The chemical industry is riding an upturn in the global economy and strength across major end-use markets such as construction and automotive. Improving fundamentals in the energy space driven by an upswing in crude oil prices also augur well for the industry.
Notwithstanding a few headwinds, including a spike in raw materials costs and softness in agricultural commodity prices, chemical companies are expected to continue the earnings momentum witnessed in Q1 into Q2 as the fundamental driving factors remain in place.
Per the Zacks Industry classification, the chemical industry is grouped under the broader Basic Materials sector. The Basic Materials sector is among the Zacks sectors that racked up the strongest gains in Q1. Overall earnings for the sector climbed 56.4% while revenues spiked 24.3%. Earnings for the sector are projected to surge 54% in Q2 while revenues are expected to go up 24.1%, per our latest Earnings Preview.
Cost-cutting measures and productivity improvement actions by chemical companies should continue to reap industry-wide margin improvements in Q2. Moreover, a number of chemical makers are taking appropriate pricing actions (reflected by hikes in chemical prices) to offset raw materials cost inflation, which should also provide margin benefits.
Chemical companies also remain actively focused on mergers and acquisitions to diversify and perk up growth. Synergies from acquisitions should also lend support to earnings in Q2.
President Donald Trump’s business-friendly tax reform also contributed to the impressive performance of the U.S. chemical makers in Q1 and would continue to be a major tailwind in Q2. The newly introduced tax reform significantly reduces the corporate tax rate from 35% to 21%, which is a positive for chemical stocks. This is expected to boost their bottom line, improve cash flows and incentivize capital investment.
In this write up, we run a comparative analysis on two major chemical stocks – Celanese Corporation (CE - Free Report) and PPG Industries, Inc. (PPG - Free Report) – to figure out which of these stocks is better placed ahead of their Q2 earnings report. Both companies are scheduled to report their Q2 numbers on Jul 19.
While Celanese carries a Zacks Rank #2 (Buy), PPG is a Zacks Rank #3 (Hold) stock. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Let's take a closer look at how Celanese and PPG are stacked up against each other in terms of certain key metrics.
ESP and Earnings History
Earnings ESP is our proprietary methodology for identifying stocks that have high chances of surprising in their upcoming earnings announcement. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate. Our research shows that for stocks with the combination of a favorable Zacks Rank #1, 2 or 3 and a positive Earnings ESP, the chance of a positive earnings surprise is as high as 70%.
Celanese is likely to beat earnings in the quarter to be reported. This is because the stock has an Earnings ESP of +4.80% and a Zacks Rank #2. However, the picture is different for PPG with an Earnings ESP of -1.51% and a Zacks Rank #3, a combination which makes surprise prediction difficult.
With respect to surprise, Celanese beat estimates in each of the trailing four quarters, delivering an average positive surprise of 7%. On the other hand, PPG beat the Zacks Consensus Estimate in two of the last four quarters while missed once and met expectations on the other occasion. In this timeframe, it came up with an average positive surprise of 0.1%.
In terms of earnings growth expectations, Celanese scores above PPG. The expected earnings per share growth rate for Celanese for Q2 currently stands at 32.4% compared with an expected rise of 3.3% for PPG.
Celanese’s shares have rallied 16.7% over the past year and outperformed the industry over the same period. On the other hand, PPG’s shares have lost 6.3% and underperformed the industry. As such, Celanese clearly scores above PPG.
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. Celanese has a debt-to-equity ratio of 102.8, while the industry has debt-to-equity ratio of 34.5. In contrast, with a debt-to-equity ratio of 95.5 PPG 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, Celanese is a winner with a current ratio of 1.88, which is superior to PPG’s reading of 1.76.
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 PPG stands at 3.6%, which is higher than 3% for Celanese.
Going by the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) multiple, which is often used to value chemical stocks, PPG looks cheaper compared with Celanese.
Both Celanese and PPG are underpriced, with EV/EBITDA ratios of 12.3 and 11.2, respectively, compared with the industry’s EV/EBITDA ratio of 12.5. Clearly, PPG 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 Celanese and PPG is 35.2% and 26.5%, respectively. As such, Celanese hasan edge here.
Our comparative analysis shows that PPG holds an edge over Celanese in terms of valuation, free cash flow yields and debt-to-equity ratio. However, when considering price performance, earnings surprise history, earnings growth projections, ROE measures and current ratio, Celanese seems to be the preferred stock. On top of that, the company has a better ESP reading vis-à-vis PPG. As the scale is clearly tipped in favor of Celanese, it makes a better investment proposition.
Some Other Stocks to Consider
Apart from Celanese, investors interested in the chemical space may also consider FMC Corporation (FMC - Free Report) and LyondellBasell Industries N.V. (LYB - Free Report) , both of which carry a Zacks Rank #2.
FMC has an expected earnings growth of 258.3% for Q2. Its shares have gained roughly 23% over a year.
LyondellBasell has an expected earnings growth of 4.3% for Q2. The company’s shares have rallied around 31% in a year.
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