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Near-Term Prospects Gloomy for Specialty Chemical Stocks

Anindya Barman

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 industry’s three major themes:

  • Trade tariffs remain a drag on the chemical specialty industry. The United States and China had imposed billions of dollars in punitive tariffs on each others’ products last year. 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 to the protracted trade dispute, the tariffs currently in place are already doing damage to the industry. China is among the most important trading partners of the American chemical industry and is one of the biggest export markets for U.S. chemicals. Beijing’s retaliatory tariffs are hurting U.S. chemical exports. Moreover, trade friction has led to a slowdown in demand in the automotive market (a major specialty chemical end-use market) in China. The trade tiff has also led to a slowdown in industrial activities across Asia and Europe, hurting demand for specialty chemicals.
     
  • Companies in the chemical specialty space face headwinds from a spike in costs of raw materials as a result of short supply. The stricter environmental policy in China has led to 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 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 are likely to 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 #232, which places it at the bottom 9% 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 a gloomy near term. 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 14.6%.

Before we present a few specialty 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 S&P 500

The Zacks Chemicals Specialty industry has lagged the Zacks S&P 500 composite over the past year. The industry has gained 5.5% over this period compared with the S&P 500’s rise of 10.5%. Meanwhile, the broader Zacks Basic Materials Sector tumbled 9.5% 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 22.22X, above the S&P 500’s 10.94X and the sector’s 8.81X.

Over the past five years, the industry has traded as high as 25.21X, as low as 16.83X, with a median of 22.32X, 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 in 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 in the near term.

None of the stocks in the Zacks Chemicals Specialty industry sports a Zacks Rank #1 (Strong Buy) or a Zacks Rank #2 (Buy). We present four 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.

Axalta Coating Systems Ltd. (AXTA): The Pennsylvania-based company has expected earnings growth of 42.2% for 2019. The company also delivered positive earnings surprise in each of the trailing four quarters, with an average positive surprise of 26.2%.

Price and Consensus: AXTA

 



 

Ingevity Corporation (NGVT): The South Carolina-based company has expected earnings growth of 16% for 2019. The company also delivered positive earnings surprise in each of the trailing four quarters, with an average positive surprise of 11.2%.

Price and Consensus: NGVT

 



 

Celanese Corporation (CE): The Texas-based company delivered positive earnings surprise in three of the trailing four quarters, with an average positive surprise of roughly 1.4%. It also has an estimated long-term earnings growth rate of 7.1%.

Price and Consensus: CE

 



 

Ecolab Inc. (ECL): This Minnesota-based company has expected earnings growth of 11.8% for 2019. Moreover, it has an estimated long-term earnings growth rate of 7.1%.

Price and Consensus: ECL

 

 

 

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Ingevity Corporation (NGVT) : Free Stock Analysis Report
 
Ecolab Inc. (ECL) : Free Stock Analysis Report
 
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