Chemicals Industry Stock Outlook - Dec 2016

Chemical Industry Stays on Course Amid a Few Worries

The chemical industry is in the process of gradual healing after being badly shaken by the Great Recession. Notwithstanding a flurry of challenges, the industry put up a decent performance in the first three quarters of 2016, benefiting from healthy demand across automotive and housing sectors -- two major end-use markets for chemicals.

Amid a still-difficult global economic backdrop, chemical makers are increasingly looking for cost synergy opportunities and enhanced operational scale through consolidations, exhibited by a wide swath of deals in the recent past. These companies are also increasingly switching their focus on high-growth markets in a bid to whittle down their exposure to businesses that are struggling with depressed demand. Strategic actions including cost management and productivity improvement remain the prime focus of these companies.

However, the highly cyclical industry is still besieged by a host of headwinds. Chemical makers are still feeling the pinch of depressed demand across agriculture and energy markets. A strong dollar is also hurting U.S. chemical exports, reducing their attractiveness in overseas markets. The Eurozone’s tepid recovery and concerns over China’s future growth also remain sources of near-term uncertainties for the chemical industry.

Nagging weakness in China -- a key market for chemicals -- is expected to remain as overhang on the chemical industry in the short haul. Persistent overcapacity, weak private investment and high levels of corporate debt are hurting the world’s second-largest economy. In addition, the European chemical industry remains in limbo, trammeled by lower prices, shrinking production and weak R&D investments.

The outlook for the fertilizer and agricultural chemicals space also remains cloudy due to continued weakness in crop commodity prices and sluggish economic conditions in certain developing markets, particularly Brazil.

Despite these challenges, the industry’s recovery is expected to continue heading into 2017, supported by continued strength in the light vehicles market, positive trends in the construction space and significant shale-linked capital investment.

U.S. Outlook Users Hope

The U.S. chemical industry remains on course for growth this year and the next despite several challenges including a strong dollar and a low 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 abundant 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 (NYSE:DOW) (DOW), BASF (BASFY), LyondellBasell Industries (LYB), Eastman Chemical (EMN), Celanese (CE) 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.

EU Still Limping Along

The outlook for the European chemical industry, on the other hand, looks lackluster given sustained sluggishness in the region. The Eurozone economy remains stuck in an insipid recovery, manifested by a tepid growth of 0.3% in the third quarter of 2016. Eurozone’s growth prospects, in the short run, are likely to be stymied by Brexit-induced political and economic uncertainties.

Moreover, concerns about the impact of U.S. President-elect Donald Trump's economic policies could hurt sentiment in the region. The European Central Bank has warned that potential protectionist policies under Trump administration could trigger financial instability and hurt EU’s trade with the U.S. as well as global growth.

Chemical makers in the European Union remain affected by lower prices and a challenging regulatory landscape. According to the European Chemical Industry Council (CEFIC), chemical output in the European Union contracted 0.3% year over year in the first eight months of 2016 with chemical prices falling 4.8% for the period. Lower pricing and output also hurt chemical sales which slipped 4.4% during this period.

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 2.4% 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 Diversified, Chemical Plastics and Chemical Specialty, all of which lie in the middle one-third of all Zacks industries with a Zacks Industry Rank #97, #101 and #168, respectively.

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

Sector Level Earnings Trends

Looking at the overall results of the Basic Materials sector, earnings for the sector participants on the S&P 500 index for third-quarter 2016 rose 4.7% from the same period last year. The sector racked up a decent beat ratio (percentage of companies coming out with positive surprises) of 65% for earnings in the quarter. However, total revenues for these companies were down 3% in the third quarter.

For fourth-quarter 2016, earnings are expected to show a measly 0.3% increase. Revenues are forecast to fall 3.2% in the quarter. For first-quarter 2017, earnings are expected to accelerate to a 10.2% rise while revenues are forecast to dip 2.3%.

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

The Road Ahead

The chemical industry is still hamstrung by a number of challenges including a weak agriculture market, depressed demand in the energy space, slowdown in China and a choppy Europe. Nevertheless, sustained healthy momentum in the automotive space and an upswing in the housing market are expected to keep the industry on the road to recovery moving into 2017.

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