INSIGHT: European chemicals stocks ride high

14 January 2013 16:19  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS)--Pointers for investors in European chemicals stocks published by the London office of Bernstein Research on Monday will chime with industry executives.

Chemicals outperformed most other sectors in Europe last year. The Dow Jones STOXX Europe 600 Chemicals index rose by 29.5% compared with an increase for the broad STOXX 600 index of 14.4%. Only Europe’s automobiles and auto parts companies and its insurance sector performed better.

The index reflects the stock price performance of a broadly-based group of 24 publicly quoted chemical firms – ranging from BASF and Bayer, to paints maker AkzoNobel, flavours and fragrances producer Givaudan and industrial lubricants company Fuchs Petrolube. Market sentiment for companies in the index mirrors some important industry fundamentals.

Chemical producers upstream and downstream have to respond effectively to cost price volatility and they have to capture growth. Industry markets have become much more volatile and difficult to navigate since the 2008-09 crash.

Demand growth has at times been strong but was weak to negative overall in 2012 and is expected only to be moderate over the next few years.

Yet economic, industrial and financial market uncertainty in some respects played into the hands of chemical companies.

Europe’s chemical players have sought for years to manage cyclicality better and to move into more stable products. And they have pushed hard to gain inroads into fast growing markets in Asia and Latin America.

Some companies clearly are better placed than others to buck the general trend. But the chemicals sector is seen as relatively robust in a weak global economic environment. Investors are attracted by these characteristics and trends.

Sector firms are facing more, not less feedstock cost price volatility, particularly as producers in North America shift away from naphtha to take advantage of lower priced ethane. That shift will help define winners and losers in petrochemicals but also help drive creativity downstream amongst intermediates processors which will have to manage raw material price volatility even better.

Bernstein Research puts it thus: “Steep cost curves give some low-cost producers ‘protected’ pricing power, which leads to a base of earnings that is more stable than expected and potentially higher valuation multiples.” It thinks Dow Chemical and LyondellBasell in ethylene and Yara and CF Industries in ammonia/urea “will continue to benefit from the shape of their industries’ costs curves.

“The ongoing shift away from naphtha cracking will cause more petrochemical price volatility (ie, the input costs for many) and lead to periodic quarterly profit warnings if customers fail to manage the inflation. This applies to nearly all European chemicals companies. The highly integrated BASF would be most insulated.”

One might imagine that European chemical company stock prices have neared a peak with risk being on the downside. Certainly, the prospects for demand growth are not great particularly compared with similar companies quoted in other parts of the world.

But investment analysts are expecting relatively strong demand growth for chemicals in 2013 which would work to underpin valuations.

“We think global chemicals volume growth could surprise to the upside if emerging-market recovery continues, even if the European economy remains weak,” Bernstein said.

The research firm’s analysts are forecasting average European chemicals volume growth of 3.3% in 2013, just ahead of the company’s forecast for GDP growth – of 2.6% – and below a forecast of 4.1% for chemical growth globally.

Whether this rate of growth is sufficient to underpin current share price performance remains to be seen. London-based HSBC chemicals analysts have suggested that industrial production (IP) growth would have to be high in 2013 to buoy chemicals.

“In our opinion, continued outperformance versus the broader market would primarily have to come from an improving trading environment or alternatively valuations becoming more attractive,” they said on Monday.

Some of the drivers of performance in 2012 are expected to continue, however.

On the positive side, investors have few alternatives. “Credit spreads are tight and government yields low, implying that investors need to move up the risk curve in their quest for return,” HSBC said.

Underweight in equities, investors are attracted to strong chemical company fundamentals and an estimated 8% growth in sector operating profits in 2013.

“We believe that this rationale could result in investors bidding the sector higher, even in the absence of a meaningful macro recovery.”

Read Paul Hodges’ Chemicals and the Economy blog
Bookmark John Richardson and Malini Hariharan’s Asian Chemical Connections blog

By: Nigel Davis
+44 20 8652 3214

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