17 June 2005 17:00 [Source: ICIS news]
While concerns of an economic slowdown remain, specialty chemical companies are poised to benefit from pricing power flowing down the chain as well as lower commodity chemical raw material costs.
"This is a good time to be looking at the specialty chemicals group," said CS First Boston analyst John McNulty. "With feedstocks coming down and pricing holding steady, this should lead to a decent widening of margins. With the exception of
"The specialty chemical group is in the sweet spot for margin expansion in the next few years," said KeyBanc/McDonald analyst Michael Sison. "Raw materials are falling and generally we’re seeing solid demand. As we move into late 2005, we could see a recovery in the electronics and construction markets, as well as industrial production that leads to price increases sticking."
"Our investment preference is for specialty chemical companies versus commodity companies, and for companies with a global demand base versus companies with a domestic demand base," said JPMorgan analyst Jeffrey Zekauskas.
The analyst recently added DuPont to the JPMorgan Focus list and set a target price of $55 (Euro45) on the stock, based on an 18.3 times price/earnings on estimated 2006 earnings/share (eps) of $3.
Shares of DuPont currently trade at around $47 versus a 52-week high of 54.90 and a low of $39.88.
"DuPont is our best large cap idea in the chemical space," said Zekauskas. "Our conviction in DuPont’s earnings growth prospects over the next 12 to 24 months is rooted in our belief in the company’s ability to increase prices. We also believe that DuPont could benefit from lower raw material costs over the coming quarters."
DuPont is a consumer of a large variety of oil derivatives and intermediates such as adipic acid, chlorine, hexamethylene diamine (HMD), dimethyl terephthalate (DMT), as well as ethane and natural gas, noted the analyst. Base petrochemical prices have declined sharply from their highs at the end of 2004.
Zekauskas expects DuPont to boost eps from $2.38 in 2004 to $2.70 in 2005 and $3 in 2006, driven by higher pricing and new product introductions.
Albemarle and Rohm and Haas are two names that stand to benefit from pricing power and falling raw material costs, according to KeyBanc/McDonald’s Sison.
"Rohm and Haas is also well positioned. The company achieved a significant amount of price increases in the first quarter and buys a lot of propylene - those prices have come down quite a bit," Sison said. "We think Rohm and Haas can come in with a better second quarter and show strong growth."
The analyst sees Rohm and Haas’ eps growing from $2.17 in 2004 to $2.85 in 2005, $3.20 in 2006 and $3.50 in 2007.
Shares of Rohm and Haas trade at nearly $48 versus a 52-week high of $50 and a low of $36.97.
"What we found is that companies like Rohm and Haas and Albemarle took a big stand in 2004 and spent a lot of time with their sales people and operating heads to really teach them how to raise prices," said Sison.
"This is an industry where many people hadn’t been asked to raise prices for 10 years. Both companies have trained their people how to raise prices, use enterprise resource planning systems to understand which products they can gain the most leverage on, and also have the ability to hold onto margin gains as raw material costs fall."
Like their commodity chemical counterparts, who have already experienced a huge wave of pricing power before the recent downturn, specialty chemical companies have significantly curbed capital spending in the past four years, setting the stage for pricing gains in certain areas.
"There haven’t been a lot of capacity expansions in brominated flame retardants so utilization has been high. That gives
CS First Boston’s McNulty is partial to Cytec Industries and Ferro. "Cytec is benefiting from lower raw material costs and the currency issues are understood," he said.
For Cytec, he expects eps to rise from $3.06 in 2004, to $3.40 in 2005 and $4 in 2006. Shares of Cytec trade at almost $42 - not far off its 52-week low of $40.12 and well below its high of $54.64.
"Ferro has cleaned up its accounting problems and its polymer additives business is now the most profitable it’s been since early 2002 after a number of price increases," McNulty said. "Its electronics business is also finally starting to show signs of life."
The analyst estimates Ferro will boost eps from 63 cents in 2004 to 92 cents in 2005 and $1.38 in 2006. Ferro trades at about $20 versus a 52-week high of $27.10 and a low of $16.77.
While much of the sector is improving, there are pockets of weakness such as on the specialty plastics side. PolyOne recently warned that second quarter sales will likely rise 2-4% versus the first quarter - lower than its earlier growth projection of 7-10%. The company also warned its operating income from continuing operations would improve by no more than $1m from the first quarter’s $38.7m.
Citing signs of demand weakness in automotive, building and construction, and recreation and leisure markets, specialty plastics and extrusion firm Spartech recently cut its second half eps guidance to 56 to 61 cents - well below consensus estimates of 90 cents.
The strength of the US dollar versus the Euro is also cause for concern. "We would be even more excited about the specialty chemicals group if we didn’t seeing the European currency rolling over," said CS First Boston’s McNulty. "That remains a risk in the group. With the average
While some analysts recommend that investors shift into specialties, others say both commodity and specialty sectors can perform well in a positive demand environment.
"The argument to switch to specialties seems a bit too simplistic," said Deutsche Bank Securities analyst David Begleiter. "Feedstocks may go right back up with crude oil at $55 now and the pricing power commodity players have had was a direct function of the cover provided by high energy prices. I think commodities and specialties are more closely aligned - there’s been a convergence over the years and now it’s hard to make a distinction."
A demand recovery would benefit both commodity and specialty companies, Begleiter argues. "They both can do well at the same time and they both have performed well. In the first quarter, Crompton made 19 cents per share - double what the [Wall] Street was looking at, and Dow came in at $1.34 - well above Street estimates."
In the specialty sector, the analyst likes Lubrizol, Cytec, the Crompton/Great Lakes combination (Chemtura), Spartech and Hercules.
"Lubrizol and Spartech have unique values," said Begleiter. "Lubrizol will achieve growth from the acquisition of Noveon last year, and Spartech has a substantial opportunity to take out costs."
For Lubrizol, the analyst sees eps increasing from $2.47 in 2004 to $2.80 in 2005 and $3.25 in 2006. He expects Spartech’s eps to fall this year to $1.03 from $1.32 in 2004, but then rebound to $1.50 in 2006 and $1.80 in 2007.
Shares of Lubrizol trade at around $40 versus a 52-week low of $32.12 and a high of $43.57. Spartech at nearly $18.50 is near its low of $17.83 and far off its high of $28.31.
"Spartech’s new chief executive George Abd is backing away from the decentralized, acquisition driven growth of the last decade," Begleiter said. "Instead, Spartech will become more centrally controlled, cost focused and return driven."
(For additional Chemical Market Reporter analysis, visit the CMR web site at http://www.chemicalmarketreporter.com.)
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