Tap an iPad, swallow an aspirin, drive a car or build a house
and you've used some form of specialty chemical or plastic. The
companies that make the coatings, coverings and parts found in
every cranny of our materialistic world continue to see a steady
increase in opportunities.
Some of those also translate into opportunities for
"Buying chemical companies may be similar to owning stock in
Levi's during the San Francisco gold rush," said Mark Elliott,
president of Elliott Asset Management in Las Vegas.
The Levi's brand made its name selling denim jeans to that
era's prospectors. Today, trends like the tablet-computing gold
rush demand specialized glass and plastics produced by only a
handful of companies in an industry with high barriers to
"Why buy the solar-wafer manufacturer, LCD (liquid crystal
display) glass producer or chip producer when you can buy the
company providing the basic building blocks for those products to
those companies and their competitors, and achieve growth at a
lower cash-flow multiple and lower risk?" said Elliott, who
manages $25 million in assets.
Those suppliers are often at the forefront of innovation. U.S.
chemical companies spend about $56 billion annually on research
and development and own one in five U.S. patents, according to
the American Chemistry Council.
A number of those innovators are included in the 13 stocks in
IBD's Chemicals-Plastics industry group, which has rallied 33%
year to date vs. 14% for the S&P 500.
The biggest gainer is a thinly traded stock, AEP Industries (
), which soared 132%. Its plastic packaging wraps everything from
Oreo cookies to industrial warehouse pallets.
) of Avon Lake, Ohio, vaulted 73% this year. It makes plastic,
vinyl, latex, printing ink, engineered resins and compounds for
clients includingDow (
) andExxon Mobil (
). It holds 7% of the $44 billion global plastic additive market,
according to Jefferies.
Eastman Chemical (
) of Kingsport, Tenn., sells fibers and specialty chemicals in
about 100 countries. Shares climbed 53% year to date.
Here are five different views into the industry and its
Earnings Outpace Sales Growth
The value of U.S. plastic shipments has grown a meager 17%
since 2002, according to the Society of the Plastics Industry, or
SPI. Production climbs just above 2.3% annually, slightly faster
than the growth in overall U.S. manufacturing.
But PolyOne grew earnings by 12% to 27% the past four quarters
on sales growth of only 1% to 4%. It's targeting 3% sales growth
in 2012 and 5% in 2013. European sales, 20% of total sales,
remain weak. Sales growth in North America and Asia is modest,
say Wells Fargo Securities analyst Frank Mitsch and his
"While the headlines suggest an improvement in consumer
confidence, we are cautious of how this realistically translates
into demand for PolyOne's higher-end thermoplastic elastomer
products," Mitsch wrote in a September client note.
Analysts see PolyOne earnings up 18% this year and 13% in
The two analysts following AEP expect earnings to grow 90%
year-over-year in 2012 and 26% in 2013. Projections see sales
slipping 17% this year, then recovering 5% in 2013.
Low Natural Gas Prices
Chemical producers demand vast amounts of natural gas, used
both as an energy source and a raw material.
The recent rise of "fracking" techniques has been generating
record levels natural gas production, creating a glut that sent
gas prices to a 13-year low in April.
"Cheap domestic natural gas has re-energized stocks that use
it as a raw material input," said Dave Carlsen, Mission,
Kan.-based co-manager of Buffalo Growth Fund with $475 million in
assets. "Stocks within the chemicals and materials sectors, whose
margins are benefiting from the lower cost inputs, have been the
In addition to higher profits, lower costs have given U.S.
producers a price advantage on international markets. But the gas
glut has also reduced incentives for gas producers. That raises
the risk of higher gas prices for plastics producers. There is
also regulatory risk, Elliott says.
"Any regulations limiting fracking in the natural gas industry
could lead to a sudden spike in natural gas prices," a severe
negative for the petrochemical sector, he said.
Streamline, Acquire, Diversify
Acquisitions, automation and aggressive streamlining of
operations have helped drive employment down 30% in the plastics
industry since 2002, according to SPI.
"Plants have been closed, corporate restructuring has taken
place, and cost-cutting measures have been implemented
industrywide," said Andrew Schrage, co-founder of Money Crashers
Personal Finance in Piscataway, N.J.
AEP acquired Webster Industries, a private-label food bag and
trash bag maker, for $25.9 million in October 2011. That added
$30.7 million in net sales in Q3 2012.
In October, PolyOne bought plastic products makerSpartech
(SPAR) for $246.3 million. In May, it projected revenue of $5
billion by 2015, up 58% from 2012's estimated total. The numbers
assume two or three more buyouts.
"It should give PolyOne access to new technologies for the
aerospace, security, packaging and health care markets,"
Jefferies' equity analysts Lucy Watson and Laurence Alexander
wrote in a client note Oct. 24. "The combined businesses should
generate significant cost synergies as well as cross-selling
opportunities." They estimate each $100 million in acquisitions
adds roughly 5 cents to earnings per share annually.
Eastman acquired Solutia in July for $4.8 billion and debt,
aiming to broaden to emerging markets and expand its product
line. With the buyout, Eastman expects to grow earnings 10%
annually for the next several years in Asia. It is also buying
out small polymer producers in China. In the past two years, it's
bought a facility in Korea, acquired a plastic producer in Brazil
and entered joint ventures in China.
Raw material price increases:
Higher prices for resin, oil and gas used in manufacturing would
drive up production costs and cut into profits unless
manufacturers are able to pass on cost increases to
For PolyOne, a 1% rise or drop in raw material prices amounts
to a 15-cent per share bonus or hit to earnings, according to
These companies are all partly growing sales through
acquisitions. How well they combine operations and manage the
newly acquired companies could make or break their success.
Higher interest rates:
These chemical companies are highly leveraged. An increase in
interest rates could raise borrowing costs and cut into earnings.
The Fed has pledged to keep interest rates low through mid-2015,
so this shouldn't be an immediate concern. AEP owes $350 million
in loans and bonds, nearly equal to its $358 million market
value. PolyOne's debts, $1.01 billion, amounts to 75% of its
$1.77 billion market cap. Eastman's $8.65 billion in debts
exceeds its market value of $8.27 billion.
Global slowdown and uncertainty in end markets:
These companies all depend heavily on foreign sales. Eastman
substantially increased exposure to China by acquiring Solutia.
Low demand in end markets such as home construction and
electronics would dampen demand for raw materials.
On the upside, PolyOne estimates every 100,000 new housing
starts should contribute about 3 cents to EPS, according to