01.08.18
Chemicals
2018 Chemicals Outlook: What’s Not to Like (Besides Valuation)?
• Prosperity across the chemicals sector appears well founded as we enter 2018. After solid outperformance in the bull market that was 2017 (S&P 500 Chemical Index alpha of +4.6% vs. S&P500), we see five key reasons to remain optimistic on prospects for US chemical companies in the year ahead: (1) global growth is healthy and synchronous, albeit not without geopolitical risk; (2) US manufacturing enjoys an improved fundamental backdrop, supported by a diminished regulatory burden and now US corporate tax reform; (3) inexpensive natural gas continues to provide US commodity producers with advantaged economics on the global stage, although we do see upside risk to ethane costs in 2019+; (4) outside of ethylene and derivatives, we expect most commodity chemical markets to continue to benefit from a dearth of new supply, coupled with ongoing constraints on existing capacity in China for environmental reasons and, in some cases, Europe for economic and/or regulatory reasons; and (5) the USD remains sufficiently weak to facilitate rising US exports and generally favorable FX translation in coming quarters. Our principal reservation remains valuation, which appears fair on a relative basis, but not especially compelling.
• We still prefer commodities vs. specialties, but now de-emphasize ethylene exposure tactically. Our research indicates balanced-to-tight market conditions across a variety of commodity chemicals in 2018 including caustic soda, TiO2 pigment and MDI. Even the lowly epoxy chain has begun to tighten, which bodes well for Olin as a supplier, yet ill for producers of coatings that must now “whack another mole” in the field raw materials. In contrast however, we expect...
• We upgrade Olin (OLN) to Buy and shift down one notch on LyondellBasell (LYB) and Westlake (WLK). We adopt a more bullish outlook on Olin (click here) for three principal reasons: (1) we expect caustic soda prices and electrochemical unit (ECU) margins to continue to rise this year with proposed increases of $70-115 per dry short ton (dst), depending on the grade, on the table for 1Q18; (2) we see nascent tightening in the epoxy chain with positive implications for Epoxy segment earnings in 2018+; and (3) Olin is a top-tier beneficiary of US corporate tax reform that didn’t trade especially well in 4Q17. With regard to Lyondell (click here) and Westlake (click here), our more balance posture is borne of…
• Our financial models now reflect the new US corporate tax regime. In addition to the aforementioned rating changes, we also adjust herein our estimates and price targets for the majority of chemical companies in our coverage as outlined in Figure 1. Our earnings revisions reflect...
• Our top picks overall are HUN and GRA. Huntsman has been among our most preferred names (top quartile anyway) on a consistent basis, since having relaunched coverage of the sector in October 2016 and we see no reason to change that now. We remain bullish on MDI growth and margins, and consider shares to be inexpensive at 7.2x our 2018 estimate of EBITDA as adjusted for full monetization of the company’s 55% ownership stake in Buy-rated Venator (VNTR). We expect Huntsman’s financial flexibility to improve greatly to a pro forma net debt balance of $0.5bn or 0.4x EBITDA by year-end 2018, which should support a credit upgrade to investment-grade by year-end. Our price target of $43 suggests upside potential of 27%, including a dividend yield of 1.5%. After a tough year in 2017, we see better days ahead for WR Grace in 2018, aided by high portfolio quality, inexpensive valuation (especially as adjusted for tax assets), an accretive acquisition of Albemarle’s polyolefin catalyst business, a recent flurry of technology licensing deals and the eventual restart of FCC catalyst customer Takreer (Abu Dhabi) in 2019. Elsewhere, we prefer DowDuPont, Eastman Chemical, and PPG Industries for large-cap exposure. For DWDP we project a 3-year EPS CAGR of 11%, or a 400bp premium to the sector fueled by cost synergies, new projects, and potential for moderate re-capitalization. While our price target of $80 is perhaps less than heroic, we see minimal downside risk from current levels. Likewise, we view risk-reward as asymmetric for EMN and PPG with upside potential of 17% and 9%, respectively
(Please see full report for details)
2018 Chemicals Outlook: What’s Not to Like (Besides Valuation)?
• Prosperity across the chemicals sector appears well founded as we enter 2018. After solid outperformance in the bull market that was 2017 (S&P 500 Chemical Index alpha of +4.6% vs. S&P500), we see five key reasons to remain optimistic on prospects for US chemical companies in the year ahead: (1) global growth is healthy and synchronous, albeit not without geopolitical risk; (2) US manufacturing enjoys an improved fundamental backdrop, supported by a diminished regulatory burden and now US corporate tax reform; (3) inexpensive natural gas continues to provide US commodity producers with advantaged economics on the global stage, although we do see upside risk to ethane costs in 2019+; (4) outside of ethylene and derivatives, we expect most commodity chemical markets to continue to benefit from a dearth of new supply, coupled with ongoing constraints on existing capacity in China for environmental reasons and, in some cases, Europe for economic and/or regulatory reasons; and (5) the USD remains sufficiently weak to facilitate rising US exports and generally favorable FX translation in coming quarters. Our principal reservation remains valuation, which appears fair on a relative basis, but not especially compelling.
• We still prefer commodities vs. specialties, but now de-emphasize ethylene exposure tactically. Our research indicates balanced-to-tight market conditions across a variety of commodity chemicals in 2018 including caustic soda, TiO2 pigment and MDI. Even the lowly epoxy chain has begun to tighten, which bodes well for Olin as a supplier, yet ill for producers of coatings that must now “whack another mole” in the field raw materials. In contrast however, we expect...
• We upgrade Olin (OLN) to Buy and shift down one notch on LyondellBasell (LYB) and Westlake (WLK). We adopt a more bullish outlook on Olin (click here) for three principal reasons: (1) we expect caustic soda prices and electrochemical unit (ECU) margins to continue to rise this year with proposed increases of $70-115 per dry short ton (dst), depending on the grade, on the table for 1Q18; (2) we see nascent tightening in the epoxy chain with positive implications for Epoxy segment earnings in 2018+; and (3) Olin is a top-tier beneficiary of US corporate tax reform that didn’t trade especially well in 4Q17. With regard to Lyondell (click here) and Westlake (click here), our more balance posture is borne of…
• Our financial models now reflect the new US corporate tax regime. In addition to the aforementioned rating changes, we also adjust herein our estimates and price targets for the majority of chemical companies in our coverage as outlined in Figure 1. Our earnings revisions reflect...
• Our top picks overall are HUN and GRA. Huntsman has been among our most preferred names (top quartile anyway) on a consistent basis, since having relaunched coverage of the sector in October 2016 and we see no reason to change that now. We remain bullish on MDI growth and margins, and consider shares to be inexpensive at 7.2x our 2018 estimate of EBITDA as adjusted for full monetization of the company’s 55% ownership stake in Buy-rated Venator (VNTR). We expect Huntsman’s financial flexibility to improve greatly to a pro forma net debt balance of $0.5bn or 0.4x EBITDA by year-end 2018, which should support a credit upgrade to investment-grade by year-end. Our price target of $43 suggests upside potential of 27%, including a dividend yield of 1.5%. After a tough year in 2017, we see better days ahead for WR Grace in 2018, aided by high portfolio quality, inexpensive valuation (especially as adjusted for tax assets), an accretive acquisition of Albemarle’s polyolefin catalyst business, a recent flurry of technology licensing deals and the eventual restart of FCC catalyst customer Takreer (Abu Dhabi) in 2019. Elsewhere, we prefer DowDuPont, Eastman Chemical, and PPG Industries for large-cap exposure. For DWDP we project a 3-year EPS CAGR of 11%, or a 400bp premium to the sector fueled by cost synergies, new projects, and potential for moderate re-capitalization. While our price target of $80 is perhaps less than heroic, we see minimal downside risk from current levels. Likewise, we view risk-reward as asymmetric for EMN and PPG with upside potential of 17% and 9%, respectively
(Please see full report for details)
