Jefferies Is Playing The Chemical Sector, But Sees 'More Murk Likely' - Cabot (NYSE:CBT), Albemarle (NYSE:ALB)

Laurence Alexander of Jefferies commented in a note that chemical rallies could "fade often and sharply."

Alexander noted the "widely-acknowledged" lack of real demand visibility has morphed the defensive stance of chemical stocks that "worked" in 2015 into a "barbell approach."

Alexander recommended investors buy "self-help" stories, such as PPG Industries, Inc. PPG, which is the "most intriguing" relative valuation in large-cap chemicals.

Laurence Alexander, Jefferies chemicals analyst, commented in a cautious note on Wednesday that chemical companies continue to suffer from the "acknowledged" lack of real demand visibility until next spring, while the "sharp" multiple compression in the group suggests that the "defensive stance that worked" in 2015 should morph into a "barbell approach."

Base Case Scenario

Looking forward, Alexander's base case scenario for the chemical sector consists of slow global demand growth and typical later-cycle cost inflation pressure incremental margins over the next few years.

Meanwhile, forward multiples for chemical stocks have "swung below" their 10-year average, but the compression in the oil/gas ratio and "adverse" foreign exchange rates could keep these valuation multiples "capped" over the next few quarters.

Related Link: Why Citi Upgraded Ailing DuPont

Alexander continued that the pace of churn within the chemical sector is likely to accelerate, while capacity delays could tighten the petrochemical supply and demand balance enough to support only a "modest" uptick in martins in 2016, only for the petrochemical cycle to "roll over" in 2017–2019.

The peak of the cycle would occur when companies begin adding capacity based on demand prospects rather than feedstock advantages, while industry consolidation will consist of "merger of equals."

Broad Recommendation

Accordingly, the analyst is recommending investors seek out "self-help" companies with margin stability and "simplicity in earnings bridges," which could support relative outperformance.

Buy Recommendations

Alexander upgraded shares of FMC Corp FMC to Buy from Hold, but with a target lowered to $47 from a previous $63 to reflect foreign exchange headwinds.

The analyst's positive bias stems from the company's acknowledgement of "inventory overhangs" and credit concerns in Brazil in 2016 – a concern that investors have had since 2014. As such, the overhang could "mark the beginning of the end" of the downward momentum in shares.

The analyst recommended PPG Industries, which is "the most intriguing relative valuation" in large-cap chemicals.

SMID-cap Buy-rated names include:

Cabot Corp CBT
Albemarle Corporation ALB
Huntsman Corporation HUN
Trinseo S.A. TSE
Koppers Holdings Inc. KOP

All of these recommendations are "well positioned as coiled springs where a little validation could spur a rally into year-end."

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