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Near-Term Prospects Appear Dim for Chemical Plastics Stocks

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The Zacks Chemicals Plastics industry consists of 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 and polystyrene that are made from raw materials sourced from crude oil and natural gas. Packaging and construction industries remain the mainstays of the chemical plastics industry.

Here are the three major themes in the industry:

  • Chemical plastics makers face the heat from trade war between the United States and China. Washington and Beijing slapped billions of dollars in punitive tariffs on each others’ products last year. China’s list of U.S. goods hit with tariffs includes an array of plastic products. China is one of the biggest export markets for U.S. chemicals and plastics. Beijing’s tariffs would harm a major market for a range of plastics products produced in the United States. The tariffs would hurt U.S. plastics exports and the competitiveness of the American plastics industry.
     
  • Companies in this space are exposed to margin pressure from a spike in costs of raw materials as a result of short supply, partly due to production outages and plant shutdowns. China’s environmental crackdown has led to tightening in the supply of certain key raw materials as a result of plant closures. The disruption in the supply chain has pushed up prices of these inputs. Nevertheless, strategic measures including cost-cutting and productivity improvement, earnings-accretive acquisitions and price increase actions should help these companies offset the headwinds.
     
  • 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. Such investments should boost capacity and export.


Zacks Industry Rank Indicates Bleak Prospects

The Zacks Chemicals Plastics industry is part of the broader Zacks Basic Materials Sector. It carries a Zacks Industry Rank #242, which places it at the bottom 6% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates gloomy near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic about this group’s earnings growth potential. Since Jul 31, 2018, the industry’s earnings estimate for 2018 and 2019 has gone down around 6.5% and 12.1%, respectively.

Before we present a few chemical plastics stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock market performance and current valuation.

Industry Lags Sector and S&P 500

The Zacks Chemicals Plastics industry has lagged both the Zacks S&P 500 composite and the broader Zacks Basic Materials Sector over the past year.

The industry has declined 34.6% over this period compared with the S&P 500’s decline of 6.8% and broader sector’s fall of 22.1%.

One-Year Price Performance



 

Industry’s Current Valuation

On the basis of trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, which is a commonly used multiple for valuing chemical stocks, the industry is currently trading at 6.03X, below the S&P 500’s 9.82X and the sector’s 7.26X.

Over the past five years, the industry has traded as high as 10.67X, as low as 3.90X, with a median of 6.98X, as the chart below shows.

Enterprise Value/EBITDA (EV/EBITDA) Ratio



 

Enterprise Value/EBITDA (EV/EBITDA) Ratio



 

Bottom Line

Trade frictions between the United States and China pose as headwind to the industry. Moreover, margins of the companies in this space will remain under pressure amid an inflationary environment given the spike in raw material costs.

Nevertheless, strategic actions including continued focus on cost and productivity and expansion of scale through acquisitions should keep them afloat over the short haul. U.S. plastic makers should also continue to reap the benefits of abundant and affordable shale gas feedstock.

We are presenting one stock with a Zacks Rank #1 (Strong Buy) and another with a Zacks Rank #2 (Buy) that are well positioned to grow. There is also another stock with a Zacks Rank #3 (Hold) that investors may currently hold on to. You can see the complete list of today’s Zacks #1 Rank stocks here.

Nexeo Solutions, Inc. (NXEO - Free Report) : The Texas-based company, sporting a Zacks Rank #1, has an expected earnings growth of 29.7% for the current fiscal year. It also has an estimated long-term earnings growth rate of 30.6%.

Price: NXEO



 

PolyOne Corporation (POL - Free Report) : The Ohio-based company, carrying a Zacks Rank #2, has an expected earnings growth of 9.4% for the current year. It also has an estimated long-term earnings growth rate of 10%.

Price: POL



 

JSR Corporation (JSCPY - Free Report) : This Japan-based company currently carries a Zacks Rank #3. The Zacks Consensus Estimate for earnings for the current fiscal year has remained stable in the last 30 days.

Price: JSCPY



 

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