The chemical industry continues its good run this year on sustained demand strength across major end-use markets such as construction and automotive. A rebound in crude oil prices has also led to a recovery in demand for chemicals in the energy market and a favorable pricing environment for chemical products as their prices essentially move in tandem with oil prices.
However, investors’ confidence on the industry’s prospects has taken a beating of late due to heightened trade tensions between the United States and China. The good fortunes of the chemical industry have been clouded by the escalating trade tussle between the world’s two biggest economies.
Notwithstanding the trade-related worries, the industry’s upturn is expected to continue in the final quarter of 2018 as the fundamental driving factors remain in place. The momentum is expected to continue on strength across automotive and construction end-markets, improving fundamentals in the energy space, strength in export markets and strategic growth initiatives by chemical companies.
Capital Investments, Strong Export Market Drive U.S. Chemical
The U.S. Chemical Industry has bounced back from the havoc wreaked by last year’s hurricanes, and is poised for healthy growth this year. The American Chemistry Council ("ACC"), a leading industry trade group, envisions U.S. chemical production (excluding pharmaceuticals) to rise 3.4% in 2018.
The growth is expected to be spurred by higher demand across light vehicles and housing markets, an upswing in U.S. manufacturing, favorable shale gas economics, capital investments and strengthening export markets. While the automotive sector is expected to remain at high levels, steady recovery in housing is expected to continue in 2018.
The American chemical 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. producers a compelling cost advantage over their global counterparts, which use oil-based feedstock such as naptha. This is driving investment in chemical production projects in the U.S. Gulf Coast to beef up capacity.
According to the ACC, 333 chemical projects (both on new plants and capacity expansions) have been already announced by chemical makers since 2010 worth $202.4 billion, 68% of which is foreign direct investment or involves an overseas partner. New capacity is expected to provide a boost to chemical production as these investments come on stream.
The trade group also expects U.S. chemicals exports to expand 7.2% in 2018 to $139.2 billion on the back of the basic chemicals sector. It sees two-way trade between the United States and its foreign partners to expand 6.2% year over year and reach $241 billion this year, aided by strong demand from overseas markets and domestic manufacturers downstream.
Strategic Actions to Offset Input Cost Inflation
Companies in the chemical space face headwinds 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 the tightening in the supply of certain key raw materials as a result of plant closures. The disruption in the supply chain has pushed up the prices of these inputs in a high demand environment.
Nevertheless, chemical companies should gain from strategic measures, including cost-cutting and productivity improvement, earnings-accretive acquisitions and aggressive price increase actions in the wake of raw material cost inflation. These actions should spur industry-wide margin improvement in the fourth quarter. Continued shift of focus on high-growth markets should also allow them lower their exposure on businesses that are grappling with weak demand and input costs pressure.
Trade Tensions Remain a Worry
Rising trade tensions between the United States and China pose as headwinds to the chemical industry. The Trump administration, in July, imposed tariffs on $34 billion in Chinese goods that led to China retaliating with tariffs on American products of equal value. The United States and China, in August, also levied a 25% tariff on $16 billion worth of each other’s products. China’s list of U.S. goods hit with tariffs includes a wide range of chemicals and plastics.
Moreover, the Trump administration recently slapped a 10% tariff (rising to 25% starting 2019) on $200 billion worth of Chinese imports. In response, China hit back with tariffs on an additional $60 billion in American products. The U.S. administration has also threatened to impose tariffs on around $267 billion of additional Chinese imports.
China is one of the biggest export markets for U.S. chemicals and thus, leaves the American chemical industry heavily exposed to Beijing’s retaliatory trade actions. The tariffs have created an uncertain demand environment for U.S. chemical products in this major market. Chemical industry trade groups are worried that the tariffs would hurt U.S. chemical exports and the competitiveness of the domestic chemical industry.
5 Chemical Stocks Set to Run Higher
Companies in the chemical space are hamstrung by a few challenges including input cost pressure and concerns over trade tariffs. However, strategic actions including expansion of scale through acquisitions, operational efficiency improvement, capacity expansion and continued focus on cost and productivity should keep them afloat through the remainder of 2018.
The U.S. chemical industry, in particular, is poised for solid upside on continued demand strength across major end-markets, gains in exports and significant capital investment on capacity additions. Moreover, U.S. chemical makers should continue to reap the benefits of abundant and affordable shale gas feedstock. Amid such a backdrop, it would be prudent to invest in chemical stocks that have compelling prospects and are well poised for solid upside in the fourth quarter.
We highlight the following five stocks with Zacks Rank #1 (Strong Buy) or 2 (Buy) that are good options for investment right now. You can see the complete list of today’s Zacks #1 Rank stocks here.
Quaker Chemical Corporation (KWR - Free Report)
Pennsylvania-based Quaker Chemical sports a Zacks Rank #1 and has an expected earnings growth of 20.6% for 2018. Earnings estimates for the current year have been revised 7.5% upward over the last 60 days. The company delivered positive earnings surprise in each of the trailing four quarters, with an average positive surprise of 5.2%. The stock has also rallied roughly 34% over the past six months.
Trinseo S.A. (TSE - Free Report)
Our next pick in the space is Pennsylvania-based Trinseo carrying a Zacks Rank #1. The company has expected earnings growth of 14.5% for 2018. Earnings estimates for the current year have been revised 1.1% upward over the last 60 days. The stock has also gained roughly 12% over the past six months.
Albemarle Corporation (ALB - Free Report)
North Carolina-based Albemarle is another attractive choice armed with a Zacks Rank #2. The company has an expected earnings growth of 17.4% for 2018. Earnings estimates for the current year have been revised 2.7% upward over the last 60 days. Moreover, the company delivered positive earnings surprise in each of the trailing four quarters, with an average positive surprise of 6.6%. The stock has also gained roughly 14% over the past six months.
Celanese Corporation (CE - Free Report)
Irving, TX-based Celanese sports a Zacks Rank #2 and also has expected earnings growth of 43% for 2018. Earnings estimates for the current year have been revised 1.6% upward over the last 60 days. Moreover, Celanese delivered positive earnings surprise in each of the trailing four quarters, with an average positive surprise of 11.5%. The stock has also gained around 14% over the past six months.
KMG Chemicals, Inc. (KMG - Free Report)
Based in Texas, KMG flaunts a Zacks Rank #2 and has expected earnings growth of 7.2% for the current fiscal year. Earnings estimates for the current fiscal have been revised 2.2% upward over the last 60 days. The company delivered positive earnings surprise in each of the trailing four quarters, with an average positive surprise of 30.1%. The stock has also rallied around 26% over the past six months.
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