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Trade Tariffs Cloud Diversified Chemical Industry Outlook

Anindya Barman

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 industry’s three major themes:

  • The diversified chemical industry is among those industries that have been the hardest hit by the fierce trade spat between the United States and China. Washington and Beijing imposed billions of dollars in punitive tariffs on each others’ products last year. China’s list of U.S. goods hit with tariffs includes an array of chemicals. Although recent talks between the world’s two biggest economies have raised hopes of a possible resolution of the year-long trade dispute, the tariffs currently in place are already doing significant harm to this space. 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 countermeasures. The trade tariffs have created an uncertain demand environment for U.S. chemical products in China. The tariffs are hurting U.S. chemical exports.
     
  • Companies in this space are exposed to headwinds from raw material cost inflation as a result of short supply. China’s environmental crackdown 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 these inputs. Some companies are also exposed to challenges from elevated logistics costs. Nevertheless, these players remain focused on countering the challenges through strategic actions, including productivity improvement, capacity expansion, price hike initiatives and expansion of scale through acquisitions. Such actions should help them alleviate any pressure on margin.
     
  • U.S. chemical makers are investing heavily on chemical production projects to ramp 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. The shale boom has provided U.S. chemical 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. However, there is also the concern that the trade tariffs currently in place may dampen new chemical investment in the United States.

 
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 #201, 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.

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 42.2%.

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 35.2% over this period compared with the S&P 500’s rise of 4.7% and the broader sector’s fall of 11.5%.

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 6.26X, below the S&P 500’s 11.22X and the sector’s 8.76X.

Over the past five years, the industry has traded as high as 12.41X, as low as 5.45X and at the median of 7.29X, as the chart below shows.

Enterprise Value/EBITDA (EV/EBITDA) Ratio




 

Enterprise Value/EBITDA (EV/EBITDA) Ratio





 

Bottom Line

The diversified chemical industry remains hamstrung by the damaging impact of the U.S.-China trade tiff. Moreover, margins of the companies in this space will remain under pressure in an inflationary environment given the spike in raw material costs.

Nevertheless, strategic actions including expansion of scale through acquisitions, operational efficiency improvement, capacity expansion and continued focus on cost and productivity should keep these companies afloat over the near term.

We are presenting one stock with a Zacks Rank #1 (Strong Buy) and three with a Zacks Rank #2 (Buy) that are well positioned to grow. You can see the complete list of today’s Zacks #1 Rank stocks here.

Compass Minerals International, Inc. (CMP): The Kansas-based company currently sports a Zacks Rank #1. It has an expected earnings growth of 35.8% for the current year. The Zacks Consensus Estimate for earnings for the current year has gone up 2.3% in the last 60 days.

Price and Consensus: CMP



 

Koppers Holdings Inc. (KOP): The Zacks Consensus Estimate for the current year for this Pennsylvania-based company has gone up 0.6% in the last 60 days. The company, carrying a Zacks Rank #2, has an estimated long-term earnings growth rate of 18%.

Price and Consensus: KOP



 

Air Products and Chemicals, Inc. (APD): The Pennsylvania-based company, carrying a Zacks Rank #2, has an expected earnings growth of 10.3% for the current fiscal year. The company also has an estimated long-term earnings growth rate of 12.3%.

Price and Consensus: APD



 

LyondellBasell Industries N.V. (LYB): The Zacks Consensus Estimate for the current year for this Netherlands-based company has gone up 1.3% in the last 60 days. The company, carrying a Zacks Rank #2, also delivered positive earnings surprise in three of the trailing four quarters, with an average positive surprise of 2.6%.

Price and Consensus: LYB


 

 

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