Recently, Barclays held The Chemical ROC Stars Conference. The purpose of the conference was to get a general feeling of where the chemical sector was heading. Different themes were identified from different companies. The three most noticeable themes were:
1) A sustained housing recovery
2) Shale gas boom
3) Declining commodity prices
Housing Recovery
Looking forward, the earnings trajectory for Sherwin-Williams Company (NYSE:SHW) is positive given the company’s outsized leverage to a U.S. Housing recovery. The company decided to buy out the largest Mexican paint maker, COMEX for $2.34 billion, last November.
The COMEX acquisition, when completed, should further cement Sherwin-Williams Company (NYSE:SHW)’s footprint in two key architectural coatings markets (Latin America & North America). The environment for Sherwin-Williams Company (NYSE:SHW)’s stock should continue to be favorable in the second quarter on easing raw material prices (both TiO2 and Propylene) as well as some possible pent-up demand from a cold winter in the Northern portions of the United States. The next catalyst for the stock, barring unexpected housing news or a COMEX close, should be Sherwin-Williams Company (NYSE:SHW)’s Analyst Day in Cleveland on May 23.
Shale gas boom and the ethylene cycle
Chemicals have largely benefited from declining natural gas prices which have resulted as a direct consequence of the shale gas boom. This decline has helped the chemical companies to obtain certain raw materials at extremely cheap prices. Shale gas boom has produced abundant supplies of ethane, a natural gas component that is converted to ethylene with heat and pressure in a process known as cracking. Ethylene, then in turn, is used to produce polymers and plastic bags.
LyondellBasel Industries NV (NYSE:LYB) has been a pure-play on ethylene prices. The declining raw material costs have meant a rise in margins for this company.
Not only declining raw material prices, LyondellBasel Industries NV (NYSE:LYB) remains a core holding over the next three years based on three more reasons: 1) attractive valuations (currently around a 10% Free Cash Flow yield), 2) lower capital allocation risk (most of it is given back to shareholders via share buyback or dividends), 3) productivity gains from management.
In the next month, we should receive more color on share repurchases. The summer could be a little bit bumpy with demand conditions uneven, but it will be worth the one- to three-year ride.
Declining TiO2 prices
El du Pont de Nemours has been the face of the US chemical industry. The company’s two major revenue-making segments are: Agriculture and Performance Chemicals.
In the past two years, positive or negative news out of the Agriculture or TiO2 markets have been the largest driver of du Pont’s stock (For those who don’t know, TiO2 or titanium dioxide is a vital raw material in paint manufacturing and is used because of its brightness. Sale of TiO2 forms a major portion of revenue of Performance Chemical segment). The Street doesn’t see this trend changing until du Pont’s “other segments” grow in relative size and also start to deliver the growth and profitability that du Pont believes it can achieve.
In Agriculture, business conditions continue to remain robust and another record year of earnings looks probable after the company’s second quarter results print. Market share in North America versus Monsanto Company (NYSE:MON) will be the focus later this year but with delayed plantings, it is hard to get a current read.
In TiO2, the commodity continues to remain a battleground on whether prices will continue to fall or will stabilize. The Street believes that prices of TiO2 will continue to move down over the next 2 years to roughly the level they averaged from 2000 to 2007.
What makes DuPont’s stock a bit more interesting at the moment is the M&A / Divestiture angle. Analysts walked away from the investor day thinking that meaningful acquisitions are a distinct possibility over the next 18 months. However, many believe that separating TiO2 from Dupont’s portfolio is not likely to happen in the near term.
Final Word
Investors were left with three themes after the ROC conference: Housing recovery, Shale gas boom (declining raw material prices) and declining TiO2 prices. Sherwin-Williams Company (NYSE:SHW) and LyondellBasel Industries NV (NYSE:LYB) seem to be good bets on the first two themes. The third theme (i.e. declining TiO2 prices) compels us to remain on the sidelines with du Pont until the TiO2 market settles out.
The article 3 Investing Themes in the Chemical Space to Profit From originally appeared on Fool.com.
Zain Abbas has no position in any stocks mentioned. The Motley Fool recommends Sherwin-Williams. Zain is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
