This Overlooked Industry Is Stronger Than Ever

Six bullish forces are converging on chem.

The chemical industry is back in business after being stuck in limbo for a spell, making it an attractive investment proposition. The industry’s upturn is expected to continue this year on continued momentum across major end-markets.

Despite 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. Let’s find out what’s supporting the bullish case for chemical stocks.

1. Shale Bounty – Driving Force for Chemical Spending

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 the ACC, 310 new chemical projects have been already announced by chemical makers worth around $185 billion that are under construction or planned. Such investments — many backed by Federal government support — are expected to boost capacity and export over the next several years.

2. Rebound in Construction

A recovery across housing and commercial construction — major chemical end-markets — has been another supporting factor for the chemical industry recovery. After being hit hard in the recession, the construction sector has bounced back on the back of healthy housing fundamentals.

Recent housing data has been fairly upbeat with U.S. housing starts scaling a four-month high in June, buoyed by a rise in both single-family and multi-family construction. Per the Commerce Department, housing starts climbed 8.3% to a seasonally adjusted annualized rate of 1.22 million units in June, the highest level since Feb 2017. Single-family starts rose 6.3% while construction of multi-family homes shot up 13.3%. Building permits, a proxy for future construction, also went up 7.4% for the month. These strong data paint an upbeat picture for U.S. homebuilding moving ahead.

The renewal of long-stalled construction projects and long-awaited access to credit from lending institutions has also helped invigorate the commercial construction sector.

3. Healthy Automotive Demand

Chemical makers continue to see healthy demand from the automotive sector — a major end-use market. The last two years have been exceptional for the auto sector. Sales in the U.S. saw record highs in both years, while sales in China and Europe also gained strength.

According to IHS Markit, global light vehicle sales are expected to increase 1.5% year over year to 93.5 million units in 2017. Moreover, IHS Markit sees U.S. light vehicle sales to reach 17.4 million units in 2017 — a slight moderation from the 2016 level of 17.5 million units, but still looks poised for another strong year.

Low interest rates, favorable financing and cheap oil have also backed a recovery in the European auto market. The auto industry in Asian countries, especially China, is also expected to thrive over the next several years. This augurs well for chemical demand in this important end-market.

4. A Resurgent European Economy

The Eurozone economy has gained traction of late, as evident from recent upbeat economic data that suggest a recovery is steadily firming in the region. The European chemical industry has also swung back to life on the back of a rebounding Eurozone economy.

The Eurozone GDP rose 0.6% in the first quarter of 2017 (according to Eurostat data) on a quarter-over-quarter basis, the fastest pace since 2015 and also above expectations. The Eurozone also outstripped the U.S. when considering the annualized economic growth rate. While the Eurozone economy rose 2.3% on an annualized basis during the first quarter, the U.S. economy expanded 1.2%. The region’s recovery is backed by rising domestic demand, declining unemployment and strengthening business and consumer confidence.

5. Chemical Bonding – M&A Binge Continues

Chemical makers remain actively focused on mergers and acquisitions to diversify and shore up growth. These companies are increasingly looking for cost synergy opportunities and enhanced operational scale through consolidations. The $130 billion mega-merger of Dow Chemical (DOW) and DuPont (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 ChemChina’s $43 billion acquisition of Syngenta (SYT), Albemarle Corp.’s (ALB) $6.2 billion buyout of Rockwood Holdings, Inc., Merck KGaA's $17 billion acquisition of Sigma-Aldrich, and the $66 billion proposed merger between Monsanto Company (MON) and Bayer AG.

6. Strategic Actions to Reap Benefits

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.

Some chemical makers are also disposing non-core assets as they shift their focus on high-margin businesses. A number of chemical makers are also taking appropriate pricing actions (reflected by hikes in chemical prices in the recent past) in the wake of a sharp rise in raw materials costs. This is also expected to lend support to their margins.

Stocks Worth a Look Right Now

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 Westlake Chemical Corporation (WLK) and The Chemours Company (CC), both sporting a Zacks Rank #1 (Strong Buy), as well as, KMG Chemicals, Inc. (KMG) , Celanese Corporation (CE), Quaker Chemical Corporation (KWR) and Albemarle Corp.

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