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During the first quarter of 2014 the U.S. experienced a polar vortex that reigned in any attempted green shoots, and posted a negative 0.1% growth rate for the quarter.  But a nice bounce in April, and May have given hope to the economy as a whole.  Economic indicators are now showing a renewed vigor within the economy, and the Federal Reserve’s Beige Book indicated activity expanded in recent weeks.  

In May new orders at factories rose to a five-month high, which triggered businesses to increase their inventory.  The Institute for Supply Management stated that their index of national factory activity increased from 54.9 in April, to 55.4 in May.  Also, the financial information services company Markit, stated that their U.S. manufacturing Purchasing Managers Index increased from 55.4 in April, to 56.4 in May (anything above 50 indicates expansion for both models).

Manufacturing is not the only area of expansion, according to the U.S. Commerce Department the expansion of construction spending, which increased 0.2% in April to an annual rate of $953.5 billion, marks the highest level since March of 2009.  Most of the construction was due to government public outlays, up 0.8%, and spending on local, state, and federal projects are increasing year over year, suggesting that public construction is rebounding after a decline for the past several years.  

So with an improving economy, increasing inventories, and a surging manufacturing base, what industry would benefit from all this expansion? Basic Materials, to which Chemicals and Plastics is a sub industry.  This industry, basic materials, is economically sensitive to swings in manufacturing and construction.  

Chemicals and Plastics!

The Chemical/Plastics industry is seeing robust growth with the improving economy.  The industry impacts a diverse manufacturing array, such as; Military, Electronics, Toys (related consumer goods), Automotive, Food (rumored that companies are playing with amino acids to be packaged in a way as to utilize a 3D printer to “print out” new foods), Technology, and Construction to highlight a few.

This industry impacts many manufacturing and construction companies, and as the product demand increases, we should expect to see a flood of orders coming in for chemicals, and plastics.

Companies to Consider

A. Schulman Inc (SHLM - Snapshot Report), a Zacks Rank #1 (Strong Buy), supplies plastic compounds and resins for packaging, automotive, consumer products, and industrial applications.  The company’s products are also used in a range of other markets, such as mobility, building and construction, electronics and electrical, agriculture, personal care and hygiene, custom services, sports, leisure, and home.  

As you can see, this company will be positively impacted by increased manufacturing and construction.  Moreover, SHLM recently acquired the assets of the Specialty Plastics business segment from Ferro Corporation for $91 million in cash.  The deal is supposed to be accretive to adjusted earnings per share, and the company expects about $5.5 million in synergies within 12-18 months.  This acquisition will give SHLM a broad portfolio of proprietary products serving a large range of end markets comprising of packaging, transportation, construction, appliances, and agriculture.  These new end market products carry higher margins.

Over the past sixty days, Q2 earnings estimates have risen from $0.63 to $0.65, and Q3 earnings estimates has increased from $0.63 to $0.67.  Moreover, this company has a solid track record of beating earnings estimates, and holds an average earnings positive surprise of 8.76% over the past four quarters.  Finally, this company has been paying a solid dividend since 1972, and is currently yielding 2.17%.

WestLake Chemical Corp (WLK - Snapshot Report), a Zacks Rank #1 (Strong Buy), manufactures and markets basic chemicals, vinyls, polymers, and fabricated building products.  The company’s products are used in various applications, such as consumer and industrial markets comprising flexible and rigid packaging, automotive products, coatings, and residential and commercial construction, as well as in other durable and non-durable goods.  

Like our other Zacks #1, this company is positioned to profit from the heightened manufacturing and construction production and demand.  To better position themselves, WLK recently acquired Vinnolit Holdings GmbH, a German-based chlor-vinyls producer for $666 million.  This acquisition enables WestLake to diversify its exposure beyond North America, adds specialty PVC (third most widely produced polymer), and it improves their international distribution capabilities.  The deal would make WestLake the sixth largest global producer of PVC.  This deal is expected to close in the beginning of Q3 2014.  

Over the past sixty days, Q2 earnings estimates have increased from $1.34 to $1.42, as well as Q3 earnings, up from $1.33 to $1.42.  For the FY 2014 earnings estimates have risen from $5.08 to $5.35.  Furthermore, this company has a strong history of beating earnings estimates, and currently holds an average four quarter positive surprise of 11.12%.

PolyOne Corp (POL - Snapshot Report), a Zacks Rank #2 (Buy), provides specialized polymer materials, services, and solutions with operations in specialty polymer formulations, color and additive systems, and polymer distribution.  The company also offers stock and custom packaging solutions for various industry processes that are used in the food, medical, consumer, and graphic arts markets.

PolyOne’s management team recently stated that their main goal was to double revenues from $3.8 billion in 2013 to $8-$10 billion in 2020.  Furthermore, the company plans to utilize their Specialty Platform Segment (very high margins), which generated 5% of the company’s total EBIT in 2006, and now accounts for 62% in 2013, to focus on innovation; expected to account for 80-90% of total EBIT by 2020.  The company is also in the process of repurchasing their shares; purchased 1.4 million shares in Q1 2014, and plans on purchasing another 3.6 million shares by Q1 2015.

Over the past sixty days, Q3 earnings estimates have risen from $0.49 to $0.50, and FY 2014 earnings estimates have increased from $1.76 to $1.80. This company has a history of beating earnings estimates, and currently holds an average positive earnings surprise of 9.21% over the past four quarters.

Bottom Line

As the U.S. economy continues to pick up steam, we should look to companies that help facilitate expansion in several key areas, such as manufacturing, and construction.  All key indicators are pointing to increased demand for goods and services, and thus, manufacturing and construction companies are increasing their inventories to meet the demand.  To meet this demand, they need the raw materials, think chemicals and plastic, to facilitate this growth.  

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