Chemical Industry Looking Up Amid a Few Worries - Industry Outlook

The chemical industry -- a roughly $5 trillion global business -- is clawing its way back after staying down for most part of last year. The industry has fared reasonably well this year amid a still-exigent global operating backdrop that has been exacerbated by lumpiness in Europe and a cooling Chinese economy.

With the U.S. economy springing back to life, the first three quarters of 2014 showed healthy demand trends for chemicals and continued healing across key end-use markets such as housing, commercial construction and electronics. The momentum is expected to continue into 2015 despite some headwinds.

U.S. Looks Bright, Europe & China Cloudy
    
According to the latest monthly report from the American Chemistry Council (ACC) -- an industry trade group -- U.S. chemical production rose on a monthly basis for the tenth straight month in Oct 2014, providing further evidence that the industry remained on the road to recovery in the second half. Growth has been witnessed across all key producing regions this year.

The outlook for the U.S. chemical industry paints an encouraging picture as the ACC recently said that national chemical production moved up 2% in 2014 (up from a 1.6% increase in 2013) and is expected to further rise to a 3.7% gain next year and 3.9% in 2016. Growth is expected to be backed by healthy demand from light vehicles market and a recovery in the housing market.

The ACC expects strong capital spending in the coming years, stemming from new investments in petrochemicals and derivatives. U.S. capital spending has jumped 12% this year to reach $33 billion, boosted by a raft of chemical projects. The shale gas boom is driving investment on plants and equipment in the U.S.

Chemical makers including majors like BASF (BASFY), Dow Chemical (DOW), DuPont (DD), LyondellBasell Industries (LYB), Eastman Chemical (EMN) and Celanese (CE) are currently ratcheting up investment on shale gas-linked projects to take advantage of ample natural gas supplies which is expected to boost capacity and export over the next several years. The U.S. has emerged as an attractive investment hotspot and chemical makers are aggressively expanding capacity in the country.

The ACC expects U.S. chemical industry to rake in trade surplus of $77 billion by 2019, supported by a significant share of gas-driven chemical investments. Accelerated growth in U.S. chemical exports are expected to lead to continued generation of trade surplus. With the revival across most export markets, strong growth is expected in inorganic chemicals, organic chemistry, plastic resins and synthetic rubber. The ACC sees domestic chemical sales to cross the $1 trillion milestone by 2019.

Agriculture and health and nutrition have emerged as attractive markets and major chemical makers are increasingly switching their focus on these markets to cut their exposure on businesses that are grappling with weak demand and input costs pressure. Moreover, strategic actions including cost containment and acquisitions/divestments remain the prime focus of chemical companies to stay afloat in a still difficult macro environment.

Outlook for Europe, however, is not so bright at the moment given fresh signs of slowdown in the region. According to the European Chemical Industry Council (CEFIC) -- which represents the European chemicals industry -- chemical output rose just 0.9% year over year in Europe in the first three quarters of 2014, stymied by lower pricing and a reduction in petrochemical output.  

CEFIC now expects European chemical output to rise 1% next year, slower than 1.5% expected earlier. Fresh reports of weakness in the Eurozone economy, hurt by sluggishness in the region's major economies (such as Germany, France and Italy) have renewed concerns about the recovery prospects of the chemical industry in that region. The European chemical industry also remains hobbled by high energy costs.   

Moreover, the recent signs of slowdown in China may weigh on demand for chemicals in this key market. The country remains battered by its tepid property market and weak infrastructure investment growth, which is contributing to its decelerating economic growth.

Crashing oil prices have also ignited investors' concerns about U.S. petrochemical makers given the potential that it may dwindle the feedstock cost advantage that is so far enjoyed by these companies. Outlook for the fertilizer/agricultural chemical space also remains smoggy due to weak market fundamentals and continued pricing pressure.

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 2.8% share of total earnings for the S&P 500 in 2014. 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 Specialty, Chemical Diversified and Chemical Plastics. Both Chemical Specialty and Chemical Diversified industries lie in the middle one-third with a Zacks Industry Rank #149 and #176, respectively. Chemical Plastics industry currently retains a Zacks Industry Rank #234, placing it in the bottom 1/3rd of the 260+ industry groups.

Looking at the exact location of these industries, one could say that the general outlook for the chemical industry as a whole is leaning toward ‘Neutral.'

Sector Level Earnings Trends

Basic Materials was among the sectors that racked up a double-digit earnings growth in the third quarter of 2014. Looking at the overall results of the Basic Materials sector, earnings for the sector participants in the S&P 500 index jumped 17.6% in the third quarter, a marked improvement from an 8.6% rise in the second.

Total revenues for these companies were up 2.6% in the third quarter versus a 3.4% rise a quarter ago. The sector delivered a healthy earnings beat ratio (the percentage of companies coming out with positive surprises) of 61.9% and revenue beat ratio of 47.6% in the third quarter.

The earnings picture for the fourth quarter, however, looks tepid with a projected decline of 5.1%. Revenues are forecast to edge down 0.9% in the quarter.

For 2014, earnings are expected to show an 8.2% increase, further accelerating to a 15.8% rise next year. Revenues are forecast to move up 1.5% this year and 4.4% in 2015.

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

The Way Forward

While some industry-specific challenges, concerns over China's future growth and sluggishness in Europe remain roadblocks, the chemical industry is expected to continue to recuperate through the balance of 2014 and into 2015, invigorated by strength in the automotive market and significant shale-linked capital investment. The recovery will also be supported by a rebound across housing and commercial construction markets.