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Chemical Industry Looking Up: Stocks Warranting a Look

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The chemical industry has gotten its mojo back on strength across major end-markets and a resurgent world economy. The industry’s upturn is expected to continue in 2018 as the fundamental driving factors remain in place.

Despite a few industry-related and macroeconomic headwinds, 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 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, 320 new chemical projects have been already announced by chemical makers worth more than $185 billion that are under construction or complete. Such investments - many backed by Federal government support - are expected to boost capacity and export over the next several years.

Chemical industry capital spending also continues to go up, clocking $38 billion in 2017, according to the ACC. This also accounts for one-half of overall construction spending by the manufacturing sector. The trade group expects capital spending to rise 6.3% in 2018 and 6.8% in 2019 and eventually reach $48 billion by 2022.

Strong Momentum in Construction

A rebound 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 U.S. homebuilding industry performed remarkably well in 2017 and the momentum is expected to continue this year. Strong employment, rising income, increasing interest from first-time homebuyers, tight inventory of new and existing homes and high homebuilder confidence are among the factors that should support continued growth in housing demand in 2018.

Moreover, 2018 has started on a positive note for 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, hit the highest level in January 2018 since 2007.

Per the American Institute of Architects (AIA), the ABI score was 54.7 (a reading above 50 indicates an increase in billings) for January, an increase from 52.8 a month ago, indicating an upturn in architectural activity. The AIA also expects non-residential construction spending to go up 4% in 2018 and 3.9% in 2019.

Positives such as an improving economy, an impressive job market, rising consumer confidence and a tight supply situation raise optimism about the construction sector’s performance. Moreover, President Donald Trump’s plan to double economic growth through an ambitious stimulus program featuring higher infrastructure spending, tax cuts and deregulation augur well for the sector.

Demand Strength in Automotive Sector

Chemical makers continue to see healthy demand from the automotive sector - a major end-use market. 2017 has been another record-setting year for global light vehicle sales. IHS Markit expects another strong year for the automotive industry on a global level in 2018 and envisions global light vehicle sales to increase 1.5% year over year to 95.9 million units this year.

Moreover, demand is expected to remain healthy in the United States this year. Rising demand for crossovers, sports utility vehicles and light trucks are aiding the U.S. auto industry. The National Automobile Dealers Association (NADA) foresees a stable, healthy market for new vehicles in 2018 and expects new cars and light trucks sales to reach 16.7 million units.

The auto industry in Asian countries, especially China, is also expected to thrive over the next several years. China is the biggest and fastest growing auto market in the world in terms of number of vehicles sold. This augurs well for chemical demand in this important end-market.

Upturn in the Eurozone Economy

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

Eurozone wrapped up 2017 on a strong note with GDP rising 0.6% in the fourth quarter of 2017 (according to Eurostat data) on a quarter-over-quarter basis, driven by strong growth across Germany and France. The bloc’s economy also expanded 2.3% in 2017, the fastest rate in more than a decade.

While geopolitical risks may still remain a drag, the Eurozone economy is poised for a strong 2018. The European Commission, in its winter 2018 forecast, said that it expects the Eurozone to grow 2.3% in 2018 (up from previous estimate of 2.1%), followed by 2% in 2019.

Resurgent Energy Sector

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 nadir of below $30 a barrel in early 2016, currently trading above the important psychological level of $60 a barrel. Oil prices recently soared to their highest level in more than three years at $66 a barrel.

The uptrend in oil prices has been supported by a decline in U.S. oil stockpiles, upbeat demand outlook and extension of oil production cuts by OPEC and other major world producers until the end of 2018.

Improving fundamentals in the energy space is expected to support chemical demand moving ahead. The rebound in oil prices has also led to a favorable pricing environment for chemical products.

Chemical M&A Wave Continues

Chemical makers remain actively focused on mergers and acquisitions to diversify their business, enhance operational scale and shore up growth. 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 Corporation, and the $66 billion proposed mega-merger between Monsanto Company MON and Bayer AG.

Strategic Actions to Reap Margin Benefits

Chemical companies continue to switch their focus on attractive, growth markets in an effort to cut their exposure on other businesses that are grappling with weak demand. Moreover, cost-cutting measures and productivity improvement actions by chemical companies are expected to deliver industry-wide margin benefits in 2018. 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 Corporation (WLK - Free Report) and LyondellBasell Industries N.V. (LYB - Free Report) , both sporting a Zacks Rank #1 (Strong Buy), as well as Air Products and Chemicals, Inc. (APD - Free Report) , Eastman Chemical Company (EMN - Free Report) , Methanex Corp. (MEOH - Free Report) and The Chemours Company (CC - 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 83% over a year. The stock has a long-term expected earnings per share (EPS) growth rate of roughly 12.2%. Earnings estimates for the current year have been revised 16.6% upward over the last 60 days. The stock has an expected earnings growth of 47.5% for the current year.

LyondellBasell has gained roughly 25% over the past year. Earnings estimates for the current year have been revised 14% upward over the last 60 days. The company also has a long-term expected EPS growth rate of 9%.

Air Products has a long-term expected EPS growth rate of 16.3%. The stock's earnings estimates for the current year have been revised 4.1% upward over the last 60 days. It has an expected earnings growth of 16% for the current year. The stock has also gained around 24% over a year.

Eastman Chemical has gained around 41% over the past year. The stock has an expected earnings growth of 12% for the current year. Earnings estimates for the current year have been revised 3.6% upward over the last 60 days. The stock also has a long-term expected EPS growth rate of 8.9%.

Methanex has gained roughly 21% over a year. It has an expected earnings growth of 29.7% for the current year. Earnings estimates for the current year have been revised 24.4% upward over the last 60 days. The stock also has a long-term expected EPS growth rate of 15%.

Chemours has gained around 48% over a year. The stock has an expected earnings growth of 38.7% for the current year. Earnings estimates for the current year have been revised 6% upward over the last 60 days. The company also has a long-term expected EPS growth rate of 15.5%.

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

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