07.15.18
Chemicals
Terrifying Tariffs or Tempest in a Teapot?
• We see three principal tariff risks: trade trajectory, cost inflation, and demand. We view prospects for new US steel and aluminum tariffs as an incremental concern for US chemical stocks for three reasons. First, the US chemical industry is a large net exporter and thus vulnerable to potential for retaliatory trade actions. Indeed, new shale gas-inspired projects along the US Gulf Coast will render US commodity chemical producers increasingly reliant upon export markets over the next 3-5 years. Second, Chemicals is the second most capital intensive industry behind energy, so higher costs for steel have a disproportionate impact on costs, especially for new plant construction. Our analysis suggests that the direct impact on maintenance capex would be de minimis. Third, as members of a cyclical industry, chemical producers are more vulnerable to any impact on demand that should result from the tax-like effects that tariffs tend to have on growth. Our conclusion: let’s not overreact; we’ll see if the proposed measures will be “walked back” in favor of a more surgical approach. If not though, potential for escalation must be monitored closely. In a worst-case scenario, we would view capital-intensive exporters of commodity petrochemicals as more vulnerable than producers of coatings and other specialty chemicals.
• The US Chemicals trade balance is now at an inflection point, absent any trade retaliation. New shale gas-inspired projects along the US Gulf Coast will render US commodity chemical producers increasingly reliant upon export markets over the next 3-5 years as US capacity growth outpaces US demand in selected markets, such as ethylene and polyethylene (PE) resin for example. As shown in Figure 1, the US chemicals industry trade surplus has eroded over the past six years from $44.6bn in 2010 to $28.3bn in 2016 – an aggregate decline of nearly 37% over this period. This trend started...
• Capital intensity is high; steel matters more than aluminum. Whereas retaliatory actions, if any, are quite unclear at this early stage, the likelihood of “self-inflicted wounds” in the form of escalating input costs is perhaps more tangible. Based on the tariffs that have been proposed thus far, we view…
• So, what might this mean in practical terms? The American Chemistry Council (ACC) has estimated additional costs for chemical companies in the range of $0.4bn to $1.82bn based on an analysis of three types of data: (A) the composition of chemical industry investments; (B) input-output relationships from the Bureau of Economic Analysis (BEA); and (C) cost engineering data. We note that the midpoint of this range of ~$1.1bn would be spread over 5+ years and would represent approximately 0.8% of an estimated $133bn of projects at risk over this period. While this is not a large percentage, we note that not all projects would be affected equally as…
• What about demand risk? While the direct impact of steel and aluminum tariffs appears minuscule, the ultimate impact on the economy is difficult to gauge due to the escalating nature of a potential trade war scenario. We can say that higher metal costs would be unhelpful in terms of both inflation and demand. As a cyclical industry, chemical producers are…
• Overall, we remain Market Weight on US Chemicals exposure, albeit with a healthy appetite for risk. Based on 10-year average data, we consider the US chemicals sector to be overvalued by 10% on an absolute basis, and modestly undervalued relative to the S&P500 index. The average stock of our 18 names now under coverage trades for 15.4x our estimate of 2018 EPS. This compares to a 10-year average P/E multiple of next twelve months (NTM) earnings of 14.1x for Vertical Research Partners’ index of 25 chemical stocks. Likewise, the average stock of our names now under coverage trades for 9.9x our estimate of 2018 EBITDA. This compares to a 10-year average multiple of next twelve months (NTM) EBITDA of 7.9x for the VRP Chemicals Index. The picture doesn’t look nearly as grim when we compare the sector valuation to that of the broader market. Using the VRP Chemicals Index as a proxy, the sector trades at a relative P/E multiple of 0.91x that of the S&P500 index’s P/E multiple, which is below the 10-year average relative P/E multiple of 0.98x. Likewise, the sector trades at a relative EBITDA multiple of 0.84x that of the S&P500 index’s EBITDA multiple, which is also a modest discount to the 10-year average relative EBITDA multiple of 0.91x. Within the sector, our analysis suggests that commodity-linked chemical names – whether pure plays or diversified portfolios – remain inexpensive vs. specialty chemical counterparts on a 5-year and a 10-year historical basis.
(Please see full report for details)
Terrifying Tariffs or Tempest in a Teapot?
• We see three principal tariff risks: trade trajectory, cost inflation, and demand. We view prospects for new US steel and aluminum tariffs as an incremental concern for US chemical stocks for three reasons. First, the US chemical industry is a large net exporter and thus vulnerable to potential for retaliatory trade actions. Indeed, new shale gas-inspired projects along the US Gulf Coast will render US commodity chemical producers increasingly reliant upon export markets over the next 3-5 years. Second, Chemicals is the second most capital intensive industry behind energy, so higher costs for steel have a disproportionate impact on costs, especially for new plant construction. Our analysis suggests that the direct impact on maintenance capex would be de minimis. Third, as members of a cyclical industry, chemical producers are more vulnerable to any impact on demand that should result from the tax-like effects that tariffs tend to have on growth. Our conclusion: let’s not overreact; we’ll see if the proposed measures will be “walked back” in favor of a more surgical approach. If not though, potential for escalation must be monitored closely. In a worst-case scenario, we would view capital-intensive exporters of commodity petrochemicals as more vulnerable than producers of coatings and other specialty chemicals.
• The US Chemicals trade balance is now at an inflection point, absent any trade retaliation. New shale gas-inspired projects along the US Gulf Coast will render US commodity chemical producers increasingly reliant upon export markets over the next 3-5 years as US capacity growth outpaces US demand in selected markets, such as ethylene and polyethylene (PE) resin for example. As shown in Figure 1, the US chemicals industry trade surplus has eroded over the past six years from $44.6bn in 2010 to $28.3bn in 2016 – an aggregate decline of nearly 37% over this period. This trend started...
• Capital intensity is high; steel matters more than aluminum. Whereas retaliatory actions, if any, are quite unclear at this early stage, the likelihood of “self-inflicted wounds” in the form of escalating input costs is perhaps more tangible. Based on the tariffs that have been proposed thus far, we view…
• So, what might this mean in practical terms? The American Chemistry Council (ACC) has estimated additional costs for chemical companies in the range of $0.4bn to $1.82bn based on an analysis of three types of data: (A) the composition of chemical industry investments; (B) input-output relationships from the Bureau of Economic Analysis (BEA); and (C) cost engineering data. We note that the midpoint of this range of ~$1.1bn would be spread over 5+ years and would represent approximately 0.8% of an estimated $133bn of projects at risk over this period. While this is not a large percentage, we note that not all projects would be affected equally as…
• What about demand risk? While the direct impact of steel and aluminum tariffs appears minuscule, the ultimate impact on the economy is difficult to gauge due to the escalating nature of a potential trade war scenario. We can say that higher metal costs would be unhelpful in terms of both inflation and demand. As a cyclical industry, chemical producers are…
• Overall, we remain Market Weight on US Chemicals exposure, albeit with a healthy appetite for risk. Based on 10-year average data, we consider the US chemicals sector to be overvalued by 10% on an absolute basis, and modestly undervalued relative to the S&P500 index. The average stock of our 18 names now under coverage trades for 15.4x our estimate of 2018 EPS. This compares to a 10-year average P/E multiple of next twelve months (NTM) earnings of 14.1x for Vertical Research Partners’ index of 25 chemical stocks. Likewise, the average stock of our names now under coverage trades for 9.9x our estimate of 2018 EBITDA. This compares to a 10-year average multiple of next twelve months (NTM) EBITDA of 7.9x for the VRP Chemicals Index. The picture doesn’t look nearly as grim when we compare the sector valuation to that of the broader market. Using the VRP Chemicals Index as a proxy, the sector trades at a relative P/E multiple of 0.91x that of the S&P500 index’s P/E multiple, which is below the 10-year average relative P/E multiple of 0.98x. Likewise, the sector trades at a relative EBITDA multiple of 0.84x that of the S&P500 index’s EBITDA multiple, which is also a modest discount to the 10-year average relative EBITDA multiple of 0.91x. Within the sector, our analysis suggests that commodity-linked chemical names – whether pure plays or diversified portfolios – remain inexpensive vs. specialty chemical counterparts on a 5-year and a 10-year historical basis.
(Please see full report for details)
