20 May 2005 17:00 [Source: ICIS news]
With the route in stocks in virtually all industrial sectors, there is increasing debate about whether this marks the death of commodities.
"Concerns of an economic slowdown have led to a sharp decline for cyclical shares across various industries, although the current weakness in ethylene and polyethylene markets has compounded the negative sentiment for chemical shares," said Merrill Lynch analyst Donald Carson.?xml:namespace>
JPMorgan analyst Jeffrey Zekauskas is downgrading commodity chemical stocks Dow Chemical and
Shares of Dow fell $1.14 to $43.93 (Euro34.75) on the downgrade - a 23% decline from its March high of $56.75.
"The dramatic decreases in ethylene spot prices and propylene contract prices call into question the consensus idea of a soft patch in commodity fundamentals," said Zekauskas. "Selected ethylene derivatives, including polyethylene and ethylene glycol, may suffer incrementally greater declines than ethylene itself."
The analyst slashed his 2005 EPS (earnings per share) forecast on Dow from $5.25 to $4.75, and his 2006 estimate from $6.25 to $5.75. For Nova, he cut his 2005 estimate from $3.60 to $3.10 and his 2006 number from $5.25 to $5.
Zekauskas said he also sees coming weakness in polyvinyl chloride (PVC), leading to the
In spite of weakening prices, Merrill Lynch’s
Inventory destocking is driving ethylene chain weakness, according to
"With high operating rates for products like acrylic monomers, epoxies and MDI (methylene diphenyl diisocyanate), price increases outstripped the sharp rise in cost for raw materials such as benzene, ethylene and propylene,"
Deutsche Bank Securities analyst David Begleiter said oversupplied conditions in the ethylene chain will maintain pressure on commodity chemical share prices until inventories are worked off - most likely in the third quarter. However, he said he expects conditions to tighten by the fourth quarter.
"While the ethylene chain has corrected severely over the past five months, further delays in Iranian ethylene capacity, likely stronger Chinese demand in the second half and relatively solid US demand gives us confidence that supply/demand balances will tighten heading into the fourth quarter," Begleiter said.
The analyst remains bullish, maintaining "buy" ratings on Dow, Huntsman and
Greenwich Consultants analyst Michael Judd said he remains optimistic on the upcycle in the long run. "Basically we had a mini-boom in the first quarter in terms of margins, but margins will be lower in the second quarter," he said. "Once the inventory correction ends, we could see another run-up in prices and margins. What happens will depend on how strong demand is, and I don’t think we will go into a recession."
The decline in commodity chemical share prices is part of an overall portfolio shift away from cyclical stocks, according to Judd. However, this is creating a buying opportunity.
"Many clients were overweight in basic materials such as chemicals, steel and paper, and have been moving back to a more neutral position because of concerns about the economy," Judd said. "Investors tend to overshoot on the upside as well as the downside. So now we think these prices are very attractive for Huntsman, Lyondell and Dow."
The specialty chemical sector has been less hard-hit than their commodity counterparts and has actually benefited from some Wall Street upgrades.
JPMorgan’s Zekauskas recently upgraded DuPont and Lubrizol from "neutral" to "overweight."
"DuPont’s price trends have improved sharply in recent months - up 4% in the fourth quarter of 2004 and 5% in the first quarter of 2005," said the analyst. "We expect DuPont to offset all of its raw material cost pressures in 2005 with higher selling prices. DuPont is well positioned to benefit from decreases in raw material cost pressure should they arise, given its current pricing power."
Zekauskas expects DuPont’s EPS to improve from $2.38 in 2004 to $2.70 in 2005 and $3 in 2006 from higher prices, cost reductions and volume growth partially as a result of new product introductions.
On a valuation basis, DuPont’s price/earnings (P/E) multiple of 17.2x estimated 2005 earnings compares favourably to a peer group average of 18.4x, notes the analyst. Based on his 2006 projections, shares of DuPont at over $46, trade at a P/E of 15.5x versus an average of 16.5x for its peers.
Zekauskas said he finds Lubrizol attractive on both an absolute and relative valuation basis. The stock, at over $37, trades at a P/E ratio of 13.8x his 2005 estimate versus 17.7x for its peer group, and 12.2x his 2006 estimate versus 15.8x for its peers. He estimated Lubrizol’s EPS will rise from $2.46 in 2004 to $2.70 in 2005 and $3.05 in 2006.
"We also recommend shares of Lubrizol based upon the outlook for its businesses," Zekauskas said. "In our opinion, volumes for both lubricant additives and specialty chemicals will be soft but that prices will continue to be resilient. Should raw material pressure abate, Lubrizol will have an opportunity to expand gross margins materially."
Fulcrum Global Partners analyst Frank Mitsch is raising estimates and reiterating a "buy" rating on specialty/commodity hybrid Eastman Chemical. The analyst is boosting his 2005 EPS estimate from $6 to $6.30 and his 2006 forecast from $6.50 to $6.75 based on strong earnings potential from both specialty Eastman businesses and the commodity Voridian businesses.
"Following our tire-kicking tour of
In the Eastman division, an emphasis on raising prices faster in response to higher raw material costs is apparent, while in the PCI intermediates business, prices are increasing down the chain with upstream capacity facing tightness, noted Mitsch. The specialty plastics unit is demonstrating pricing power, fibres is finally growing and the IntegRex polyethylene terephthalate (PET) plant is being constructed ahead of schedule.
As of Wednesday, the chemical sector has staged somewhat of a comeback, with commodity and specialty shares up between 2-5% off of recent lows.
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