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What Could Dampen Chemical Industry Momentum?

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The chemical industry is finding traction again after staying down for a while. Chemical makers should benefit from continued strong demand in major markets and strategic measures including expansion into high-growth markets, aggressive cost management, acquisitions and investment on capacity expansion. However, the industry is still exposed to certain headwinds. There are a few reasons to be mindful about the chemical industry in the near term, which we have outlined below:

China Worries Persist

Fears of an economic slowdown in China -- a major market for chemicals -- is a deterrent over the short haul. The world’s second-biggest economy remains hampered by persistent industrial overcapacity, weak property investment and rising corporate debt. In particular, ballooning debt levels (manifested by rising debt-to-GDP ratios) and rapid credit expansion have raised a red flag on the Chinese economy.

China’s GDP expanded 6.9% in 2017, better than the Chinese government’s growth target of roughly 6.5%, aided by a recovery in export. However, the country’s economy is expected to lose momentum this year and faces headwinds from tighter regulations, trade tensions with the United States and a weaker consumer sector.

The Chinese government expects a slowdown in economic growth this year and sees a GDP growth of 6.5%. The expected slowdown, in part, is due to Beijing’s efforts to curb risks in the financial system, reduce poverty and clean up the environment (partly through reduction in steel and coal production).

Moreover, the International Monetary Fund (IMF), its annual report on the Chinese economy, had issued a warning about the country’s surging debt level that has raised risks for a potential sharp decline in growth in the medium term. The IMF projects China’s growth to moderate gradually and sees GDP to grow 6.6% in 2018, further slowing to a 6.4% growth in 2019.

Capital outflow pressures, rapid credit expansion, continued reliance on stimulus measures and geopolitical uncertainties are among the key risks to the country’s economic growth. As such, a sluggish Chinese economy may weigh on demand for chemicals in this significant market.

Still-Difficult Fertilizer/Agrichemical Space

Agriculture market fundamentals remain weak, and there is continuous negative sentiment among agriculture investors that can create uncertainty in the near term. Moreover, the prevailing softness in agricultural commodity pricing remains a concern for fertilizer and agricultural chemicals companies. Prices of major crops (such as corn and soybeans) remain at their multi-year lows as markets remain awash with grains.

Adding to the concerns is the expected decline in U.S. farm income in 2018. U.S. farm profits are expected to hit 12-year low this year, per the U.S. Department of Agriculture’s (USDA) outlook. The USDA envisions net U.S. farm income to tumble 6.7% year over year to $59.5 billion in 2018, the lowest level since 2006.

The projected decline in profits is due to lower expected cash receipts from the sale of crop inventories as well as low crop prices. The USDA expects cash receipts for all commodities to go down 0.5% year over year to $363.1 billion in 2018. Cash receipts for crops have been forecast to dip 0.8% to $188.2 billion. The USDA also sees prices of corn and soybean to drop this year.

As such, lower anticipated farm income is likely to negatively influence farmers’ nutrient-purchasing decisions this year. Lower profit is expected to lead to tightened spending by growers.

Raw Material Cost Pressure

Commodity pricing remain a concern for many U.S. chemical producers. Their ability to pass these costs on to end consumers is not always easy, given the competitive pressures in play.

A number of chemical companies including PPG Industries, Inc. (PPG - Free Report) , Celanese Corp. (CE - Free Report) and Eastman Chemical Co. (EMN - Free Report) are witnessing a spike in raw material prices, exacerbated by short supply due to hurricanes. As a result, margins of these producers may be under pressure moving ahead amid an inflationary environment. A number of chemical makers, in their December quarter earnings calls, have warned of continued headwinds from elevated input costs through first-half 2018.

Trump Trade Tariffs Pose Headwinds

While President Trump’s actions toimpose heavy tariffs on steel and aluminum imports would provide more protection to the domestic producers of these metals, it poses a headwind for the U.S. chemical industry. The move is expected to hurt new chemical investment in the United States and may lead to a slowdown in growth in the domestic chemical industry. These costly tariffs are likely to push up the costs of building chemical plants that use a significant amount of steel.

According to the American Chemistry Council (“ACC”), the chemical industry has invested $185 billion in new factories, expansions and restarts of plants across the United States with more than half of these projects presently in the planning stage. The trade group has raised concerns that the hefty trade tariffs may force investors to consider doing business elsewhere.

Stocks to Get Rid of Now

As you can see, there are certain reasons to be cautious about the chemical industry. As such, it would also be a prudent choice to get rid of certain companies in the space that show weak fundamentals and carry an unfavorable Zacks Rank.

We hold a bearish view on Olin Corp. (OLN - Free Report) , Compass Minerals International, Inc. (CMP - Free Report) and Ashland Global Holdings Inc. (ASH - Free Report) , each holding a Zacks Rank #5 (Strong Sell). We also suggest staying away from stocks such as Innophos Holdings, Inc. (IPHS - Free Report) , Innospec Inc. (IOSP - Free Report) and Axalta Coating Systems Ltd. (AXTA - Free Report) , all carrying a Zacks Rank #4 (Sell).

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

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