While the September quarter mirrored some of the challenging
issues witnessed earlier, it elicited signs of recovery in the
chemical industry on strength across agriculture and automotive
markets and healthy demand in emerging geographies.
Although the quarter showed improvement across commercial
construction and electronics end-markets, they are still not out of
the woods. Moreover, a still-challenging economic backdrop in
Europe continued to muffle a meaningful upturn in chemical demand.
The European economy continues to limp along and effects of
sequestration and fiscal gridlock in Washington are weighing on the
domestic economic recovery. Nevertheless, the September quarter
portrayed healthy demand trends across a spate of industries in the
While a material recovery is not expected in the final quarter of
2013 given a still-challenging global economic scenario, the
chemical industry is expected to end this year on a positive note
and fare relatively better in 2014, aided by healthy Chinese demand
and a shale gas boom in the U.S. Strong agricultural market
fundamentals in Latin America and a gradual revival in the housing
market also augur well for the industry.
Chemicals are used to make 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, paper and primary metals.
The chemical industry, a roughly $5 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 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
economy. The chemical industry has been consistently leading the
U.S. economy's business cycles due to its early position in the
supply chain. It also touches 96% of manufactured goods, making the
manufacturing industry the biggest consumer of chemical products.
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
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 3% 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
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
#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 four chemicals related industries: Chemical Plastics,
Chemical Specialty, Chemical Diversified and Chemical Fibers. Both
Chemical Plastics and Chemical Fibers industries currently retain a
Zacks Industry Rank #110, placing them in the middle 1/3rd of the
260+ industry groups. The Chemical Diversified industry also lies
in the middle one-third with a Zacks Industry Rank #165. The
Chemical Specialty industry with a Zacks Industry Rank #235 is
placed in the bottom one-third of all Zacks industries.
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 Material
sector, earnings went up 3.6% in the third quarter, a turnaround
from a 9.9% decline in the second quarter. Total revenues were up
1.1% in the third quarter versus a 1.4% fall a quarter ago. The
sector racked up earnings beat ratio (the percentage of companies
coming out with positive surprises) of 62.5% and revenue beat ratio
of 41.7% in the third quarter.
The Basic Material sector is expected to continue its uptrend in
the fourth quarter with an expected 5% rise in earnings. Revenues
are forecast to move up 1.5% in the quarter with an expected 0.7%
rise for 2013.
For 2014, earnings are expected to show a 17.6% increase, a rebound
from a projected 0.2% fall in 2013. Revenues are expected to expand
at a higher clip (3.6%) compared with 2013.
Key Feedstock Trends
The chemical industry uses oil, naphtha and natural gas as energy
and feedstock inputs. 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 April 2013 for the first time since July 2012 on weak
demand outlook for oil.
However, Brent has been hovering around $110 per barrel of late,
supported by stabilization of Chinese oil demand and concerns over
supply disruption from Libya due to unrest amid higher winter oil
The price of the other key raw material, naphtha, which is produced
from oil, averaged $937 per metric ton last year. High crude prices
kept the cost of naphtha elevated. Natural gas has been a bright
spot on the feedstock front. The average annual price of natural
gas in the U.S. was $3 per million British thermal units (mmbtu) in
Over the last few 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. Shale-driven
cheaper natural gas production is expected to keep natural gas
Recovery Picking up Steam, Brighter Outlook for
While lingering crisis in Europe coupled with other
industry-specific challenges continues to pose downside risks, the
global chemical industry is poised for a recovery this year and the
The American Chemistry Council (ACC), an industry trade group,
foresees national chemical output (excluding pharma) to rise 1.9%
in 2013 (following a 1.5% gain in 2012) and 2.3% in 2014. Strength
across light vehicle and aerospace markets bodes well for the
industry. U.S. chemical exports are expected to rise 4.7% this year
(up from 1.8% in 2012) and 6.6% in 2014, leading to an expansion in
The ACC expects global chemical industry output to grow 4.3% in
2013 and 4.7% in 2014. Chemical makers in the emerging economies
are expected to deliver a 7.5% production gain in 2013.
The ACC sees strong capital spending in the coming years, stemming
from new investments in petrochemicals and derivatives. The trade
group envisions capital spending to reach $64.5 billion by 2017.
The shale gas boom is expected to drive investment on plants and
equipment in the U.S. A rebound across emerging markets is expected
to contribute to accelerated rise over the next several years.
However, the European Chemical Industry Council (CEFIC), which
represents the European chemicals industry, expects chemical output
to contract 1% in 2013 (versus a 1.5% decline in 2012) given tough
economic conditions in the region and weak demand across automotive
and construction markets. Nevertheless, the association expects
European chemicals industry to return to a growth of 1.5% in 2014
on stabilization of industrial production in Europe and a modest
uptick in exports.
Shale Boom Driving U.S. Chemical
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, 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. ACC report
indicated that over 50 projects have been announced by the U.S.
chemical makers (representing capital investment of more than $40
billion) to take advantage of ample natural gas supplies. Such
investments are expected to boost capacity and export over the next
Boost from Agriculture
Major chemical makers are increasingly focusing on businesses that
cater to agriculture and nutrition markets in an effort to cut
their exposure on other businesses (such as titanium pigment) 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
represents 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 staunch
inflation appears to bear fruit and exports to the U.S. and other
key markets are regaining momentum.
China's economy grew at its fastest clip this year in the third
quarter. The nation's GDP rose to 7.8% in the quarter from 7.5% in
the second riding on government stimulus measures, improving
domestic demand and a recovery in exports. Government-backed
investments in infrastructure are supporting growth. An improved
demand outlook for China bodes well for the chemical industry next
Stocks We Like
Stocks in the chemical space that we like include
E.I. DuPont de Nemours & Co.
The Dow Chemical Company
PPG Industries Inc.
(MEOH). DuPont and Dow, in particular, are witnessing significant
momentum in agriculture, driven by higher demand for crop
protection products. We also have a bullish view on specialty
The Valspar Corporation
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 crisis 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.
The U.S. housing sector, a key consumer of chemicals, has shown
signs of recovery lately, manifested by rising housing starts,
increase in building permits and a steady pick-up in home prices.
However, demand from this industry remains way below the historic
levels. In addition, weakness still persists in commercial
construction, which is among the key end-markets.
Chemical makers may also face regulatory challenges.
Environmentalists as well as different consumer and industry groups
long argued that the existing Toxic Substances Control Act (TSCA),
administered by the U.S. Environmental Protection Agency (EPA), is
outdated and needs an overhaul.
Sen. Frank Lautenberg along with other co-sponsors introduced the
Safe Chemicals Act of 2013 in April 2013, which is geared to limit
the use of toxic chemicals linked to a broad range of diseases and
place the burden on chemical makers to prove that their chemicals
are safe. Nevertheless, the government shutdown has caused
policymakers to put aside the issue for the time being.
Pricing, FX Headwinds
Commodity prices, though subsiding lately, 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 continue to 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.
Uncertainty in Agrichemical Space
Moreover, agricultural chemicals and fertilizer makers face
significant challenges following the exit of world's largest potash
maker Uralkali Group from one of the biggest potash cartels -- the
Belarus Potash Company (BPC). Uralkali's Board decided to end
export sales through BPC and direct all potash export through its
Switzerland-based trade arm Uralkali Trading.
BPC is one of the two largest cartels (along with North America's
Canpotex) that influence potash pricing by controlling the
production and supply. Uralkali's game-changing move has triggered
industry-wide fear of a price war and put pressure on fertilizer
Moreover, demand for potash remains somewhat weak in India, a key
import market. Indian government's move to trim potash subsidy
levels coupled with higher retail pricing and local currency
devaluation contributing to lower demand in that country. Also,
global phosphate market is expected to remain weak in the near
term, partly due to lower demand from India.
Stocks Warrant Caution
We steer clear of chemical stocks including
Eastman Chemical Company
Air Products and Chemicals Inc.
). We also have a bearish view on 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
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
VALSPAR CORP (VAL): Free Stock Analysis Report
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