Factors That Could Mar Chemical Industry Momentum

The chemical industry has gotten its mojo back on strength across major end-markets and an improving world economy. While chemical makers should benefit from strategic growth measures and investment on capacity expansion, the industry is still reeling under certain headwinds. There are a few reasons to be cautious about the chemical industry in the near term, which we have outlined below:

China Woes Linger

Slowdown in China -- a major market for chemicals -- remains a deterrent over the short haul. The world’s second-biggest economy remains plagued by persistent industrial overcapacity, weak property investment and rising corporate debt. In particular, ballooning debt levels (manifested by rising debt to GDP ratio) and rapid credit expansion have raised a red flag on the Chinese economy.

The country’s GDP expanded 6.7% in 2016, a deceleration from 6.9% a year ago, also the weakest annual growth in 26 years. The International Monetary Fund (IMF), its annual report on the Chinese economy, issued a warning about the country’s surging debt level that has raised risks for a potential sharp decline in growth in the medium term. The IMF projects China’s GDP to grow 6.8% in 2017, moderating to 6.5% in 2018. Moreover, the Chinese government has set a GDP growth target of roughly 6.5% for 2017.

Capital outflow pressures, rapid credit expansion, continued reliance on stimulus measures and geopolitical uncertainties are among the key risks to the country’s economic growth. As such, a sluggish Chinese economy may weigh on demand for chemicals in this significant market.

Harvey-Stoked Disruptions Pose a Concern

Hurricane Harvey weighed on U.S. chemical production during the third quarter, knocking off a sizable chunk of production capacity. Harvey led to the shutdown of several chemical plants along the Gulf Coast -- the epicenter of the U.S. specialty chemicals and petrochemicals industry.

In particular, the storm ravaged Texas that accounts for nearly three-quarters of the U.S. production of ethylene, which is among the world’s most important petrochemicals and a basic ingredient for final products ranging from plastic bottles to tires to polyester fabric. Many chemical plants producing ethylene are located near the Gulf Coast’s concentration of petroleum facilities.

According to IHS Markit, 54% of total U.S. ethylene production capacity was hit by Harvey. A number of major chemical producers had to shutter or cut back ethylene production, leading to reduced supply of this major chemical. The lingering effects of Harvey is a concern for U.S. chemical companies. Lost production volumes as well as costs related to the disruptions caused by the storm may pose some headwinds for U.S. chemical makers in the fourth quarter of 2017.

Still-Challenging Fertilizer/Agrichemical Space

Fertilizer and agricultural chemical companies are still grappling with a difficult pricing environment. While the potash market has stabilized this year from the 2016 lows, the picture is not so good for nitrogen and phosphate.

Higher supply has contributed to a softer nitrogen pricing environment. Abundant nitrogen supply driven by new production capacity is expected to weigh on global prices in 2017. Additional nitrogen capacity including a significant increase in North America is expected to come online globally in the back half of the year.

Global capacity expansion continues to exert pressure on urea and other nitrogen fertilizer prices. Elevated supply in the global nitrogen market is hurting prices, causing farmers to delay buying activities. As such, nitrogen margins of fertilizer producers remain thwarted by a weak pricing environment.

Excess capacity (outpacing demand) also continues to hurt prices of phosphate as witnessed so far this year. Phosphate markets are expected to remain oversupplied through the second half, thereby putting pressure on prices.

Moreover, agriculture market fundamentals remain weak and there is continuous negative sentiment among agriculture investors that can create uncertainty in the near term. Insipid economic growth in certain key markets including Latin America is affecting demand for nutrients. Moreover, the prevailing softness in agricultural commodity pricing remains a concern for fertilizer and agricultural chemicals companies as it is hindering fertilizer usage by farmers given the adverse effect of lower crop pricing on growers’ income.

Prices of major crops (such as corn and soybeans) remain at their multi-year lows as markets remain awash with grains. An expected bumper corn and soybean harvest is likely to put a cap on crop prices in 2017.

Raw Material Pricing Headwinds

Commodity pricing remain a concern for many U.S. chemical producers. Their ability to pass these costs on to end consumers is not always easy, given the competitive pressures in play.

A number of chemical companies including PPG Industries (NYSE:PPG), Inc. (PPG), Celanese Corp. (CE) and Eastman Chemical Company (NYSE:EMN) (EMN) are witnessing a spike in raw material prices, exacerbated by short supply due to hurricanes. As a result, margins of these producers may be under pressure moving ahead amid an inflationary environment. A number of chemical makers, in their September quarter earnings call, have warned of continued headwinds from elevated input costs through the rest of 2017.

Stocks to Steer Clear Of

As you can see, there are a number of reasons to be watchful about the chemical industry. As such, it would also be a prudent choice to get rid of certain companies in the space that show weak fundamentals and carry an unfavorable Zacks Rank.

We hold a bearish view on KMG Chemicals, Inc. (KMG), Compass Minerals International, Inc. (CMP), Stepan Company (SCL) and Axalta Coating Systems Ltd. (AXTA), each holding a Zacks Rank #5 (Strong Sell).

We also suggest staying away from stocks such as PPG Industries, Platform Specialty Products Corp. (PAH) and International Flavors & Fragrances Inc. (IFF), all carrying a Zacks Rank #4 (Sell).

(Check out our latest Chemical Industry Outlook for a more detailed discussion on the fundamental trends.)

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