Wall Street Pounds the Table for Commodities

23 August 2004 00:01  [Source: ICB Americas]

Wall Street is pounding the table for commodity chemical stocks because of its forecasts of an impending peak in the cycle in the years ahead.

Expecting the next upswing of the chemical cycle to unfold over the coming 12 months, Smith Barney analyst P.J. Juvekar has upgraded major chemical producers Dow Chemical Company and Lyondell Chemical Company from “hold” to “buy” and reiterated his “buy” rating on Nova Chemicals Corp.

“Producers are gaining real pricing power as operating rates approach the low- to mid-90 percent range, and debt is being paid down with cash flow,” says Mr. Juvekar. “The signs we were looking for came in the second quarter when chemical companies expanded margins despite a huge run-up in raw material costs. The expansion of margins, especially in ethylene, convinced us that the producers are just beginning to get real pricing power.”

While the analyst left his 2004 and 2005 earnings per share estimates unchanged, he raised his price targets on Dow from $41 to $46, Lyondell from $19 to $21, and Nova from $32 to $36.50.

“Dow and Lyondell should generate significant amounts of free cash flow from the tightening of the supply-demand cycle in 2005 to 2006,” says Mr. Juvekar. “The companies are likely to pay down debt with this cash, as both companies are highly leveraged.”

Despite the fact that oil prices have surged to over $45 per barrel, Mr. Juvekar argues that positive supply-demand fundamentals should lead to higher margins. “The real impact of oil now is not from the raw material side, but the question is what happens to GDP growth if oil stays high,” he says. “High oil prices could slow the economy, but with the lack of capacity additions over the next 12 months, the outlook for the commodity chemical cycle remains positive.”

Goldman Sachs analyst Robert Koort is reiterating his “outperform” rating on Dow Chemical following his most recent global supply-demand analysis. “We expect margins in the ethylene chain to continue to recover, peak in 2006, and possibly extend into 2007 to 2008 as planned capacity additions in the Middle East are delayed.”

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