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Chemical Industry on Solid Footing: Stocks Worth a Look

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The chemical industry is finding traction again after staying down for a while. The industry’s upturn is expected to continue on sustained momentum across major end-markets.

Notwithstanding a few industry-related headwinds, weak demand in agricultural 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 Boom: Driving Force for Chemical investment

The shale gas revolution in the United States has been a huge driving force behind chemical investment on plants and equipment in the country. According to the American Chemistry Council (ACC), the United States 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 United States to produce ethylene and propylene in a cost-effective way. Per the ACC, 310 new chemical projects have been already announced by chemical makers worth around $185 billion that are under construction or planned. Such investments -- many backed by Federal government support -- are expected to boost capacity and export over the next several years.

Rebound in Construction

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.

Demand in the U.S. homebuilding industry remains strong and is expected to continue in the rest of 2017 and next year. Strong employment, rising income, increasing interest from first-time homebuyers, low inventory of new and existing homes and post-hurricane rebuilding efforts are among the factors that should support continued growth in housing demand.

The renewal of long-stalled construction projects and long-awaited access to credit from lending institutions has also helped invigorate the commercial construction sector. The U.S. Architecture Billings Index (ABI), an economic indicator that provides a roughly nine to 12-month glimpse into the future of non-residential construction spending activity, has been above 50 (a reading above 50 indicates an increase in billings) for most part of this year, indicating growth in architectural activity. The American Institute of Architects (AIA) expects non-residential construction spending to go up 3.8% in 2017 and 3.6% in 2018.

Positives such as an improving economy, low interest rates, positive consumer confidence and a tight supply situation raise optimism about the construction sector’s performance.

A Resilient Automotive Sector

Chemical makers continue to see healthy demand from the automotive sector -- a major end-use market. The last two years have been exceptional for the auto sector. Sales in the United States saw record highs in both years, while sales in China and Europe also gained strength.

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 from the 2016 level of 17.5 million units, 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. This augurs well for chemical demand in this important end-market.

A Resurgent European Economy

Eurozone’s economic recovery continues apace, as evident from recent upbeat economic data. The region’s recovery is backed by declining unemployment and strengthening business and consumer confidence. The European chemical industry has also swung back to life on the back of a rebounding Eurozone economy.

The Eurozone GDP rose 0.6% in the third quarter of 2017 (according to Eurostat data) on a quarter-over-quarter basis, coming above the consensus estimate of 0.5%. The euro area unemployment rate also fell to its lowest level in almost nine years. Notably, the French economy (the bloc’s second-largest economy) grew at an annual rate of 2.2%, the strongest pace since 2011, on the back of consumer spending and business investment.

While political risks may still remain a drag, the Eurozone economy is poised for a strong 2017. The European Commission, in its spring 2017 forecast, said that it expects the Eurozone to grow 1.7% in 2017 (up from previous estimate of 1.6%), followed by 1.8% in 2018.

Recovery in Energy Space

A rebound in crude oil prices has led to a recovery in demand for chemicals in the energy space, an important end-use market. Oil prices have been steadily recovering from their historic lows, currently trading above the important psychological level of $50 a barrel. The commodity has risen roughly 30% since sinking to a ten-month low of $42 a barrel in late June 2017 in the face of a surging U.S. oil output. Oil prices also recently soared to their highest level in more than two years.

The rebound in crude prices is backed by the OPEC cartel’s compliance with its production cut agreement, slowing production in the United States as well as the prospects of extended oil production cuts by OPEC and other major global producers.

Improving fundamentals in the energy space is expected to support chemical demand moving ahead. Rising crude prices also augur well for chemical prices as they essentially move in tandem with oil prices.

Chemical M&A Wave Continues

Chemical makers remain actively focused on mergers and acquisitions to diversify and shore up growth. These companies are increasingly looking for cost synergy opportunities and enhanced operational scale through consolidations. The $130 billion mega-merger of The Dow Chemical Company and E.I. du Pont de Nemours & Company (DuPont) to create DowDuPont Inc. (DWDP - 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 China National Chemical Corporation’s $43 billion acquisition of Syngenta AG, Albemarle Corporation’s (ALB - Free Report) $6.2 billion buyout of Rockwood Holdings, Inc., Merck KGaA's $17 billion acquisition of Sigma-Aldrich Corp., and the $66 billion proposed mega-merger between Monsanto Company MON and Bayer AG.

Strategic Measures to Yield Margin Benefits

Chemical companies continue to shift their focus on high-growth markets (driven by megatrends) in an effort to whittle down their exposure on other businesses that are struggling with weak demand and input costs pressure. Moreover, cost-cutting measures and productivity improvement actions by chemical companies are expected to yield industry-wide margin improvements. Some chemical makers are also disposing non-core assets as they shift their focus on high-margin businesses.

Moreover, a number of chemical makers are taking pricing actions (reflected by hikes in chemical prices in the recent past) in the wake of a sharp rise in raw materials costs. This is also expected to reap margin benefits moving ahead.

Stocks to Bet 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 Westlake Chemical Corp. (WLK - Free Report) and Kraton Corp. (KRA - Free Report) , both sporting a Zacks Rank #1 (Strong Buy), as well as Air Products and Chemicals, Inc. (APD - Free Report) , Celanese Corp. (CE - Free Report) , Albemarle Corp. and FMC Corp. (FMC - Free Report) , all carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Westlake has gained around 78% over a year. The stock has a long-term expected earnings per share (EPS) growth rate of roughly 8.4%. Earnings estimates for the current year have been revised 3.6% upward over the last 60 days.

Kraton has gained roughly 89% over the past year. Earnings estimates for the current year have been revised 17% upward over the last 60 days. The stock has an expected earnings growth of 25.4% for the current year.

Air Products has a long-term expected EPS growth rate of 12.1%. The stock’s earnings estimates for the current year have been revised 3.1% upward over the last 60 days. It has an expected earnings growth of 10.9% for the current year. The stock has also gained around 17% over a year.

Celanese has gained around 47% over the past year. The stock has an expected earnings growth of 11.5% for the current year. It also has a long-term expected EPS growth rate of 9%.

Albemarle has gained roughly 73% over a year. The stock has an expected earnings growth of 22.1% for the current year. It also has a long-term expected EPS growth rate of 14.8%.

FMC has gained around 75.3% over a year. The stock has a long-term expected EPS growth rate of 11.3%.

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

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