growth continues to struggle due to weaknesses across some key
end-markets, including electronics.
Companies in the chemicals space saw their profits sag in the
September quarter, largely due to the fragile economic conditions
in Europe and weak pricing. Activity across the emerging Asian
economies remained subdued in the quarter given the slowdown in
exports due to weak western demand. The U.S. economy, on the other
hand, is treading on thin ice given the concerns regarding the
looming "fiscal cliff."
While the scenario is not expected to change in the December
quarter, the industry is expected to continue to see slack demand,
amplified by the production disruptions associated with Superstorm
Sandy and uncertainty in the U.S. economy. Nevertheless, the
fledgling recovery in the housing market may represent a potential
positive for the industry heading into 2013.
Industry Fact File
Chemicals are generally used to make a number of consumer goods and
are also used in the agriculture, manufacturing, construction and
service industries. In fact, the chemical industry itself consumes
26% of its own output. Major industrial consumers include rubber
and plastic, textiles, apparel, petroleum refining, pulp and paper
and primary metals.
The chemical industry, a nearly $3 trillion global business, has
grown at a brisk pace for more than five decades. The fastest
growing areas have involved the manufacture of synthetic organic
polymers used as plastics, fibers and elastomers. The chemical
industry is mainly concentrated in three areas of the world:
Western Europe, North America and Japan. Europe is the largest
producer, followed by the U.S. and Japan.
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 $187 billion
annually. Roughly 5.5 million additional jobs are backed by the
purchasing activity of the chemical industry. The U.S. chemical
industry supports roughly 25% of the nation's gross domestic
product (GDP). The industry shipped more than 759 million tons of
products in 2011.
The chemical industry is cyclical by nature and heavily linked to
the overall condition of the U.S. economy. Chemical industry also
touches 96% of manufactured goods, making the manufacturing
industry the biggest consumer of chemical products.
There are 170 major chemical companies in the U.S. operating
internationally with more than 2,800 facilities abroad. The
chemical industry is among the biggest industries in the U.S., a
roughly $760 billion enterprise. It has been consistently leading
the U.S. economy's business cycle due to its early position in the
According to chemical giant
), global chemical production (excluding pharmaceuticals) rose 4.8%
in 2011, backed by healthy demand from major industries. In the EU,
chemical production edged up 1.6% while declining 3.1% in Japan,
hurt by the March 2011 quake.
The sluggish economy took a toll on growth in the U.S. as the
nation's chemical production increased a nominal 2.1% in 2011.
South America and Asia (excluding Japan) witnessed growth of 4.7%
and 11.1%, respectively. Growth in Asia was led by strong
contributions from China.
Weak Manufacturing Hurting Production
U.S. chemical output barely rose on a monthly basis in October,
according to the latest monthly report from the American Chemistry
Council (ACC). The Washington-based chemical industry trade group
reported that the U.S. Chemical Production Regional Index (CPRI)
edged up 0.2% in October, following an upwardly revised 0.3% gain
in September. The tepid growth reflects the continued weakness in
the overall manufacturing sector.
The U.S. CPRI, which was created by Moore Economics to track
chemical production in seven regions nationwide, is comparable to
Federal Reserve's industrial production index for chemicals. The
ACC noted that chemical production improved across all regions
other than West Coast, Mid-Atlantic and Northeast on a monthly
comparison basis in October.
The October reading showed that overall chemical production fell
0.2% when compared on a year-over-year basis. On a region-by-region
basis, production rose across the Gulf Coast and Ohio Valley areas
while the Midwest, Mid-Atlantic, Southeast, Northeast and West
Coast regions saw declines. On a year-to-date basis (production for
the first nine months of 2012 compared with the year-ago data),
production inched up 0.1%.
On a monthly comparison basis, chemical production in the Gulf
Coast region, where key building block materials are produced,
edged up 0.5% in October. The Midwest and Ohio Valley regions
witnessed a 0.1% and 0.6% increase, respectively. Output slipped in
the Mid-Atlantic (down 0.1%), Northeast (0.1%) and West Coast
(0.2%) regions. Production crept up 1% in the Southeast.
Output from the U.S. manufacturing sector dipped 0.5% in October
after declining 0.2% a month ago. Within this sector, output rose
in several key chemistry end-user markets including appliances,
aerospace and structural panels.
The manufacturing sector serves as a barometer to gauge the overall
health of the U.S. economy and has a major influence on the
chemical industry. Lower investment, given the ongoing uncertainty
surrounding the fiscal cliff, led to the weakness in manufacturing.
The U.S. market is gripped by the fear that the economy may slip
back into recession should the Congress fail to avoid the roughly
$600 billion in tax hikes and spending cuts scheduled to take
effect in January 2013.
The ACC said that output rose across many segments such as organic
chemicals, plastic resins, consumer products, coatings, adhesives,
and other specialty chemicals. This was, however, masked by
declines in pesticides, fertilizers, man-made fibers, synthetic
rubber industrial gases and pharmaceuticals.
Chemical output continues its declining trend in Europe. According
to the European Chemical Industry Council ("CEFIC"), chemicals
production in the European Union fell 2.2% year over year in the
first eight months of 2012. Production fell 2.2% year over year in
August 2012. Chemicals prices rose 1% year over year in August, led
by an increase in the price for basic inorganics.
Raw Material Trends
The chemical industry uses oil, naphtha and natural gas as energy
and feedstock inputs. Oil prices remain high despite the sub-par
growth outlook for the global economy, largely owing to
geostrategic reasons. BASF report states that the price of Brent
crude oil rose sharply in 2011 (averaging $110 a barrel), stirred
by the combined impact of strong demand and political unrest in the
Middle East and North Africa.
Brent crude, which hit a four-year high of $128 a barrel in March
2012, is hovering between a high of $115 and a low of $105 since
October 2012. Geopolitical tension in the Middle East, exacerbated
by Iran's nuclear program and the unrest in Egypt, is keeping price
from sliding given the concerns about a potential supply crunch.
Price of the other key raw material, naphtha, averaged $930 per
metric ton in 2011, representing more than 30% year-over-year
surge. Naphtha prices are also expected to remain elevated relative
to last year's levels. The only bright spot for the industry on the
feedstock front is natural gas. In fact, the price of natural gas
has dropped to its lowest level in over a decade.
Over the past five years, the U.S. natural gas markets have seen a
dynamic shift due to the emergence of a new source of energy, shale
gas, which exists in large quantities with sources close to many
big energy-intensive cities. Shale gas is not only desirable for
environmental reasons, given its low carbon footprint relative to
oil or coal, but is at the same time cost effective.
Weak View for 2012, Better Days Ahead
The European debt crisis, weak U.S. manufacturing along with
sluggish activity in China and other key emerging markets led to
weak demand for chemical products in the September quarter,
something which is expected to continue through 2012. While the
U.S. is not headed toward another recession, the debt issue in
Europe coupled with other economic uncertainty poses downside risks
to the nation's economic outlook.
The ACC foresees modest production growth in 2012 followed by a
stronger recovery in 2013. National chemical output is expected to
slow to 0.5% in 2012 from 3.8% a year ago, and then rise to 2.3% in
The ACC expects weaker growth in European chemicals output in 2012,
in part, due to increased uncertainty. While developed economies,
restrained by debt and stricter fiscal policies, are likely to
increase chemical production at a modest pace, more rapid growth in
output from the emerging markets is expected in 2012.
The ACC sees global chemical industry output to grow 2.3% in 2012,
4.3% in 2013 and 4.7% in 2014. Stronger growth is expected in
specialty chemicals, consumer products and agricultural chemicals
Growth in China is expected to be healthy, albeit at a slower pace,
while production in other emerging markets is expected to expand in
2012. Chemical makers in the emerging economies are expected to
deliver a 6.2% production increase in 2012 followed by a 7.5%
growth in 2013.
The ACC expects strong growth in capital spending in the coming
years, stemming from new investments in petrochemicals and
derivatives. It envisions capital spending to reach $35.5 billion
in 2012 and steadily advance to $51.5 billion in 2017. A rebound
across emerging markets is expected to contribute to accelerated
growth over the next several years.
A recent CEFIC report says that European chemical output will
contract 2% year over year this year followed by a modest increase
(of 0.5%) in 2013. The economic downturn in Europe and the region's
weak construction and automotive sector will contribute to lower
output in 2012.
Moreover, chemical production in the European Union is expected
be 8% below its pre-recession level in 2012, as austerity measures
adopted to staunch the high sovereign debt levels have led to
higher unemployment levels and weak demand. The expectation for a
slim recovery in 2013 stems from the anticipated modest growth in
every quarter, partly driven by export markets.
According to the ACC, emerging market growth and abundant shale gas
should help drive 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 strong 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,
Further, 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.
Mergers and acquisitions offer chemical companies another means to
shore up growth in this difficult 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 such as China and Brazil.
We feel that chemical companies with strong earnings quality,
healthy growth trajectory and liquidity profiles are better placed
in the current rickety market environment considering their ability
to leverage strong balance sheet and cash flows in maximizing
shareholder value in form of dividends and share repurchases or use
them for value acquisitions.
We have a bullish view on
Eastman Chemical Company
), which is delivering forecast-topping earnings and is well placed
to benefit from its Solutia acquisition. The company's diversified
chemical portfolio and integrated and diverse downstream businesses
represents the pillars of strength. It also benefits from business
restructuring, cost-cutting measures and increased capacity
We are also optimistic about
) despite the challenges it faces in Europe. We like the company's
initiatives to improve margins and profits by running its plants
better and controlling expenses. The company's strong presence in
emerging markets, especially in China, will enable it to deliver
incremental earnings in 2012. We are also upbeat about the prospect
of its TCX ethanol process technology.
In specialty chemical space,
PPG Industries Inc.
) represents an attractive play. The company witnessed strong
growth in its North American automotive OEM coatings business in
the September quarter, enabling it to deliver better-than-expected
earnings. It has a diversified base of products and markets, and
looks to grow its businesses strategically along with controlling
We also hold a favorable view on specialty chemical company
). The company has taken up a number of steps, including production
ramp ups in New Zealand and the Medicine Hat unit, to boost
capacity. We are upbeat about its Louisiana project, which is
expected to create significant value for its shareholders and
meaningfully contribute in cash generation.
Commodity price hikes, though subsiding lately, is adding to
feedstock costs 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 will continue to be under pressure.
Given the industry's sensitivity to the global economy, any
negative current in the macro economy would be reflected in the
prospects of the chemical companies. The turmoil 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 (particularly in the construction industry) and the
lingering impact of debt crisis.
The U.S. housing sector, a key consumer of chemicals, has shown
signs of recovery lately, manifested by a steady pick-up in home
prices. However, demand from this industry still remains way below
the historic levels. Weakness in the electronics and construction
end-markets may continue to weigh on the results.
Chemical companies generate a considerable amount of revenues
outside the U.S., and therefore are exposed to foreign exchange
fluctuations. Unfavorable currency exchange translation (stemming
from a stronger dollar) dented most of these companies' results in
the most recent quarter.
Another challenge comes in the form of production disruptions as a
result of Hurricane Sandy, which wreaked havoc on the Northeast
U.S. Production is expected to be hit by associated outages in the
The Dow Chemical Company
) was hammered by several headwinds in the September quarter. Its
profit slid on lower pricing across all regions. The company also
saw weak demand for its products in the quarter, stemming from the
challenging conditions in Europe and sluggish activity across major
Moreover, building and construction sales remain under pressure due
to lower volume in Europe and recovery in electronics remains slow,
partly due to sluggish growth China. Moreover, currency headwinds
are expected to continue given the weak euro. The company announced
a major restructuring program including headcount reductions, plant
closures and capital spending cuts.
The other chemical giant
) had a drab third quarter due to lower demand across titanium
dioxide and photovoltaic markets. It witnessed weakness across a
number of end markets in the quarter. The company reduced its
earnings forecast for 2012 and announced a restructuring plan that
includes retrenchment of 1,500 workers globally.
DuPont also remains exposed to raw material cost inflation, which
is expected to constrict its margin in the fourth quarter.
Moreover, currency headwinds weighed on the performance of a number
of segments in the third quarter and are expected to reduce its
earnings for 2012.
Air Products and Chemicals Inc.
) also felt the heat in the September quarter as weak demand due to
the sluggish economic conditions led to a big slide in its profit.
Slowing U.S. manufacturing growth due to high unemployment and the
concerns over the U.S. fiscal cliff coupled with the slowdown in
Asia is expected to impinge its results moving ahead. We have
downgraded our rating on the stock to Underperform factoring in the
challenges it may face in the next fiscal year.
Agricultural chemical company
) has put up a lackluster third quarter on weak potash demand and
is expected see a weak December quarter due to a significant
decline in international potash demand and lower ammonia sales
volume in Western Canada. Moreover, global phosphate market is
expected to remain weak in the near term, partly due to lower
demand from India.
Specialty chemical company
) is contending with the difficult global economic conditions.
Persistent weakness in its Paints segment hurt its sales in the
most recent quarter. The segment has been hit by a weak residential
housing market in Australia, which may continue to affect revenues
AGRIUM INC (AGU): Free Stock Analysis Report
AIR PRODS & CHE (APD): Free Stock Analysis
CELANESE CP-A (CE): 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
PPG INDS INC (PPG): Free Stock Analysis Report
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