Near-Term Prospects Cloudy for Diversified Chemical Stocks

Shutterstock photo

The Zacks Chemicals Diversified industry consists of manufacturers of basic chemicals, plastics, specialty chemicals and agricultural chemicals. Companies in this space serve a host of end-use markets such as automotive, building & construction, transportation, electronics, aerospace and agriculture.

Basic chemicals are produced in large quantities and include petrochemicals and intermediates (such as ethylene, propylene and benzene), polymers (including plastic resins such as polyethylene, polypropylene and polyvinyl chloride) and inorganic chemicals (such as chlorine, caustic soda and titanium dioxide). Specialty chemicals that include catalysts, surfactants, speciality polymers, coating additives and oilfield chemicals are used in specific fields based on their performance. Agricultural chemicals include herbicides, fungicides and insecticides that are used to protect crops from disease, pests and weeds.

Here are the three major themes in the industry:

  • The diversified chemical industry is facing the challenges emanating from the ongoing trade war between the United States and China. Notably, China is one of the biggest export markets for U.S. chemicals and, thus, leaves the American chemical industry heavily exposed to Beijing's retaliatory trade actions. The trade tariffs have created an uncertain demand environment for U.S. chemical products in China.
  • Companies in this space are exposed to headwinds from a spike in costs of raw materials as a result of short supply, partly due to production outages and plant shutdowns. China's environmental crackdown has led to the tightening in the supply of certain key raw materials as a result of plant closures. The disruption in the supply chain has pushed up prices of these inputs. Nevertheless, the companies should be able to offset the concerns with the ongoing strategic measures, including cost-cutting and productivity improvement, earnings-accretive acquisitions and aggressive price increase actions. These actions should help them alleviate any pressure on margin. Moreover, continued shift of focus toward high-growth markets should help revive demand.
  • U.S. chemical makers are spending heavily on chemical production projects to beef up capacity. The shale gas revolution in the United States has been a huge driving force behind chemical investments in plants and equipment in the country. And currently, the U.S. petrochemical industry is in the middle of a shale-induced investment boom, leveraging access to abundant and cheaper feedstock. The shale bounty has provided U.S. producers a compelling cost advantage over their global counterparts and incentivized a number of companies to plough billions of dollars for setting up facilities (crackers) in the United States to produce key feedstocks like ethylene and propylene in a cost-effective way. Such investments are expected to boost capacity and export.

Zacks Industry Rank Indicates Bleak Prospects

The Zacks Chemicals Diversified industry is part of the broader Zacks Basic Materials Sector. It carries a Zacks Industry Rank #203, which places it at the bottom 21% of more than 250 Zacks industries.

The group's Zacks Industry Rank , which is basically the average of the Zacks Rank of all the member stocks, indicates gloomy near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Before we present a few diversified chemical stocks that you may want to consider for your portfolio, let's take a look at the industry's recent stock market performance and current valuation.

Industry Lags Sector and S&P 500

The Zacks Chemicals Diversified industry has lagged both the Zacks S&P 500 composite and the broader Zacks Basic Materials Sector over the past year.

The industry has declined 26.8% over this period compared with the S&P 500's rise of 5.2% and broader sector's fall of 14.2%.

One-Year Price Performance

Industry's Current Valuation

On the basis of trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, which is a commonly used multiple for valuing chemical stocks, the industry is currently trading at 8.65X, below the S&P 500's 10.87X. However, it is ahead of the sector's trailing-12-month EV/EBITDA of 7.42X.

Over the past five years, the industry has traded as high as 19.79X, as low as 6.59X, with a median of 9.79X, as the chart below shows.

Enterprise Value/EBITDA (EV/EBITDA) Ratio

Enterprise Value/EBITDA (EV/EBITDA) Ratio

Bottom Line

Escalating trade tussle between the United States and China pose challenges to the diversified chemical industry. Moreover, margins of the companies in this space will remain under pressure amid an inflationary environment given the spike in input costs.

Nevertheless, strategic actions including expansion of scale through acquisitions, operational efficiency improvement, capacity expansion and continued focus on cost and productivity should keep them afloat over the short haul.

Here, we present two stocks sporting a Zacks Rank #1 (Strong Buy) that are well positioned to gain amid the prevailing challenges. There are also a couple of stocks with a Zacks Rank #3 (Hold) that investors may currently hold on to. You can see the complete list of today's Zacks #1 Rank stocks here .

Methanex Corporation (MEOH): The consensus EPS estimate for this Vancouver, Canada-based company has moved 7% higher for the current year, over the last 90 days.  The Zacks Consensus Estimate for 2018 EPS indicates year-over-year growth of 63.7%. The company, sporting a Zacks Rank #1, also has an estimated long-term earnings growth rate of 15%.

Price and Consensus: MEOH

Koppers Holdings Inc. (KOP): The Pennsylvania-based company, carrying a Zacks Rank #1, has an expected earnings growth of 11.4% for the current year. The consensus EPS estimate has moved 7% higher for the current year, over the last 90 days. The company delivered an average positive earnings surprise of 18.4% in the trailing four quarters. It also has an estimated long-term earnings growth rate of 18%.

Price and Consensus: KOP

LyondellBasell Industries N.V. (LYB): The Netherlands-based company currently carries a Zacks Rank #3. It has an expected earnings growth of 14.8% for the current year. The company delivered an average positive earnings surprise of 10.8% in the trailing four quarters. It has an estimated long-term earnings growth rate of 9.5%.

Price and Consensus: LYB

Eastman Chemical Company (EMN): The Tennessee-based company has a Zacks Rank #3. The Zacks Consensus Estimate for earnings for 2018 indicates year-over-year growth of 11%. The company has delivered an average positive earnings surprise of 15.4% in the trailing four quarters. It also has an estimated long-term earnings growth rate of 8.7%.

Price and Consensus: EMN

Wall Street's Next Amazon

Zacks EVP Kevin Matras believes this familiar stock has only just begun its climb to become one of the greatest investments of all time. It's a once-in-a-generation opportunity to invest in pure genius.

Click for details >>

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

Methanex Corporation (MEOH): Free Stock Analysis Report

LyondellBasell Industries N.V. (LYB): Free Stock Analysis Report

Koppers Holdings Inc. (KOP): Free Stock Analysis Report

Eastman Chemical Company (EMN): Free Stock Analysis Report

To read this article on Zacks.com click here.

Zacks Investment Research

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Business , Investing Ideas , Stocks
Referenced Symbols: MEOH , LYB , KOP , EMN

More from Zacks.com




Equity Research

Research Brokers before you trade

Want to trade FX?