The chemical industry has gotten its mojo back on an upswing in the global economy and strength across major end-use markets. The highly cyclical industry put up a commendable performance in fourth-quarter 2017. A host of companies in the space posted better-than-expected earnings in the quarter, driven by strategic measures including productivity improvement, pricing actions, portfolio restructuring and earnings-accretive acquisitions.
The Zacks Chemicals Diversified industry has outperformed the broader market in a year’s time. The industry has gained around 17.5% over this period, higher than the S&P 500’s corresponding return of roughly 16.4%.
While the chemical industry still faces a few headwinds, its momentum is expected to continue this year on sustained demand strength across construction and automotive markets, a rebound in demand in the energy place and significant shale-linked capital investment.
Cost-cutting measures and productivity improvement actions by chemical companies should continue to reap industry-wide margin improvements in 2018. Moreover, a number of chemical makers including Celanese Corp. (CE - Free Report) and PPG Industries, Inc. (PPG - Free Report) are taking appropriate pricing actions to offset raw materials cost inflation, which should also provide margin benefits.
The U.S. Chemical Industry has recovered from the damaging effects of hurricanes and is set for solid growth in 2018. The American Chemistry Council ("ACC"), an industry trade group, envisions U.S. chemical production (excluding pharmaceuticals) to rise 3.7% in 2018. The growth is expected to be spurred by higher demand across light vehicles and housing markets, capital investments and strengthening export markets.
The European chemical industry is also back in business after remaining in a rut for a spell. The business environment for the European chemical industry has improved on the back of a resurgent Eurozone economy and improving global economic sentiment.
In this write up, we run a comparative analysis on two prominent chemical payers – LyondellBasell Industries N.V. (LYB - Free Report) and Eastman Chemical Company (EMN - Free Report) – to figure out which one is a better option for investment right now.
LyondellBasell, a Zacks Rank #1 (Strong Buy) stock, has a market capitalization of around $41.6 billion and is among the leading plastics, chemical and refining companies globally. You can see the complete list of today’s Zacks #1 Rank stocks here.
LyondellBasell is executing its expansion projects to leverage the U.S. natural gas liquids advantage. The company’s expansion initiatives are expected to boost capacity and add to its earnings. LyondellBasell expects capital spending of roughly $2.4 billion for 2018 with roughly 55% is targeted toward profit generating growth.
LyondellBasell, last month, agreed to buy A. Schulman, Inc. , a leading supplier of high-performance plastic compounds, in a deal worth $2.25 billion. The buyout doubles the size of LyondellBasell's existing compounding business and creates a platform for future growth with reach into additional high-growth markets.
Eastman Chemical, sporting a Zacks Rank #2 (Buy), is a global chemical company boasting a broad portfolio of chemical, plastic, and fiber products with a market capitalization of $13.1 billion.
Eastman Chemical is gaining from strong growth of high-margin products in its specialty businesses and its strategic acquisitions. It remains focused on cost-cutting and productivity actions, which is helping it to offset raw material cost inflation and other cost headwinds.
Let's take a closer look at how LyondellBasell and Eastman Chemical are stacked up against each other in terms of certain key metrics.
Eastman Chemical’s shares have rallied 36.7% over the past year while LyondellBasell’s shares have gained 19.7%. While both stocks have outperformed the Zacks Chemicals Diversified industry over the same period, Eastman Chemical clearly scores above LyondellBasell.
The debt-to-equity ratio is a good indicator of the financial well-being of a company and is a good proxy for its debt-servicing capacity. Eastman Chemical has a debt-to-equity ratio of 112.2, while the industry has debt-to-equity ratio of 34.8. In contrast, with a debt-to-equity ratio of 96.3 LyondellBasell wins this round.
This metric measures the ability of a company to meet its short-term debt obligations efficiently. In other words, it is the ratio of the current level of total assets and versus the current level of liabilities. Here, LyondellBasell is a clear winner with a current ratio of 2.46, which is superior to Eastman Chemical's reading of 1.59.
Going by the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) multiple, a preferred valuation metric for cyclical industries like chemicals, LyondellBasell looks cheaper compared with Eastman Chemical.
Both LyondellBasell and Eastman Chemical are underpriced, with EV/EBITDA ratios of 8.6 and 11.8, respectively, compared with the industry’s EV/EBITDA ratio of 17. Clearly, LyondellBasell is cheaper and scores on this front.
Return on Equity (ROE)
ROE is a measure of a company’s efficiency in utilizing shareholder’s funds. ROE for the trailing 12-months for LyondellBasell and Eastman Chemical is 55.1% and 22%, respectively. While both stocks have scored above the industry’s level of 9.4%, LyondellBasell holds an edge here.
Free Cash Flow Yields
Companies with strong operations generally have high free cash flow yield, indicating that the amount of money investors are generating is more than the amount spent on the stock.
Our proprietary model shows that free cash flow yield for LyondellBasell stands at 8.5%, higher than 6.6% of Eastman Chemical.
Earnings Surprise History
Eastman Chemical has outpaced the Zacks Consensus Estimate in each of the trailing four quarters, with an average positive earnings surprise of 17.7%. On the other hand, LyondellBasell has delivered positive earnings surprises in two of the trailing four quarters while missed twice, generating an average positive earnings surprise of 2.1%.
In terms of earnings growth expectations, Eastman Chemical scores above LyondellBasell. The expected earnings per share growth rate for Eastman Chemical for the current year stands at 12.1% compared with an expected increase of 5.1% for LyondellBasell.
Our comparative analysis shows that Eastman Chemical holds an edge over LyondellBasell in terms of price performance, earnings surprise history and earnings growth projections. However, when considering valuation, free cash flow yields, ROE measures, current ratio and debt-to-equity ratio, LyondellBasell seems to be the preferred stock. As the scale is clearly tipped in favor of LyondellBasell, it makes a better investment proposition compared to Eastman Chemical.
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