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The chemical industry is still in gradual recovery mode from the trough of the Great Recession. Despite a spate of headwinds, the highly cyclical industry fared reasonably well in the first half of the year, helped by continued strength across automotive and housing markets -- two major end-use markets for chemicals.

Chemical companies are increasingly looking for cost synergy opportunities and enhanced operational scale through consolidations amid nagging macroeconomic challenges. These companies also remain actively focused on increasing their reach in high-growth markets in a bid to cut their exposure to businesses that are struggling with depressed demand. Strategic measures including cost management and productivity improvement also remain the prime focus of these companies to stay afloat in a still-difficult global economic backdrop.

Some industry-specific challenges, the Eurozone’s feeble recovery and concerns over China’s future growth remain sources of near-term uncertainties for the chemical industry. Moreover, chemical makers are also feeling the bite of weak demand in the energy markets amid a still depressed oil price environment. A strong dollar is also hurting U.S. chemical exports, reducing their attractiveness in overseas markets.

Lingering weakness in China -- a key market for chemicals -- is expected to remain a major drag on the chemical industry in the short haul. A persistent credit crunch, overcapacity and weak infrastructure and manufacturing investment are hurting the world’s second-largest economy.

In addition, the outlook for the fertilizer and agricultural chemicals space remains cloudy due to sluggish economic conditions in certain developing markets, particularly Brazil.

Notwithstanding these challenges, the chemical industry is expected to continue to recuperate through the balance of 2016, supported by continued strength in the light vehicles market, positive trends in the construction space and significant shale-linked capital investment.

Prospects Look Healthy in the U.S., but EU Stuck in a Rut

The U.S. chemical industry is poised for growth this year and the next despite several challenges including a strong dollar and a difficult oil price environment. According to the American Chemistry Council (ACC), an industry trade group, U.S. chemical production will rise 1.6% in 2016 and 3.7% in 2017. Barring production of the pharmaceuticals segment, output is expected to go up 2.7% this year and 4.1% in 2017.

In particular, the trade group expects basic chemicals production to expand 3.1% in 2016 and 4.9% in 2017. Chemical production is also expected to increase across all regions of the country this year.

The ACC envisions the U.S. chemical industry to continue to gather momentum over the next several years on the heels of new capital investments, capacity additions and feedstock cost advantage, and even transcend the nation’s overall economic growth in the long term.

The shale gas bounty and ample supply of natural gas liquids has been a huge driving force behind chemical investment on plants and equipment in the U.S. and have provided domestic petrochemicals producers a compelling cost advantage over their global counterparts. The ACC expects this competitiveness to drive export demand and new capital investment in the country.

The shale revolution has made the U.S. an attractive investment hotspot. Chemical makers including Dow Chemical DOW, LyondellBasell Industries (LYB - Free Report) , BASF (BASFY - Free Report) , Eastman Chemical (EMN - Free Report) , Celanese (CE - Free Report) and Westlake Chemical (WLK) are investing heavily on shale gas-linked projects to take advantage of abundant natural gas supplies which is expected to boost capacity and export over the next several years. The ACC expects domestic chemical industry capital spending to increase 10.4% in 2016 and 7.8% in 2017.

Outlook for the European chemical industry, on the other hand, looks tepid given sustained sluggishness in the region. The Eurozone economy remains stuck in an insipid recovery, manifested by a paltry growth of 0.3% in the second quarter of 2016 (according to preliminary estimates published by Eurostat). The region’s economic growth, in the short run, is likely to be stymied by Brexit-induced political and economic uncertainties.

Chemical makers in the European Union remain affected by lower prices, relatively higher energy and feedstock costs and a challenging regulatory landscape. According to the European Chemical Industry Council (CEFIC), chemical output in the European Union contracted 0.7% year over year in the first four months of 2016 with chemical prices falling 3.8% for the period. Chemical production in the region rose just 0.6% last year.

CEFIC expects a modest growth of roughly 1% in chemical output in both 2016 and 2017. Healthy domestic demand coupled with tailwinds from a strong construction end-use market are expected to be offset by sluggish demand for European chemical exports due to a challenging global environment.

Zacks Industry Rank

Within the Zacks Industry classification, the chemical industry falls under the broader Basic Materials sector (one of 16 Zacks sectors) which is expected to have a 2.5% share of total earnings for the S&P 500 in 2016. We rank all of the more than 260 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry.

The way to look at the complete list of 260+ industries is that the outlook for the top one-third of the list (Zacks Industry Rank of #88 and lower) is positive, the middle 1/3rd or industries with Zacks Industry Rank between #89 and #176 is neutral while the outlook for the bottom one-third (Zacks Industry Rank #177 and higher) is negative. (To learn more visit: About Zacks Industry Rank.)

We have three chemicals related industries: Chemical Plastics, Chemical Specialty and Chemical Diversified. Both Chemical Plastics and Chemical Specialty industry are featuring in the top one-third of all Zacks industries with a Zacks Industry Rank #20 and Zacks Industry Rank #64, respectively. The Chemical Diversified industry currently retains a Zacks Industry Rank #171, placing it in the middle one-third of the 260+ industry groups.

Looking at the exact location of these industries, one could say that the general outlook for the chemical industry is ‘Positive-to-Neutral.’

Sector Level Earnings Trends

Looking at the overall results of the Basic Materials sector, earnings for 95% of the sector participants on the S&P 500 index that have unveiled their second-quarter 2016 numbers so far are down 11.8% from the same period last year on 9.1% lower revenues. Nevertheless, the sector racked up a decent beat ratio (percentage of companies coming out with positive surprises) of 63.2% for earnings in the quarter.

Basic Materials is among the sectors that are expected to see double-digit year-over-year earnings decline in the second quarter. The sector’s earnings are expected to drop 11.7% in the quarter on 7.6% lower revenues, considering the companies that are yet to report.

However, the earnings outlook for the sector for second-half 2016 paints an encouraging picture. Earnings for third-quarter 2016 are projected to increase 1.7%, accelerating to a 19.3% rise in the fourth quarter. Revenues are forecast to dip 2.6% in the third quarter and rise 3.2% in the fourth.

For more details about the earnings of this sector and others, please read our ‘Earnings Trends’ report.

The Way Forward

The chemical industry faces certain roadblocks including a still weak agriculture market, depressed demand in the energy space, slowdown in China and a choppy Europe. Nevertheless, continued strong momentum in the automotive space and an upswing in the construction markets bodes well for the industry.

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