Why Chemical Stocks Are Worth Adding to Your Portfolio

The chemical industry is still feeling the bite of weak demand across agricultural and energy markets, slowdown in China and headwinds from a strong dollar, as witnessed in the September quarter. Nevertheless, the industry is gradually gaining strength, aided by an improving U.S. economy, sustained healthy momentum in the automotive space and rebounding construction markets. There are a number of reasons to be optimistic about the broader chemical industry for both the short and long haul, which we have highlighted below:

Shale Bounty Driving Chemical Investments

The shale gas revolution in the U.S. has been a huge driving force behind chemical investment on plants and equipment in the country. According to the American Chemistry Council (ACC), abundant shale gas production is driving U.S. chemical exports. New methods of extraction such as horizontal drilling and hydraulic fracturing (or fracking) are boosting shale production, bringing down prices of ethane (derived from shale gas) in the process.

Leveraging the abundant natural gas supply, chemical makers are ratcheting up investment on shale gas-linked projects which is expected to beef up capacity. The shale revolution made the U.S. an attractive investment hotspot and incentivized a number of chemical companies to pump in billions of dollars for setting up facilities (crackers) to produce ethylene and propylene in a cost-effective way.

Per an ACC report, domestic chemical investment related to shale gas has reached as high as $153 billion, more than 60% of which are from firms outside the U.S. Already 246 projects -- many backed by the Federal government -- have been announced by chemical makers to take advantage of ample natural gas supplies. Such investments are expected to boost capacity and export over the next several years.

Automotive Racing Ahead

The automotive sector is witnessing significant momentum. This major chemical end-use market is enjoying the fruits of low gasoline prices. Global automotive sales are expected to hit 88.12 million units in 2016, representing a 2.1% rise from 86.31 million units expected this year, according to IHS Automotive.

The U.S. auto industry also remains in high gear, with new car and light truck sales expected to jump to 17.3 million units in 2015 (from 16.4 million units in 2014) and further rise to 17.7 million units in 2016 on the back of reduced gasoline prices and low interest rate on auto loans, as per The National Automobile Dealers Association (NADA) estimates.

In particular, U.S. light vehicles (a key end-user market) sales are expected to increase this year, riding on improving employment rates and household income, lower fuel prices, attractive financing options and pent-up demand. The Auto industry in Asian countries, especially China, is also expected to thrive over the next several years. As such, chemical makers are expected to gain from higher demand from this important end-market.

Strategic Moves

Chemical companies continue to shift their focus on attractive, growth markets (driven by megatrends) in an effort to cut their exposure on other businesses that are struggling with weak demand and input costs pressure. Moreover, cost-cutting measures -- including plant closures and headcount reduction -- and productivity improvement actions by chemical companies are expected to yield industry-wide margin improvements. Several chemical makers are also disposing non-core assets as they shift their focus on high-margin businesses.

M&A Activity Gathering Steam

Chemical companies remain actively focused on mergers and acquisitions to diversify and shore up growth in a still-challenging economic environment. These companies continue to explore growth opportunities in the fast-growing emerging markets, particularly in the lucrative regions of Asia-Pacific and Latin America. The industry saw a pick-up in consolidation activities in 2014 and the momentum continues this year.

Albemarle Corp.'s ( ALB ) $6.2 billion buyout of Rockwood Holdings, Inc., Eastman Chemical Company's ( EMN ) purchase of specialty chemical company Taminco Corp. for $2.8 billion, PPG Industries Inc.'s ( PPG ) acquisition of Mexican paint company Comex, Olin Corp.'s ( OLN ) acquisition of a significant portion of Dow Chemical's ( DOW ) chlorine business for $5 billion, Merck KGaA's $17 billion acquisition of Sigma-Aldrich, FMC Corp.'s ( FMC ) acquisition of Cheminova A/S, CF Industries' ( CF ) planned acquisition of certain assets of Netherlands-based OCI N.V. for around $8 billion, and the $130 billion proposed mega-merger of Dow Chemical and DuPont ( DD ) -- the largest chemical deal of all time -- are among the major deals that have taken place in the chemical space in the recent past.

A Rebounding Construction Space

A recovery across housing and commercial construction -- major chemical end-markets -- has been another supporting factor for the chemical industry recovery. After being hit hard in the recession, the construction industry is currently in the process of gradual healing.

The housing sector saw steady recovery in 2015 backed by stabilizing mortgage rates, improving job market and moderating home prices, and the momentum is expected to continue into 2016. While the U.S. housing market witnessed a slowdown at the beginning of 2015 due to harsh winter, housing activity picked up steam in the crucial spring and summer months.

However, housing data has been rather weak over the last couple of months and land and labor shortages are limiting the growth in home production. Nevertheless, this is viewed by the market as only a temporary setback. The underlying demand trends in the housing space remain strong and homebuilding is expected to pick up pace in 2016, aided by an improving economy, encouraging job picture, affordable interest/mortgage rates and rising consumer confidence.

The renewal of long-stalled construction projects and long awaited access to credit from lending institutions have helped invigorate the commercial construction sector. U.S. architecture firm billings continue to rise. The US Architecture Billings Index (ABI), an indicator that offers a glimpse into the future of U.S. non-residential construction spending activity, clocked 53.1 in October 2015 (a reading above 50 indicates an increase in billings).

Moreover, the American Institute of Architects (AIA) expects non-residential construction spending to go up nearly 8.9% in 2015 and 8.2% in 2016. This bodes well for demand for chemicals in the construction markets.

Wrapping Up

The chemical industry is finally looking up after being in a rut for long, making it an attractive investment proposition. As you can see from the above-stated factors, there are a few good reasons to be optimistic about the industry.

Chemical stocks that are well placed in the current operating backdrop include Celanese Corp. ( CE ), The Dow Chemical Company, LyondellBasell Industries NV ( LYB ), Air Products and Chemicals Inc. ( APD ), Eastman Chemical Company and PPG Industries Inc.

Check out our latest Chemical Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector.

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PPG INDS INC (PPG): Free Stock Analysis Report

OLIN CORP (OLN): Free Stock Analysis Report

LYONDELLBASEL-A (LYB): Free Stock Analysis Report

FMC CORP (FMC): Free Stock Analysis Report

EASTMAN CHEM CO (EMN): Free Stock Analysis Report

DOW CHEMICAL (DOW): Free Stock Analysis Report

DU PONT (EI) DE (DD): Free Stock Analysis Report

CF INDUS HLDGS (CF): Free Stock Analysis Report

CELANESE CP-A (CE): Free Stock Analysis Report

AIR PRODS & CHE (APD): Free Stock Analysis Report

ALBEMARLE CORP (ALB): Free Stock Analysis Report

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

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

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