10.16.17
Chemicals
3Q Earnings Preview; Signal vs. Noise
• Look through a noisy 3Q to focus on 2018E. It has been an eventful quarter, hasn't it? Since our last preview we've had three hurricanes wreaking havoc, earthquakes in Mexico, ongoing M&A activity, and an appreciably weaker USD despite heightened geopolitical tensions. As a result, we have adjusted estimates for the majority of stocks in our coverage, either previously or herein (see Figure 1). For investors though, these sources of "noise" will render 3Q earnings prints less meaningful than usual. So, we aim to focus on the "signal", i.e. the likely trajectory of earnings in 2018. Here, we find the fundamental outlook encouraging as evidenced by favorable trends in US ISM manufacturing as well as architectural billings (ABI), feedstocks and energy, and prospective incremental demand stimulus in two end-use markets: autos and construction. Meanwhile, valuation is far from compelling, but fair on a relative basis.
• Five fundamental themes of interest through year end: (1) we expect hurricanes to boost US auto SAAR by 2.1-4.2% on supply replacement; underlying US auto fundamentals remain near peak, but international markets should enjoy modest growth; (2) look for consecutive waves of re-investment in US residential repair and construction markets as flood damaged homes are restored and replaced in hurricane-impacted areas; (3) industrial end markets in...
• What about earnings prospects in 2018? We expect industry level supply constraints to lend support to petrochemical prices into 1Q18, which should bode well for commodity producers through year-end. Herein we raise 2018 EPS estimates for Celanese and Eastman having previously hiked for Lyondell, Olin and Westlake Chemical on 5 October. We also expect HUN to benefit from ongoing price/margin momentum in MDI and we consider shares inexpensive with or without a pending MOE with Clariant. Conversely, coatings companies must...
• Lots of housekeeping; disasters necessitate numerous adjustments. Given the sheer concentration of chemical assets on the Gulf and the magnitude of Harvey-related flooding, the vast majority of our chemical coverage has felt the impacts of this hurricane season to some extent. While we anticipate many of the companies with hard assets will have insurance to help cover extended business interruptions and certain property damage, we still expect near term estimates to move lower across our chemical universe on account of lost sales, plant outages, raw material shortages, and/or logistical delays. In general, we believe that investors should...
• Overall, we remain Market Weight on US 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, LYB 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 of mid-2017, since the former group struggles to defend margins in an environment of rising raw material costs and ongoing supply-chain consolidation.
(See full report for details)
3Q Earnings Preview; Signal vs. Noise
• Look through a noisy 3Q to focus on 2018E. It has been an eventful quarter, hasn't it? Since our last preview we've had three hurricanes wreaking havoc, earthquakes in Mexico, ongoing M&A activity, and an appreciably weaker USD despite heightened geopolitical tensions. As a result, we have adjusted estimates for the majority of stocks in our coverage, either previously or herein (see Figure 1). For investors though, these sources of "noise" will render 3Q earnings prints less meaningful than usual. So, we aim to focus on the "signal", i.e. the likely trajectory of earnings in 2018. Here, we find the fundamental outlook encouraging as evidenced by favorable trends in US ISM manufacturing as well as architectural billings (ABI), feedstocks and energy, and prospective incremental demand stimulus in two end-use markets: autos and construction. Meanwhile, valuation is far from compelling, but fair on a relative basis.
• Five fundamental themes of interest through year end: (1) we expect hurricanes to boost US auto SAAR by 2.1-4.2% on supply replacement; underlying US auto fundamentals remain near peak, but international markets should enjoy modest growth; (2) look for consecutive waves of re-investment in US residential repair and construction markets as flood damaged homes are restored and replaced in hurricane-impacted areas; (3) industrial end markets in...
• What about earnings prospects in 2018? We expect industry level supply constraints to lend support to petrochemical prices into 1Q18, which should bode well for commodity producers through year-end. Herein we raise 2018 EPS estimates for Celanese and Eastman having previously hiked for Lyondell, Olin and Westlake Chemical on 5 October. We also expect HUN to benefit from ongoing price/margin momentum in MDI and we consider shares inexpensive with or without a pending MOE with Clariant. Conversely, coatings companies must...
• Lots of housekeeping; disasters necessitate numerous adjustments. Given the sheer concentration of chemical assets on the Gulf and the magnitude of Harvey-related flooding, the vast majority of our chemical coverage has felt the impacts of this hurricane season to some extent. While we anticipate many of the companies with hard assets will have insurance to help cover extended business interruptions and certain property damage, we still expect near term estimates to move lower across our chemical universe on account of lost sales, plant outages, raw material shortages, and/or logistical delays. In general, we believe that investors should...
• Overall, we remain Market Weight on US 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, LYB 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 of mid-2017, since the former group struggles to defend margins in an environment of rising raw material costs and ongoing supply-chain consolidation.
(See full report for details)
