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Chemical Industry Back on Track: Stocks Worth a Look

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The chemical industry is back on the growth path after being stuck in a rut, making it an attractive investment proposition for 2017. Strength in the automotive sector and a rebound in non-residential construction and housing markets have helped pull the industry out of its funk, notwithstanding a persistently challenging global economic environment.

Despite a few industry-related headwinds, weak demand across agricultural and energy markets and sluggishness in China, there are a number of reasons to be optimistic about the broader chemical industry for both the short and long haul. Let’s find out what’s supporting the bullish case for chemical stocks.

Shale Bounty – Driving Force for Chemical Spending

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), the U.S. has emerged as an attractive investment location and petrochemical makers are now significantly expanding capacity in the country leveraging new supplies of natural gas. 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.

The shale boom has incentivized a number of chemical companies to pump in billions of dollars for setting up facilities (crackers) in the U.S. to produce ethylene and propylene in a cost-effective way. Per the ACC, over 275 new chemical projects have been announced by chemical makers (worth more than $170 billion) since 2010, nearly half of which already complete or under construction. Such investments -- many backed by Federal government support -- are expected to boost capacity and export over the next several years.

Automotive – Healthy Run Continues

Chemical makers continue to see healthy demand from the automotive sector -- a major end-use market. The sector is enjoying the fruits of low fuel prices. The last two years have been exceptional for the auto sector. Sales in the U.S. saw record highs in both years, while sales in China and Europe also gained strength.

U.S. light vehicles (a key end-user market for chemicals) continued to show strength in 2016, supported by an improving job market, rising personal income, improved consumer confidence, low fuel prices and attractive financing options. A high average age of cars on the U.S. roads is also fueling replacement demand for cars. U.S. sales of new cars and trucks hit a record high of 17.55 million in 2016, rising 0.4% from 2015's record of 17.47 million.

According to IHS Markit, global light vehicle sales are expected to increase 1.5% year over year to 93.5 million units in 2017. Moreover, IHS Markit sees U.S. light vehicle sales to reach 17.4 million units in 2017 -- a slight moderation compared with the 2016 level, but still looks poised for another strong year.

Low interest rates, favorable financing and cheap oil have also backed a recovery in the European auto market. The auto industry in Asian countries, especially China, is also expected to thrive over the next several years. Healthy momentum in the automotive space augurs well for chemical demand in this important end-market.

A Rebound in Construction Sector

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 sector has bounced back on the back of strong housing fundamentals.

The underlying demand trends in the housing space remain strong, supported by an improving employment levels, affordable interest/mortgage rates and a rise in income levels. The year 2016 was reasonably good for the housing market, and the momentum is expected to continue this year.

Recent housing data has been fairly upbeat with U.S. housing starts scaling a four-month high in February, buoyed by construction of single-family houses that rose 6.5% to reach its highest level in nearly a decade. Housing starts rose 3% to a seasonally adjusted annualized rate of 1.29 million units in February, per the Commerce Department. Homebuilding was up 6.2% year over year for the month. These data paint an upbeat picture for U.S. homebuilding.

The renewal of long-stalled construction projects and long awaited access to credit from lending institutions has also 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 50.7 in February 2017 (a reading above 50 indicates an increase in billings), up from 49.5 in January.

Moreover, the American Institute of Architects (AIA) expects healthy growth in non-residential construction spending this year based on strong growth expectations for hotels, office space and retail. The AIA sees spending to go up 5.6% in 2017 and 4.9% in 2018.

Trump’s $1 Trillion Spending Boost

The U.S. chemical industry is expected to be one of the key beneficiaries of Donald Trump's presidency. Chemical stocks got a boost following Trump’s election win in November on expectations of significant infrastructure spending in a Trump administration.

Trump has pledged to pump $1 trillion of new infrastructure spending into the U.S. economy, aimed at fixing America's "crumbling" infrastructure. The president has called on Congress to pass a bill that would produce a $1 trillion investment in the national infrastructure to rebuild roads, bridges and other public infrastructure, and create millions of new jobs.

The president’s call for the massive infrastructure spending -- one of his key campaign promises -- is likely to have a beneficial effect on the U.S. chemical industry given the expected increase in demand for chemicals used in construction.

Chemical Bonding – M&A Gathering Steam

Chemical makers remain actively focused on mergers and acquisitions to diversify and shore up growth in a still-difficult global economic environment. The industry saw a pick-up in consolidation activities in 2015 and the momentum continued in 2016.

Chemical companies are increasingly looking for cost synergy opportunities and enhanced operational scale through consolidations. The $130 billion mega-merger of Dow Chemical (DOW - Free Report) and DuPont (DD - Free Report) -- the biggest chemical deal ever -- is a huge testimony to these strategic moves.

Other major deals that have taken place in the chemical space in the recent past include Albemarle Corp.’s (ALB - Free Report) $6.2 billion buyout of Rockwood Holdings, Inc., Merck KGaA's $17 billion acquisition of Sigma-Aldrich, ChemChina’s proposed $43 billion acquisition of Syngenta (SYT - Free Report) , and the $66 billion proposed merger between Monsanto Company and Bayer AG.

Strategic Measures

Chemical companies continue to shift their focus on high-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.

Stocks Worth Betting On Right Now

As you can see from the above-mentioned factors, there are many reasons to be optimistic about the chemical industry. Chemical stocks that are well placed in the current operating backdrop include Univar Inc. , KMG Chemicals, Inc. and Kronos Worldwide, Inc. (KRO - Free Report) , each sporting a Zacks Rank #1 (Strong Buy), as well as The Chemours Company (CC - Free Report) and Albemarle Corp., both carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Univar has gained around 72% over a year. The stock has a long-term expected earnings per share (EPS) growth rate of roughly 9.4%. Earnings estimates for the current year have been revised 42.9% upward over the last 60 days.

KMG Chemicals has gained nearly 83% over a year. The stock’s earnings estimates for the current year have been revised 11.5% upward over the last 60 days. It has an expected earnings growth of 25.8% for the current year.

Kronos has gained around 176% over the past one year. Earnings estimates for the current year have been revised 122% upward over the last 60 days. The stock has an expected earnings growth of 159.1% for the current year.

Chemours has a long-term expected EPS growth rate of roughly 15.5%. Earnings estimates for the current year have been revised 15.7% upward over the last 60 days. The stock has gained a whopping 402% over the past one year.

Albemarle has gained roughly 64% over a year. The stock’s earnings estimates for the current year have been revised 4.3% upward over the last 60 days. It has a long-term expected EPS growth rate of roughly 13.8%.

(Check out our latest Chemical Industry Outlook for a more detailed discussion on the fundamental trends.)

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