04 August 2003 00:00 [Source: ICB Americas]Despite dismal second quarter results from Lyondell, Nova and a warning from Millennium, major chemical stocks are rallying big time as Dow and Eastman beat Wall Street expectations and analysts upgraded some names in the sector. While volumes were generally weak across the board, Dow and Eastman demonstrated pricing power in the face of stubbornly high raw material costs.
Dow Chemical Company posted a 56 percent increase in comparable second quarter profits to $393 million as sales surged 14 percent to $8.24 billion. Earn-ings per share of 43 cents blew past Wall Street estimates of 35 cents. Cost-cutting and pricing improvements more than offset a $700 million rise in feedstock and energy costs compared to the year-ago period.
"In spite of the huge challenges faced by industry in the second quarter-persistently high feedstock and energy costs, and global geopolitical and economic uncertainty-Dow has responded well," says executive vice president and CFO Pedro Reinhard. "This is primarily due to the company's focus on the financial discipline implemented since the beginning of the year. Excellent progress has been made on expense reduction, working capital management and capital spending control." Dow has cut around $250 million in structural costs year to date, according to Mr. Reinhard.
Prices improved 16 percent while volumes declined 2 percent. Dow Agro-Sciences had a record showing and earnings from joint ventures were also up.
Dow posted operating profit gains in performance plastics (+12 percent), performance chemicals (+12 percent), agricultural sciences (+23 percent) and even plastics (+50 percent). The chemicals segment swung to a profit of $101 million versus a loss of $15 million a year ago.
Plastics sales rose 11 percent with higher prices more than making up for reduced volumes. Polyethylene volume was down in North America and Latin America but was slightly up in Europe and Asia Pacific.
Shares of Dow surged from $31.95 before the release to $35.05 as of the middle of last week.
Eastman Also Beats Estimates
Eastman Chemical Company's un-derlying second quarter earnings rose 7 percent to $47 million on 6 percent higher sales of $1.48 billion. Earnings per share (EPS) of 61 cents beat Street estimates of 48 cents.
Pricing improved 8 percent from a year ago, but volumes fell 7 percent. The earnings gain also reflected a $12 million positive impact from the previously announced change in Eastman's vacation policy, as well as other cost savings measures such as the 3 percent pay cut.
In the second half, Eastman says it will need to maintain selling prices in a difficult market environment. "While we expect that sales volumes will improve in the second half, our profitability will be driven by our relative success in pricing," says chairman and CEO Brian Ferguson.
Shares of Eastman jumped from $33.20 before the earnings announcement to $36.13 by the middle of last week.
Salomon Upgrades Chemicals
Lighting a fire under the sector, Salomon Smith Barney analyst P.J. Juvekar upgraded Dow and Eastman from "in-line" to "outperform," and raised his rating on the entire chemicals group from "marketweight" to "overweight" based on two data points showing strength in the face of adversity.
"The first data point came in the first quarter when Dow and Eastman managed to report upside surprises despite high and volatile energy prices," says Mr. Juvekar. "The second came in the second quarter when the companies reported upside surprises again despite the weak volume environment after the war. When the third data point, demand, becomes obvious, it will be too late to own chemical stocks." The analyst sees 40 to 50 percent upside in Dow and Eastman in the next 24 months.
Lyondell Posts Big Loss
Lyondell Chemical Company posted a net loss of $54 million, excluding $14 million in financing and restructuring costs, on proportionate sales of $2.57 billion. The underlying loss per share of 34 cents came in worse than Street estimates of an 11 cent loss. Proportionate EBITDA (earnings before interest, taxes, depreciation and amortization) fell 26 percent year over year to $161 million, but improved versus $78 million in the first quarter.
"Results during the quarter showed improvement when compared to the last two quarters, but were below the level that we anticipated when we entered the quarter," says president and CEO Dan F. Smith.
Product shipments improved slowly but steadily and this trend is continuing into the third quarter, according to the company. Lyondell says fundamentals will likely continue to favor Equistar's liquid-based olefins position.
The intermediate chemicals and derivatives segment, hurt by lower methyl tertiary-butyl ether profitability, generated EBITDA of $48 million versus $53 million in the first quarter and $120 million in the year-ago period.
Equistar Chemicals LP (of which Lyondell holds a 70.5 percent share) ge-nerated EBITDA of $80 million versus a loss of $19 million in the first quarter and a profit of $96 million a year ago. Lyondell estimates that Equistar's Gulf Coast liquid-based olefins advantage resulted in about a $100 million im-provement in Equistar's net income.
Upgrades and Downgrades
JPMorgan analyst Jeffrey Zekaus-kas upgraded Lyondell from "neutral" to "overweight" based on the company's 6 percent dividend yield and the potential for a cyclical recovery in earnings. However, he slashed his 2003 EPS estimate from a loss of $1.15 to a loss of 1.45 and his 2004 number from a profit of $1.15 to earn-ings of $1 per share.
Standard & Poor's lowered both Lyondell and Equistar's corporate credit ratings from "BB" to "BB-". "The downgrades follow Lyondell's announcement of disappointing second quarter operating results and diminishing prospects for a meaningful recovery in the petrochemicals sector this year," says S&P chemicals analyst Kyle Loughlin.
Shares of Lyondell shrugged off the credit ratings downgrade, rising from $13.78 before the earnings announcement to a high of $16.10 last week be-fore a downgrade by UBS analyst An-drew Cash, who cut his rating on Lyon- dell from "buy" to "neutral" based on valuation. Lyondell's stock subsequently fell 69 cents to $14.81.
Nova's Loss Widens
Nova Chemicals Corp. posted an underlying second quarter loss of 42 cents per share versus Street estimates of a profit of 1 cent. Once again, it appeared Wall Street forgot to take into account Nova's first in, first out (FIFO) method of ac-counting, contributing to the huge miss.
The company recorded an underlying loss of $42 million versus a year-ago loss of $22 million and a profit of $4 million in the first quarter. Sales jumped 24 percent from the year-ago period to $964 million.
"Demand for our products declined in the quarter due to a combination of a global industrial production downturn and customer inventory depletion," says president and CEO Jeff Lipton. "Operat-ing performance in the second quarter suffered because reduced demand limited price increases and pricing did not keep pace with higher feedstock costs."
The olefins/polyolefins business posted a net loss of $5 million versus first quarter income of $4 million. Polyethy-lene price increases were more than offset by higher feedstock costs, while ethylene and polyethylene volumes declined slightly from the first quarter.
The styrenics business generated a loss of $42 million versus a loss of $17 million in the prior quarter as volumes fell sharply. The company's now divested stake in Methanex Corp. generated $12 million in equity earnings.
Nova's styrene monomer unit at Bayport, Tex., which suffered from a fire in the ethylbenzene unit on June 11, is expected to resume production in the third quarter using contracted ethylbenzene. It could take six months before the Bayport facility is fully operational. Nova took a pretax charge of $13 million in the quarter related mainly to property damage not covered by insurance.
"The flow through to the P&L [in-come statement] of the first quarter spike in hydrocarbon costs, mainly in the styrenics segment, accounted for the bulk of the shortfall versus expectations," notes Merrill Lynch analyst Donald Carson. "Nova is the only company among its peers which uses FIFO inventory ac-counting. Just as the Street had underestimated the benefit from FIFO in the first quarter when Nova reported a 5 cent profit versus forecasts for a significant loss, the Street underestimated the negative impact in the second quarter."
Methanex Firmly in the Black
Methanex's second quarter profits more than tripled to $49.9 million (39 cents per share) versus the year-ago period on 66 percent higher sales of $372 million. The earnings came in shy of Street estimates of 48 cents. Earnings were also down from $75.5 million in the first quarter.
While methanol prices are slightly lower in the third quarter, industry fundamentals are still strong and no new supply is expected this year, according to the company. Towards the end of the second quarter, strong industry operating rates and lackluster demand took pricing down.
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