June quarter results mostly reflect a slow economic recovery in
the U.S. and persistent recessionary conditions in Europe, leading
to weakening demand for chemical products. High input costs and
weaknesses across some key end-markets (such as construction and
electronics) remain the major impediments to growth.
Companies in the chemicals space witnessed slowing economic
activity in the quarter, largely due to the fragile economic
conditions in Europe. Outlook for the U.S. economy has also
suffered, though more recent data points seem to indicate some
Even the emerging markets have not been immune from global
downturn. Activity in China and some other emerging economies
slowed in the June quarter. The Chinese economy has been going
through a rough patch as government stimulus actions have not been
successful failed to staunch the slowdown, at least for now. The
problems were compounded by a slowdown in exports. These issues are
expected to continue to weigh on the performance of the chemical
stocks in the second half of 2012.
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 roughly 19% of the global
chemical output and employs more than 800,000 people. It is
responsible for 10% of the nation's merchandise exports,
aggregating $145 billion annually. Roughly 5.5 million additional
jobs are backed by the purchasing activity of the chemical
The chemical industry, by nature, is cyclical and heavily linked
to the overall condition of the U.S. economy. Chemical industry
also touches 90% 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 BASF SE ( BASFY
), 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 grew 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
U.S. chemical production continues its monthly declining streak as
reflected in the recently released data by the American Chemistry
Council ("ACC"). The Washington-based chemical industry trade group
said that the Chemical Production Regional Index (CPRI) fell 0.1%
in June, following a downwardly revised 0.5% decline in May.
The U.S. CPRI, which was created by Moore Economics to track
chemical production in seven regions across the nation, is
comparable to Federal Reserve's industrial production index for
chemicals. The ACC reported that chemical production dipped in the
Gulf Coast, Midwest, Southeast and West Coast regions and was flat
in the Ohio Valley, Mid-Atlantic and Northeast regions.
On a region-by-region basis, production declined across all
regions except the Gulf Coast and Ohio Valley areas. On a
year-to-date basis (production for the first six months of 2012
compared with the year-ago data), production nudged up 0.2%.
On a monthly comparison basis, chemical production in the Gulf
Coast region, where key building block materials are produced, was
down 0.4% in June. The Midwest region saw a decline of 0.2%.
Productions in the Ohio Valley and Mid-Atlantic regions were flat
in June. Production slipped in the Southeast (down 0.2%) and West
Coast (0.1%) regions during the month while remained unchanged in
Output from the U.S. manufacturing sector, the largest consumer of
chemical products, crept up 0.2% in June, following a 0.1% fall a
month ago. Within this sector, output rose in several key chemistry
end-user markets including appliances, motor vehicles, computers,
apparel, structural panels, rubber products, paper and
Demand for U.S. manufacturing has been weak in recent months given
the ongoing European predicament and slowdown in Chinese
manufacturing sector. The ACC noted that output clipped in a number
of key segments including plastic resins, fertilizers, adhesives,
organic chemicals and pharmaceuticals. However, production rose
across many segments such as inorganic chemicals, industrial gases,
consumer products, pesticides, coatings and synthetic rubber.
The decline in chemical output was also witnessed in Europe .
According to the European Chemical Industry Council ("ECIC"),
chemicals production in the European Union fell 2.1% year over year
in the first five months of 2012. Production edged down 0.7% year
over year in May 2012. Chemicals prices rose 2.7% year over year in
May, led by a 4% 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, recently exceeded $116 (highest in more than three months) on
supply concerns stemming from Iran's controversial nuclear program
and a sharp decline in U.S. crude oil inventories.
Price of the other key raw material, naphtha, averaged at $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.
2012: A Balanced View
For the rest of 2012, the outlook for the global chemical industry
is balanced, as the U.S. and European Union continue to contend
with soft local economies while the emerging markets are expected
to show higher growth in output despite the recent slowdown.
The ACC foresees moderate production growth this year followed by
a stronger recovery in 2013. National chemical output is expected
to slow to 1.6% in 2012 from 3.8% a year ago, and then rise to 2.1%
in 2013. A rebound across most of the key end-use markets is
helping to maintain the industry's contribution to the nation's
The chemicals outlook indicates moderate growth over the next few
years, depending on certain factors including strengthening
domestic demand and an improvement in overseas exports. Exports
climbed nearly 11% to $189 billion last year and are projected to
surpass $230 billion in 2014.
While the U.S. economy is not headed toward another recession, the
sovereign debt plight in Europe coupled with other economic factors
poses downside risks to the U.S. economic outlook.
The ACC projects weaker growth in the European chemicals output
than its earlier forecast in 2012, in part, due to increased
uncertainty. Most of last year's output growth took place in the
first quarter after a strong demand recovery with double-digit
growth witnessed in 2010.
The ECIC, however, sees growth resuming in 2012, strengthening
steadily through the year. The group forecasts 1.5% chemical
industry growth this year. 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.
Asia and other emerging markets are expected to continue to lead
in volume increases. Chemical makers in the emerging markets are
expected to deliver a 6.2% production increase in 2012 followed by
7.5% in 2013.
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,
such as plant closures, aggressive cost containment and production
improvement initiatives, should yield industry-wide margin
improvements. Cash flows derived through these actions can be used
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.
Some of the key end-markets for chemical products are on an
uptrend. This has been evident from the recent earnings reports of
leading chemical players. E.I. DuPont de Nemours &
Co. ( DD ), for example, put up a healthy performance
in the recently reported quarter. The company saw strong
performance in agriculture, food and bioscience businesses, along
with its advanced materials business, which witnessed healthy
results despite weak European markets. The Danisco acquisition
contributed to higher sales in the quarter.
Eastman Chemical Company ( EMN ) is
well placed to benefit from its acquisition of Solutia. The
company's diversified chemical portfolio, along with its integrated
and diverse downstream businesses, is driving earnings. The company
benefits from business restructuring, cost-cutting measures and
increased capacity additions.
We also hold a favorable view on Celanese Corp. (
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, which should yield results through
the rest of 2012. 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 agricultural chemical space, we like the prospects of
Agrium Inc. ( AGU ).
Fertilizer stocks like Agrium stands to gain from the U.S. Midwest
drought in the remainder of 2012. The company has logged a solid
second quarter and is poised to benefit from skyrocketing crop
prices and overall strong fundamentals for the agriculture and crop
input market. High crop prices (especially for corn) and tight
grain inventories are expected to create huge demand for its
The global nature of the industry puts competitive issues into
sharp focus. The U.S. producers have responded to competitive
pressures by streamlining operations, relocating manufacturing
facilities to low-cost regions closer to end-markets, and being
overall more nimble and flexible in responding to market
opportunities. And it is not always easy to pull this off.
Commodity price hikes, though subsiding lately, is adding to
feedstock costs for many of these 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.
Moreover, the U.S. housing sector remains a weak end-market. The
domestic housing sector, a key consumer of chemicals, is likely to
remain soft through the remainder of 2012. Weakness in the
electronics and construction end-markets may weigh on the results
in the back half of the year.
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.
Chemical titan The Dow Chemical Company ( DOW )
was pummeled by several headwinds in the June quarter. The
company's results were hurt by the beleaguered economic conditions
in Europe. Softness across electronics and construction markets may
continue to impinge its results in the second half. Moreover, Dow
is facing challenges in Western Europe due to the recessionary
conditions and expects currency headwinds to continue given the
Air Products and Chemicals Inc. ( APD )
also felt the heat in the June quarter as it faced challenging
conditions in Europe and Asia and unfavorable currency exchange
impact. The company has reduced its adjusted earnings per share
target for fiscal 2012 factoring in the currency headwinds and
slower economic growth.
In specialty chemical space, PPG Industries Inc. ( PPG ) is
expected to face greater challenges going ahead. While the company
had a decent second quarter recently, it expects the European
market to remain under pressure and foresees inconsistent growth in
North America and Asia. Moreover, the company expects higher input
costs to continue to weigh on its results in the second half.
Currency exchange also remains a sore point.
Also in specialty chemical, Methanex Corp. ( MEOH )
posted lower-than-expected results in the second quarter. The
company's production was hit by curtailment in natural gas supplies
and eventually constrained revenues. Methanex remains exposed to
tight economic conditions and uncertainties associated with the
demand and pricing of methanol. We have downgraded our rating on
the stock to Underpeform factoring in these issues.
Another specialty chemical company Valspar
Corporation ( VAL ) is contending with the difficult global
economic conditions. Unfavorable currency exchange swings hurt the
company's sales in the most recent quarter. The uncertain
macroeconomic backdrop, slow recovery in the U.S. and decelerating
growth in China is expected to continue to impact its results
AGRIUM INC (AGU): Free Stock Analysis
AIR PRODS & CHE (APD): Free Stock Analysis
CELANESE CP-A (CE): Free Stock Analysis
DU PONT (EI) DE (DD): Free Stock Analysis
DOW CHEMICAL (DOW): Free Stock Analysis
EASTMAN CHEM CO (EMN): Free Stock Analysis
METHANEX CORP (MEOH): Free Stock Analysis
PPG INDS INC (PPG): Free Stock Analysis
VALSPAR CORP (VAL): Free Stock Analysis
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