Kevin McCarthy, Chemical Analyst, Vertical Research Partners08.31.17
Chemicals
Before the Aftermath
We would like to extend our heartfelt best wishes to our many friends and business associates in Texas, many of whom must now deal with immense and simultaneous challenges in their personal and business lives. In this context, we hesitate to dwell on the ramifications of Hurricane Harvey, yet financial consequences are significant, the stock market is open, and our phones are ringing. So, we offer herein our updated thoughts entering day five of the ordeal.
• Six key concepts based on what we know now: (1) the combination of Harvey’s path, duration and rainfall total is wreaking havoc with the supply side of the U.S. chemicals industry on an unprecedented scale – we certainly haven’t seen anything quite like it in our 18 years of following chemical stocks on Wall Street; (2) at the industry level, we would expect consensus EPS for 3Q17 to trend lower on weaker volumes, followed by potential for partial recovery in 4Q, aided by higher selling prices; (3) from a stock price perspective, we expect commodity chemical producers to fare better than specialty chemical peers as a group; (4) the extent of damage to both assets and infrastructure remains highly uncertain at this stage; logistics capability is arguably the biggest wild card in assessing the likely trajectory of recovery; (5) despite supply constraints, our global ethylene cycle view remains intact, i.e. looking beyond short-term price hikes, we still see increasing length of supply in 2018 followed by a cyclical trough in 2019 – for context, ethylene cycle periods are typically 7-10 years in duration; and (6) this too shall pass – don’t mess with Texas! As disruptive as it is, even Hurricane Harvey will prove to be a transitory event as it relates to chemical stocks.
• Harvey hit the U.S. Gulf Coast hard and is coming back for more. We continue to receive news of new plant outages. As indicated in our prior notes (click here and here), the rainfall associated with the storm is projected to be much worse than predicted this time last week. With Harvey set to hit land again today into Thursday, we see ongoing risk that outages (see tables herein) will grow in number as…
• More than half of U.S. ethylene capacity is offline. In addition to the outages highlighted Monday, we have received word that DuPont has taken down production at its Orange, Texas olefins complex, Flint Hills was shutting its Port Arthur, Texas facility, and ExxonMobil was throttling back at Beaumont, Texas. We also have, to our knowledge, the first Lake Charles-based operational force majeure with Lyondell having declared on…
• We see two keys for coming days: A) the likely duration of outages as companies assess damage or lack thereof; and B) the potential for…
• Look for price hikes as the storm ends and visibility improves. At least in the short term, we suspect that prices for most petrochemicals will move higher. For polyethylene (PE) resin a number of…
• Specialty chemical effects will be neutral or negative as well in our view. Nearly one-third of US crude oil refining capacity lies in the “cone” of Harvey’s potential path. In this context, we expect…
• Sell-rated Univar issued the first pre-release after the close. This volume concern was made evident with last night’s earnings guidance cut by Univar, which flagged…
• Our preferred way to play is Westlake; Lyondell appears most affected thus far. Among stocks in our coverage, our preliminary view remains that Buy-rated Westlake Chemical (WLK) is perhaps best positioned given competitors’ outages in nearly…
• Overall, we remain Market Weight on U.S. Chemicals exposure, albeit with a healthy appetite for risk. Within the chemicals sector we continue to prefer value vs. growth, preferably with a catalyst. Notwithstanding the strong performance of most commodity-linked chemical stocks YTD, our bottom-up work on cash flow and valuation leads us to believe that exposure here remains attractive, whether through pure-play or diversified chemical names. Our Buys of this ilk are DOW, EMN, HUN and WLK having shifted CE down a notch to Hold in July. Among growth-oriented specialty chemical producers, the pickings are slimmer in our opinion, although we did launch on WR Grace in May 2017 with a Buy and have since become (even) more constructive. Elsewhere among specialties we’ve shifted to a less bearish, although still not constructive posture on industrial gases having upgraded Air Products to Hold from Sell in early August. For the first time in nearly six years, we consider coatings and gases to be on equal footing in terms of risk-reward, as the former group struggles to defend margins.
(Please see full report for details)
Before the Aftermath
We would like to extend our heartfelt best wishes to our many friends and business associates in Texas, many of whom must now deal with immense and simultaneous challenges in their personal and business lives. In this context, we hesitate to dwell on the ramifications of Hurricane Harvey, yet financial consequences are significant, the stock market is open, and our phones are ringing. So, we offer herein our updated thoughts entering day five of the ordeal.
• Six key concepts based on what we know now: (1) the combination of Harvey’s path, duration and rainfall total is wreaking havoc with the supply side of the U.S. chemicals industry on an unprecedented scale – we certainly haven’t seen anything quite like it in our 18 years of following chemical stocks on Wall Street; (2) at the industry level, we would expect consensus EPS for 3Q17 to trend lower on weaker volumes, followed by potential for partial recovery in 4Q, aided by higher selling prices; (3) from a stock price perspective, we expect commodity chemical producers to fare better than specialty chemical peers as a group; (4) the extent of damage to both assets and infrastructure remains highly uncertain at this stage; logistics capability is arguably the biggest wild card in assessing the likely trajectory of recovery; (5) despite supply constraints, our global ethylene cycle view remains intact, i.e. looking beyond short-term price hikes, we still see increasing length of supply in 2018 followed by a cyclical trough in 2019 – for context, ethylene cycle periods are typically 7-10 years in duration; and (6) this too shall pass – don’t mess with Texas! As disruptive as it is, even Hurricane Harvey will prove to be a transitory event as it relates to chemical stocks.
• Harvey hit the U.S. Gulf Coast hard and is coming back for more. We continue to receive news of new plant outages. As indicated in our prior notes (click here and here), the rainfall associated with the storm is projected to be much worse than predicted this time last week. With Harvey set to hit land again today into Thursday, we see ongoing risk that outages (see tables herein) will grow in number as…
• More than half of U.S. ethylene capacity is offline. In addition to the outages highlighted Monday, we have received word that DuPont has taken down production at its Orange, Texas olefins complex, Flint Hills was shutting its Port Arthur, Texas facility, and ExxonMobil was throttling back at Beaumont, Texas. We also have, to our knowledge, the first Lake Charles-based operational force majeure with Lyondell having declared on…
• We see two keys for coming days: A) the likely duration of outages as companies assess damage or lack thereof; and B) the potential for…
• Look for price hikes as the storm ends and visibility improves. At least in the short term, we suspect that prices for most petrochemicals will move higher. For polyethylene (PE) resin a number of…
• Specialty chemical effects will be neutral or negative as well in our view. Nearly one-third of US crude oil refining capacity lies in the “cone” of Harvey’s potential path. In this context, we expect…
• Sell-rated Univar issued the first pre-release after the close. This volume concern was made evident with last night’s earnings guidance cut by Univar, which flagged…
• Our preferred way to play is Westlake; Lyondell appears most affected thus far. Among stocks in our coverage, our preliminary view remains that Buy-rated Westlake Chemical (WLK) is perhaps best positioned given competitors’ outages in nearly…
• Overall, we remain Market Weight on U.S. Chemicals exposure, albeit with a healthy appetite for risk. Within the chemicals sector we continue to prefer value vs. growth, preferably with a catalyst. Notwithstanding the strong performance of most commodity-linked chemical stocks YTD, our bottom-up work on cash flow and valuation leads us to believe that exposure here remains attractive, whether through pure-play or diversified chemical names. Our Buys of this ilk are DOW, EMN, HUN and WLK having shifted CE down a notch to Hold in July. Among growth-oriented specialty chemical producers, the pickings are slimmer in our opinion, although we did launch on WR Grace in May 2017 with a Buy and have since become (even) more constructive. Elsewhere among specialties we’ve shifted to a less bearish, although still not constructive posture on industrial gases having upgraded Air Products to Hold from Sell in early August. For the first time in nearly six years, we consider coatings and gases to be on equal footing in terms of risk-reward, as the former group struggles to defend margins.
(Please see full report for details)
