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Near-Term Prospects Cloudy for Specialty Chemical Stocks

Zacks Equity Research

The Zacks Chemicals Specialty industry consists of manufacturers of specialty chemical products for a host of end-use markets such as textile, paper, automotive, electronics, personal care, energy, construction and agriculture. These chemicals (including catalysts, surfactants, speciality polymers, coating additives, pesticides and oilfield chemicals) are used based on their performance and have a specific purpose. They have application in the manufacturing process of a vast range of products including paints and coatings, cosmetics, petroleum products, inks and plastics.

Here are the three major themes in the industry:

  • Trade tensions between the United States and China cloud the prospects of the chemical specialty industry. The Trump administration slapped punitive tariffs on $250 billion worth of Chinese products last year while China has imposed retaliatory tariffs of $110 billion on U.S. goods. China’s tariffs on American products include a wide range of chemical products including specialty chemicals. While recent talks between the countries have raised hopes of a possible resolution of the trade dispute, the tariffs currently in place are already doing damage to the industry. China is one of the biggest export markets for U.S. chemicals. Beijing’s retaliatory tariffs have created an uncertain demand environment for U.S. chemical products in this significant market. Notably, the trade friction has led to a slowdown in demand in the automotive market (a major specialty chemical end-use market) in China.
  • Companies in the chemical specialty space face headwinds from a spike in costs of raw materials as a result of short supply partly due to production outages and plant shutdowns. The stricter environmental policy in China 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 the prices of inputs. Higher raw material prices are, thus, likely to squeeze margins of chemical specialty companies over the short haul.
  • In a challenging environment, chemical specialty companies remain focused on strategic actions including cost-cutting and productivity improvement, expansion into high-growth markets, operational efficiency improvement and expansion of scale through acquisitions. Moreover, a number of companies are taking aggressive price increase actions in the wake of raw material cost inflation. These actions should help them alleviate any pressure on margin.

Zacks Industry Rank Indicates Bleak Prospects

The Zacks Chemicals Specialty industry is part of the broader Zacks Basic Materials Sector. It carries a Zacks Industry Rank #193, which places it at the bottom 25% 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.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic about this group’s earnings growth potential. Over the past year, the industry’s earnings estimate for the current year has gone down 9%.

Before we present a few chemical specialty 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 S&P 500 on Shareholder Returns

The Zacks Chemicals Specialty industry has lagged the Zacks S&P 500 composite over the past year. The industry has gained 1.5% over this period compared with the S&P 500’s rise of 2.1%. Meanwhile, the broader Zacks Basic Materials Sector tumbled 14.8% over the past year.

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 21.38X, above the S&P 500’s 10.57X and the sector’s 7.60X.

Over the past five years, the industry has traded as high as 25.94X, as low as 9.83X, with a median of 22.24X, as the chart below shows.

Enterprise Value/EBITDA (EV/EBITDA) Ratio



Enterprise Value/EBITDA (EV/EBITDA) Ratio



Bottom Line

Chemical specialty companies are bearing the brunt of trade tariffs. Moreover, margins of these producers will remain under pressure over the near term amid an inflationary environment given raw material supply constraints. Nevertheless, strategic actions including continued focus on cost and productivity, selling price hikes and earnings-accretive acquisitions should keep them afloat over the short haul.

None of the stocks in the Zacks Chemicals Specialty industry sports a Zacks Rank #1 (Strong Buy). However, we present a stock that has a Zacks Rank #2 (Buy) and is well positioned to grow. There are also three 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.

Israel Chemicals Ltd. (ICL): This Israel-based company currently carries a Zacks Rank #2. It has expected earnings growth of 10.8% for 2019. The company delivered positive earnings surprise in each of the trailing four quarters, with an average positive surprise of 12.3%.

Price and Consensus: ICL



Ingevity Corporation (NGVT): The South Carolina-based company carries a Zacks Rank #3. It has expected earnings growth of 21.5% for 2019. The company delivered positive earnings surprise in each of the trailing four quarters, with an average positive surprise of 19.8%.

Price and Consensus: NGVT



Quaker Chemical Corporation (KWR): The Pennsylvania-based company, carrying a Zacks Rank #3, has expected earnings growth of 20.2% for 2019. It also delivered positive earnings surprise in each of the trailing four quarters, with an average positive surprise of roughly 5%.

Price and Consensus: KWR



Ferro Corporation (FOE): This Ohio-based company carries a Zacks Rank #3 and has expected earnings growth of 15.7% for 2019. Moreover, the company delivered positive earnings surprise in three of the trailing four quarters, with an average positive surprise of 0.3%.

Price and Consensus: FOE



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