What's Weighing on Chemical Industry Stocks? - Industry Outlook

While chemical makers should gain from healthy momentum in automotive, recovery in the construction space, strategic growth measures and investment on capacity expansion, the industry still remains saddled by a number of headwinds. There are a few reasons to be careful in the chemical industry space in the near term, which we have highlighted below:

Eurozone Worries Persist

The European economy is still not out of the woods as evident from the meager Eurozone GDP growth (of 0.6%) in the third quarter of 2014. Reports of weakness in Germany have signaled a slowdown in the much-awaited recovery in the Eurozone economy. Western Europe continues to pose challenges on chemical stocks due to weak demand, thus remaining a source of near-term uncertainty.

Slowdown in China

Economic cooling in China -- a major market for chemicals -- casts a spell of uncertainty over the near term. China's GDP rose 7.3% in the third quarter, the slowest pace in five years and also down from 7.5% registered in the second. A downturn in the country's housing market, persisting credit crunch and tepid infrastructure investment are hurting the world's second-largest economy. As such, a sluggish Chinese economy may weigh on demand for chemicals in this significant market.

Oil Price Crash May Spoil Shale Party

U.S. chemical makers are currently enjoying the fruits of the abundance of low-cost North American feedstock. Affordable natural gas and ethane (derived from shale gas) has so far offered U.S. producers a compelling cost advantage over their global counterparts who use a more expensive, oil-based feedstock.

However, the recent plunge in oil prices has created a layer of uncertainty regarding the sustainability of this advantage. West Texas Intermediate crude recently nosedived to below the $60 per barrel threshold for the first time since Jul 2009 on supply gut.

Both Brent crude and West Texas crude have tumbled to fresh five-year lows as OPEC remains firm on its decision not to reduce production. A potential curtail in shale production due to the oil price slump could lead to elevated costs for U.S. chemical makers and compress their margins in the process.

Pricing, FX Pressure

Commodity pricing remain a concern for many of the U.S. chemical producers. Their ability to pass these costs on to end consumers is not always easy, given the competitive pressures at play. As a result, margins for a number of producers may be under pressure.

In addition, chemical companies generate a major chunk of their revenues outside the U.S., and therefore are exposed to foreign exchange fluctuations. Currency exchange translation remains a headwind for these companies.

A Still Smoggy Fertilizer/Agrichemical Space

Fertilizer and agricultural chemicals makers continue to face challenges from weak pricing, affecting their margins. Prices for potash have been under pressure following the exit of world's largest potash maker Uralkali Group from one of the biggest potash cartels -- the Belarus Potash Company (BPC) -- that influence potash pricing by controlling the production and supply. Uralkali's Board decided to end export sales through BPC and direct all potash export through its Switzerland-based trade arm Uralkali Trading.

While potash prices have recovered this year after taking a nosedive in 2013, producers of the nutrient are still faced with weak market fundamentals. Moreover, demand for potash and phosphate remains somewhat weak in India, a key import market. Depressed subsidy levels coupled with a weak local currency contributing to somewhat weak demand for the nutrient in that country. Moreover, the demand environment for phosphate is expected to remain uncertain in India in the near term.

Moreover, weakness in agricultural commodity prices represents another concern for fertilizer makers. Weak crop pricing coupled with anticipated reduction in planted acreage is expected to weigh on demand for nutrients in the next spring application season.

Wrapping Up

As you can see, there are a number of reasons to be cautious about the chemical industry despite the recent recovery in the space. We hold a bearish view on FMC Corp. (FMC), DuPont (DD), Methanex Corp. (MEOH) and Air Products and Chemicals Inc. (APD).

It would also be a prudent choice to steer clear of certain companies in the fertilizer space that show weak fundamentals. Companies that fit the bill are The Mosaic Company (MOS), Potash Corp. (POT) and CF Industries Holdings, Inc. (CF).

But what about investing in the space right now, are there opportunities for short term investors? Check out our latest Chemical Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector.