Chemicals November: Earnings Trends and Macro Positive, Performance Mixed

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Graham Copley / Nick Lipinski



November 16th, 2017

Chemicals November: Earnings Trends and Macro Positive, Performance Mixed

  • Nearly 90% of the companies in our Chemicals index beat revenue expectations in Q3 ’17, the highest mark this decade, and the magnitude of year over year growth was the highest since 2011
    • The sole negative was Coatings, which remains a space under pressure – Akzo was the only chemical company to miss both revenue and EPS estimates (see commentary and referenced research below) while PPG, RPM, and SHW also posted lackluster numbers relative to the rest of the generally very positive chemical sector
  • Nevertheless, mixed performance over the past month has the Chemical group in aggregate slightly behind the S&P 500
    • DWDP the major weight, trending down after earnings
    • Commodity stocks the positive outlier (strong earnings from WLK, acquisition chatter for LYB – see below)
    • Ag continues to lag, while Industrial Gas stocks were bid up following solid earnings – PX/Linde remains our favorite idea in the sector – we do not like the APD China deal.
  • Chemicals research since our last monthly:
    • Lyondell – acquisition of Braskem would consolidate several basic chemical markets without inciting regulatory action, and enhance LYB’s leverage to the ethylene cycle; the price would not be exorbitant given Braskem’s current valuation
    • Akzo – we are not enthusiastic about a potential acquisition of AXTA; likely premium required not justified by synergies or end market growth; value destructive move compounded by the company’s intention to exit Specialty Chemicals, yielding the upside of a turnaround to the buyer; we would continue to avoid this stock
    • European arbitrage – noting the difference in expectations for US versus European chemical companies, we analyzed who has the most upside/downside to convergence
  • Our preferences in the Chemical sector are summarized in Exhibit 1
    • We are positive on most of the large cap names in the space – DWDPLYB, PX
    • At the subsector level, we are overweight the Diversified group given the large weight of DWDP, in addition to our continued overweight positions in Commodities and Industrial Gas
      • In part because of valuations, in part because of improving fundamentals or mergers – for commodities we are assuming that oil stays around $50
      • Order of preference within Industrial gas is PX/LIN over Air Liquide
    • We remain underweight on Coatings; our Akzo concern is tempered by Elliott’s continued (increased) presence; SHW continues to look stretched in our view,
      • We would be underweighting the coatings group (US and Europe) and underweight Ag, at least through the end of the year – otherwise the broad picture is quite positive

Exhibit 1

Exhibit 2

Source: SSR Analysis – See Appendix 1 for background and see Appendix 2 for a larger version of this table.


Chemicals companies have by and large been surprising to the upside on earnings for the past four quarters now and that trend continued in full force in Q3, suggesting a broadly improving macro environment. Nearly 90% of the 30+ companies in our Chemical index beat revenue expectations in Q3, and year over year growth was as healthy as it has been since the early part of the decade – Exhibit 3.

Exhibit 3


Source: Capital IQ and SSR Analysis

Looking at the individual company results in Exhibit 4 below, significant operating leverage is apparent with small top line surprises often leading to considerable beats on the bottom line. Some of the most meaningful surprises were seen in companies that produce intermediate polymers (SHLM, HUN, EMN, POL, Covestro) indicating healthy demand across a wide variety of industries. On the other end of the spectrum, towards the bottom left of Exhibit 4, the Coatings space remains troubled – Akzo most significantly so – extending to adhesives as seen in results for FUL.

Exhibit 4

Source: Capital IQ, SSR Analysis

Exhibit 5 plots return on tangible capital versus enterprise value. This is a valuation plot we have used in the past for our SMID work to overcome the limitations of historical data and lack of proxies. It also highlights how cheap TSE remains, despite the performance last year and this year. Skepticism with respect to the styrenics markets is holding TSE back, but if some of our growth theories are right, TSE’s products should remain in reasonably tight supply – albeit with the volatility associated with the sector. At current values TSE could be a very accretive takeout for anyone wanting to consolidate in basic chemicals.

Exhibit 5

Source: Capital IQ and SSR Analysis

In Exhibit 6 we detail our Chemical subsector composition, and our usual valuation summary is shown in Exhibit 7.

Exhibit 6

Exhibit 7


Exhibit 8 summarizes discount from normal value at the sector level, and Exhibit 9 shows a stock level view. Coatings remains the valuation concern – the premium for the Diversified group is not inclusive of the DWDP synergy upside. Only Ag screens cheap at the sector level but we are cautious on the fundamentals in this space – CF the possible exception.

Exhibit 8

Source: Capital IQ and SSR Analysis

Exhibit 9

Source: Capital IQ and SSR Analysis

In Exhibit 10 we show performance by Chemical subsector over the past month. DWDP comprised most of the Diversified underperformance, while Ag weakness was driven by CF and SMG offsetting a 5% move higher for MOS on positive earnings. Gases earnings also were taken positively, as were WLK’s in the commodity space. LYB also gained on Braskem acquisition speculation.

Exhibit 10

Source: Capital IQ and SSR Analysis


Exhibits 11 through 13 show profitability at the sector, subsector, and stock level. SHW’s returns are inflated as the capital base does not yet accurately reflect the acquired VAL assets.

Exhibit 11

Source: Capital IQ and SSR Analysis

Exhibits 12 and 13 show the net income margin for the Chemicals sector as a whole and for the individual subsectors, respectively. The new subsector classification demonstrates the recent strength in the combined DWDP and also highlights a flat to declining trend in commodity chemicals net income margins over the past several years.

Exhibit 12

Source: Capital IQ and SSR Analysis

Exhibit 13

Source: Capital IQ and SSR Analysis

Portfolio Performance

Exhibit 14 summarizes the 5 most attractive and unattractive stocks on our normalized earnings valuation and skepticism index frameworks as of the start of the month. We note that these are based solely on our valuation models and we do not make any judgment calls to adjust these selections (see Exhibit 1 for our preferences by Chemicals subsector).

Results are tracking well again in 2017, particularly in the overlap group which continues to produce the most robust returns – Exhibit 15.

We also include a screen based on prior analysis combining these valuation and skepticism components with earnings revisions – Exhibit 16. The only change in the composition of this group over the past month is the swap of CF for fellow fertilizer producer MOS. Exhibit 17 frames the historical performance results that inform this portfolio selection methodology.

Exhibit 14

Exhibit 15