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
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 supply chain.
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
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
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 2013.
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
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 in 2012.
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
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.
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
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 additions.
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 costs.
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
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 December quarter.
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 emerging markets.
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
AGRIUM INC (AGU): Free Stock Analysis Report
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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
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 moving ahead.