Soft Demand, Tariffs Mar Diversified Chemical Industry Outlook

The Zacks Chemicals Diversified industry consists of manufacturers of basic chemicals, plastics, specialty chemicals and agricultural chemicals. Companies in this space serve a host of end-use markets such as automotive, building & construction, transportation, electronics, aerospace and agriculture.

Basic chemicals are produced in large quantities and include petrochemicals and intermediates (such as ethylene, propylene and benzene), polymers (including plastic resins such as polyethylene, polypropylene and polyvinyl chloride) and inorganic chemicals (such as chlorine, caustic soda and titanium dioxide). Specialty chemicals that include catalysts, surfactants, speciality polymers, coating additives and oilfield chemicals are used in specific fields based on their performance. Agricultural chemicals include herbicides, fungicides and insecticides that are used to protect crops from disease, pests and weeds.

Here are the industry’s three major themes:

• The diversified chemical industry is bearing the brunt of the protracted U.S.-China trade spat. Washington and Beijing imposed billions of dollars in punitive tariffs on each others’ products last year. China’s tariffs on American products include an array of chemicals. While there are still uncertainties surrounding a possible resolution to the bitter trade dispute, the tariffs currently in place are already doing significant harm to this space. Notably, China is one of the biggest export markets for U.S. chemicals and, thus, leaves the American chemical industry heavily exposed to Beijing’s countermeasures. The retaliatory tariffs are hurting demand for U.S. chemical exports. There is also the concern that the trade tariffs currently in place may impede new chemical investment on capacity expansion in the United States.
  
• Diversified chemical companies grapple with weak demand amid a slowing global economy. The trade war has led to a slowdown in industrial activities globally, leading to a drop in demand for chemicals across key markets including automotive. In particular, trade issues have resulted in a slowdown in industrial activities across Asia and Europe. Notably, chemical makers are seeing demand weakness in China amid a slowing Chinese economy. The trade friction has led to a reduction in demand in the automotive market (a major chemical end-use market) in China. The difficult demand environment is expected to continue in the near term.
  
• Companies in this space are exposed to cost pressure associated with raw materials as a result of short supply. China’s environmental crackdown has led to tightening in the supply of certain key raw materials as a result of plant closures. The supply disruptions in China has pushed up prices of these inputs. Some companies are also exposed to challenges from elevated logistics costs. Nevertheless, these players are focused on countering the challenges through measures like productivity improvement, capacity expansion, price hike initiatives and expansion of scale via acquisitions. Such actions should help alleviate any pressure on margin.

Zacks Industry Rank Indicates Bleak Prospects

The Zacks Chemicals Diversified industry is part of the broader Zacks Basic Materials sector. It carries a Zacks Industry Rank #187, which places it at the bottom 26% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates gloomy near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic about this group’s earnings growth potential. Over the past year, the industry’s earnings estimate for the current year has gone down 45.7%.

Before we present a few diversified chemical stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock market performance and current valuation.

Industry Lags Sector and S&P 500

The Zacks Chemicals Diversified industry has lagged both the Zacks S&P 500 composite and the broader Zacks Basic Materials sector over the past year.

The industry has declined 23.5% over this period compared with the S&P 500’s rise of 14.4% and the broader sector’s fall of 4%.

One-Year Price Performance

Industry’s Current Valuation

On the basis of trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, which is a commonly used multiple for valuing chemical stocks, the industry is currently trading at 7.42X, below the S&P 500’s 11.51X and the sector’s 9.25X.

Over the past five years, the industry has traded as high as 12.41X, as low as 5.08X and at the median of 7.21X, as the chart below shows.

Enterprise Value/EBITDA (EV/EBITDA) Ratio

Enterprise Value/EBITDA (EV/EBITDA) Ratio

Bottom Line

The diversified chemical industry is bruised by the lingering U.S.-China trade conflict. Moreover, margins of companies in this space will remain under pressure in an inflationary environment given the spike in raw material costs. The industry players also face the heat from a decline in demand across Asia (particularly China) and Europe.

However, strategic actions including continued focus on cost and productivity, operational efficiency improvement and acquisitions should keep these companies afloat over the near term.

None of the stocks in the Zacks Chemicals Diversified industry sports a Zacks Rank #1 (Strong Buy). We are presenting two stocks with a Zacks Rank #2 (Buy) that are well positioned to grow. There are also a couple of stocks with a Zacks Rank #3 (Hold) that investors may hold on to for now. You can see the complete list of today’s Zacks #1 Rank stocks here.

BASF SE (DE:BASFN) (BASFY): The Zacks Consensus Estimate for this Germany-based company’s current-year earnings has gone up 4.8% in the last 60 days. The company, carrying a Zacks Rank #2, has an estimated long-term earnings growth rate of 9.5%.

Price and Consensus: BASFY

Northern Technologies International Corporation (NTIC): The Minnesota-based company currently carries a Zacks Rank #2. It has an expected earnings growth of 18.2% for the current fiscal year. The Zacks Consensus Estimate for its current-fiscal earnings has moved up 8.3% in the last 60 days.

Price and Consensus: NTIC

Air Products and Chemicals (NYSE:APD), Inc. (APD): The Pennsylvania-based company, carrying a Zacks Rank #3, has an expected earnings growth of 15.5% for the current fiscal year. The company also has an estimated long-term earnings growth rate of 9.5%.

Price and Consensus: APD

PPG Industries (NYSE:PPG), Inc. (PPG): The Pennsylvania-based company has an expected earnings growth of 5.6% for the current year. The company, carrying a Zacks Rank #3, also delivered positive earnings surprise in each of the trailing four quarter, the average positive surprise being 6.1%.

Price and Consensus: PPG

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