Good Reasons To Bet On Chemical Stocks

The chemical industry’s recovery remains on track amid a still-fragile global economic environment. The industry’s recovery is supported by healthy demand across automotive and construction markets. Notwithstanding a few industry-related headwinds, weak demand across agricultural and energy markets and sluggishness in China, there are a number of reasons to be optimistic about the broader chemical industry for both the short and long haul, which we have highlighted below:

Shale Boom – Driving Force for Chemical Investment

The shale gas revolution in the U.S. has been a huge driving force behind chemical investment on plants and equipment in the country. According to the American Chemistry Council (ACC), the U.S. has emerged as an attractive investment location and petrochemical makers are now significantly expanding capacity in the country leveraging new supplies of natural gas. New methods of extraction such as horizontal drilling and hydraulic fracturing (or fracking) are boosting shale production, bringing down prices of ethane (derived from shale gas) in the process.

The shale boom has incentivized a number of chemical companies to pump in billions of dollars for setting up facilities (crackers) in the U.S. to produce ethylene and propylene in a cost-effective way. Per ACC, domestic chemical investment related to shale gas has reached as high as $164 billion, more than 60% of which are from firms outside the U.S.

Already 264 projects -- many backed by the Federal government -- have been announced by chemical makers to take advantage of ample natural gas supplies, with 40% of them already complete or under construction. Such investments are expected to boost capacity and export over the next several years. The ACC expects average annual gains of more than 8% in U.S. chemical industry capital spending through 2018.

Construction Sector Gathering Steam

A recovery across housing and commercial construction -- major chemical end-markets -- has been another tailwind for the chemical industry. After being hit hard in the recession, the construction sector has bounced back on the back of strong housing fundamentals. The U.S. housing sector saw steady recovery in 2015 backed by stabilizing mortgage rates, improving job market and moderating home prices, and the momentum continues this year.

The underlying demand trends in the housing space remain strong, supported by an improving employment levels, affordable interest/mortgage rates and a rise in income levels. Recent housing data has been fairly upbeat with housing starts scaling a 9-year high in October as builders ramped up construction to meet rising demand for new homes and apartments.

The renewal of long-stalled construction projects and long awaited access to credit from lending institutions has also helped invigorate the commercial construction sector. U.S. architecture firm billings continue to rise. The US Architecture Billings Index (ABI), an indicator that offers a glimpse into the future of U.S. non-residential construction spending activity, clocked 50.8 in October 2016 (a reading above 50 indicates an increase in billings).

Moreover, the American Institute of Architects (AIA) expects healthy growth in non-residential construction spending based on strong demand for hotels, office space, manufacturing facilities and amusement and recreation spaces. The AIA sees spending to go up 5.8% in 2016 and 5.6% in 2017.

Automotive – Good Run Continues

Chemical makers continue to see healthy demand from the automotive sector -- a major end-use market. The sector is enjoying the fruits of low fuel prices.

U.S. light vehicles (a key end-user market for chemicals) sales hit all-time high of around 17.5 million units in 2015. The U.S. light vehicles market continues to show strength this year, supported by an improving job market, rising personal income, low fuel prices and attractive financing options.

A high average age of cars on the U.S. roads is also fueling replacement demand for cars. U.S. light-vehicle sales rose 3.6% year over year to 1.38 million units in November 2016, hitting a new high for the month. New car and light truck sales are expected to reach to 17.4 million units in 2016, as per The National Automobile Dealers Association (NADA) estimates, indicating a fairly stable market.

Low interest rates, favorable financing and cheap oil have also backed a recovery in the European auto market this year. The auto industry in Asian countries, especially China, is also expected to thrive over the next several years. According to IHS Automotive, new vehicle sales are expected to touch nearly 90 million units globally in 2016. Healthy momentum in the automotive space augurs well for chemical demand in this important end-market.

Chemical Bonding – M&A Heating Up

Chemical makers remain actively focused on mergers and acquisitions to diversify and shore up growth in a still-difficult global economic environment. The industry saw a pick-up in consolidation activities last year and the momentum continues in 2016.

Chemical companies are increasingly looking for cost synergy opportunities and enhanced operational scale through consolidations. The $130 billion proposed mega-merger of Dow Chemical (NYSE:DOW) (DOW) and DuPont (NYSE:DD) (DD) -- the biggest chemical deal ever -- is a huge testimony to these strategic moves.

Other major deals that have taken place in the chemical space in the recent past include Albemarle Corp.’s (ALB) $6.2 billion buyout of Rockwood Holdings, Inc., Merck (NYSE:MRK) KGaA's $17 billion acquisition of Sigma-Aldrich, FMC Corp (NYSE:FMC).’s (FMC) acquisition of Cheminova A/S, Westlake Chemical’s (WLK) $3.8 billion acquisition of Axiall Corp., ChemChina’s proposed $43 billion acquisition of Syngenta (SYT), and the $66 billion proposed merger between Monsanto Company (NYSE:MON) (MON) and Bayer AG (DE:BAYGN) (BAYRY).

Strategic Measures

Chemical companies continue to shift their focus on high-growth markets (driven by megatrends) in an effort to cut their exposure on other businesses that are struggling with weak demand and input costs pressure. Moreover, cost-cutting measures -- including plant closures and headcount reduction -- and productivity improvement actions by chemical companies are expected to yield industry-wide margin improvements. Several chemical makers are also disposing non-core assets as they shift their focus on high-margin businesses.

Stocks to Consider

As you can see from the above-mentioned factors, there are many reasons to be optimistic about the chemical industry. Chemical stocks that are well placed in the current operating backdrop include FMC Corp., Westlake Chemical and The Chemours Company (CC), all sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

We also have a bullish view on Celanese Corp. (CE) and Methanex Corp. (MEOH), both carrying a Zacks Rank #2 (Buy).

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

Confidential from Zacks

Beyond this Industry Outlook, would you like to see Zacks' best recommendations that are not available to the public? Our Executive VP, Steve Reitmeister, knows when key trades are about to be triggered and which of our experts has the hottest hand. Click to see them now>>