The chemical plastic industry includes manufacturers of polymer materials for a host of end-use markets such as packaging, building & construction, transportation, electronics, containers and aerospace. These products include plastic resins such as polyethylene, polypropylene, polyvinyl chloride (PVC) and polystyrene that are made from raw materials sourced from crude oil and natural gas.
While escalating trade tensions between the United States and China pose as headwinds to the chemical plastic industry, it is poised to gain from an upswing in the global economy and healthy demand from major end-markets such as packaging, building & construction and transportation.
Concerns over a fierce trade war between Washington and Beijing have gripped the markets since March 2018. The United States and China recently levied a 25% tariff on $16 billion worth of each other’s products, ramping up the trade tussle between the world's two biggest economies. The Trump administration, in July, had imposed tariffs on $34 billion in Chinese goods that led to China retaliating with tariffs on American products of equal value. China’s list of U.S. goods hit with tariffs include chemicals and plastics.
China’s retaliatory tariffs would harm a major market for a range of chemicals and plastics produced in the United States. Chemical industry groups have raised concerns that the tariffs would hurt U.S. plastics exports and the competitiveness of the domestic chemical plastic industry.
Notwithstanding trade-related worries, prospects of the chemical plastic industry look encouraging over the near term. In particular, the U.S. plastic industry is set for strong growth. The American Chemistry Council ("ACC"), a leading industry trade group, envisions U.S. plastic resins production to grow at the fastest pace this year since 2012 as new capacity comes onstream and demand firms for domestic and overseas customers.
The American chemical plastic industry continues to enjoy the advantage of access to abundant and cheap ethane feedstock extracted from shale gas. The shale bounty has provided U.S. plastic producers a compelling cost advantage over their global counterparts, which use oil-based feedstock such as naptha.
This is driving investment in plastic production projects in the U.S. Gulf Coast to beef up capacity. The shale boom has incentivized a number of companies to plough billions of dollars for setting up facilities (crackers) in the United States to produce key feedstocks like ethylene and propylene in a cost-effective way.
Over the short haul, broader economic growth, higher industrial activities and growing consumer spending are expected to support demand for major plastic products including polyethylene and PVC across key markets. Demand for polyethylene -- the most widely consumed polymer globally -- remains strong in the packaging market for applications in films, bags, bottles and other packaging materials, thanks to growing usage in food and consumer packaging.
Moreover, building and construction is a significant market for PVC (usages include piping, flooring, roofing and windows frames) and the favorable overall outlook for the housing market augurs well for this major plastic product.
The companies in this space should also continue gaining from strategic measures, including cost-cutting and productivity improvement, earnings-accretive acquisitions and price increase actions in the wake of raw material cost inflation. These actions should spur industry-wide margin improvement. President Trump’s business-friendly tax reform would also remain a tailwind. The tax reform should favorably impact the bottom line and cash flows of U.S. chemical plastic companies.
Industry Tops on Shareholder Returns
The Zacks Chemicals Plastics industry, which is a 9-stock group within the broader Zacks Basic Materials Sector, has outperformed both the S&P 500 and its own sector over the past year.
While the stocks in this industry have collectively surged 26.8%, the Zacks S&P 500 Composite and Zacks Basic Materials Sector have gained 18.2% and 5.3%, respectively.
The outperformance has been driven by a rally in the stocks of U.S. plastic makers. While the ongoing trade war has threatened the industry, American plastic makers are gaining from their cost-advantaged position, strong end-market demand as well as organic and inorganic growth measures.
One-Year Price Performance
Stocks in the Industry Trading Cheap
Despite the outperformance of the chemical plastic industry over the past year, the valuation looks cheap now. One might get a good sense of the chemical plastic industry’s relative valuation by looking at its EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. The industry's valuation picture looks attractive.
The EV/EBITDA multiple is a preferred measure for valuating cyclical industries like chemicals that have significant fluctuations in earnings from one quarter to the next. Notably, the value of commodity companies is dependent on the movements of the prices of commodities and growth in the underlying industry/economy, both of which typically move in cycles.
Going by this multiple, valuation for the Zacks Chemicals Plastics industry looks cheap at the moment when compared to the broader market and its own sector.
The industry has a trailing 12-month EV/EBITDA ratio of 7.8, which is below its own average of 9.1 and the highest level of 10.6 in the past one year. The industry compares favorably with the market at large, as the trailing 12-month EV/EBITDA ratio for the S&P 500 is at 11.7 and the median level is 11.5.
Enterprise Value/EBITDA (TTM)
Moreover, a comparison of the group’s EV/EBITDA ratio with that of its broader sector indicates that the group is trading at a discount. Zacks Basic Materials Sector’s trailing 12-month EV/EBITDA ratio of 8 and the median level of 10.4 for the same period are above the respective ratios of the Zacks Chemicals Plastics industry.
Enterprise Value/EBITDA (TTM)
Earnings Outlook Paints Favorable Picture
Chemical plastic stocks are expected to continue delivering positive returns over the near term on the back of favorable end-market fundamentals and expectations of industry-wide margin improvement driven by strategic actions. But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead.
One reliable measure that can help investors understand the industry's prospects for a solid price performance is the earnings outlook for its member companies. Empirical research shows that a company's earnings outlook significantly influences the performance of its stock.
While one could get a good sense of a company's earnings outlook by comparing the consensus earnings expectation for the current financial year with last year's reported number, an effective measure could be the magnitude and direction of the recent change in earnings estimates.
The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.
Price and Consensus: Zacks Chemicals Plastics industry
This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.
Please note that the $4.92 EPS estimate for the industry for 2018 is not the actual bottom-up dollar estimate for every company within the Zacks Chemicals Plastics industry but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the industry's earnings per share for 2018 but how this estimate has evolved recently.
Current Fiscal Year EPS Estimate Revisions
As you can see here, the EPS estimate for 2018 is up from $4.75 at the end of June, $4.47 at the end of March and $3.41 this time last year. In other words, the sell-side analysts covering the companies in the Zacks Chemicals Plastics industry have been steadily raising their estimates.
Zacks Industry Rank Indicates Upbeat Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates a positive picture for the near term.
The Zacks Chemicals Plastics industry currently carries a Zacks Industry Rank #53, which places it at the top 21% of more than 250 Zacks industries. Our back-testing shows that the top 50% of the Zacks ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Long-term Growth Prospects Look Promising
The long-term (3-5 years) EPS growth estimate for the Zacks Chemicals Plastics industry appears upbeat. The group’s mean estimate of long-term EPS growth rate has been increasing since April 2018 to reach the current level of 15.4%. This compares to 9.8% for the Zacks S&P 500 composite.
Mean Estimate of Long-Term EPS Growth Rate
In fact, the basis of this long-term EPS growth could be the recovery in top line that stocks in this industry group have been showing since the beginning of 2016.
Another important indication of solid long-term prospect is the improvement in the group’s EBITDA, which is an important metric for evaluating chemical stocks.
Chemical plastic makers face the heat from trade tariffs. However, strong end-market demand coupled with strategic actions including expansion of scale through acquisitions, capacity expansion and continued focus on cost and productivity should keep them afloat over the short haul.
Packaging and construction industries will continue to be the mainstays of the chemical plastic industry. Moreover, U.S. plastic makers should continue to reap the benefits of abundant and affordable shale gas feedstock.
Keeping the long-term expectations in mind, investors could take advantage of the cheap valuation and bet on a few stocks in this space that have a strong earnings outlook.
Stocks to Buy
Below we list two stocks that have been witnessing positive earnings estimate revisions and carry a Zacks Rank #1 (Strong Buy) or 2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
Trinseo S.A. (TSE - Free Report) : The stock of this Pennsylvania-based company has gained 20% over the past year. The Zacks Consensus Estimate for the current-year EPS has been revised 3% upward over the last 30 days.
Price and Consensus: TSE
Rayonier Advanced Materials Inc. (RYAM - Free Report) : The consensus EPS estimate for this Florida-based company has moved 9.5% higher for the current year, over the last 30 days. The stock has rallied 55% over the past year.
Price and Consensus: RYAM
Stock to Hold
Investors may also hold onto the following stock that has been seeing positive earnings estimate revision. It currently carries a Zacks Rank #3 (Hold).
Nexeo Solutions, Inc. (NXEO - Free Report) : The consensus EPS estimate for this Texas-based company has moved 1.4% higher for the current year, over the last 30 days. The stock has returned 38% over the past year.
Price and Consensus: NXEO
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