Chemical earnings engine roars

NASCAR.jpgAs they say in US NASCAR racing – gentlemen, start your engines!

After a blip down in world stock markets on Tuesday, October 19, sparked by China’s quarter-point hike of a key interest rate as well as continuing fears in the US about the consequences of an ongoing investigation into improper foreclosures, bourses were back in the black on Wednesday.

Industrial stocks, including chemicals of course, were pounded on Tuesday but led the rally on Wednesday.

The widespread rally in the chemical sector was bolstered by the announcement by Germany’s BASF, the world’s largest chemical company, that it expects strong third-quarter earnings and record overall 2010 results.

And looking to the fourth quarter, the company expects the favorable business conditions to continue. For all of 2010, it anticipates sales of €63bn ($88bn) and underlying earnings before interest and tax (EBIT) of over €8bn.

Hassan Ahmed, analyst at US-based investment advisory firm Alembic Global Advisors, found it “particularly noteworthy” that BASF’s underlying Q3 earnings EBIT guidance of €2.2bn is ahead of its reported Q2 EBIT of €2.1bn, signaling sequential earnings improvement.

This bodes well for US-based Dow Chemical and Westlake Chemical, as well as Netherlands-based LyondellBasell, said the analyst.

“Current consensus estimates for all three companies are looking for sequential earnings declines in Q3, contrary to BASF’s guidance. We are above consensus on all three names for Q3 as well as 2010.” said Hassan.

Indeed, Wall Street consensus estimates indicate a significant decline in sequential earnings per share (EPS) for Dow (-24%) and Westlake (-26%). The Street also sees sequential EPS declines for Hunstman (-9%), Celanese (-35%), Methanex (-23%) and Georgia Gulf (-10%).

DuPont’s sequential numbers are skewed by seasonality in its ag business, while newly-listed LyondellBasell has no comparable consensus Q3 to Q2 EPS figures available.

But all signs point to an overall strong Q3 for the chemical industry. Analysts will likely boost profit estimates, or companies will surprise to the upside, or both.

Many commodity chemical and polymer markets have remained tight or have tightened further during Q3 – a trend that remains in effect today. During the financial and economic crisis of 2008-2009, companies cut back on capital expenditures and shut down marginal production facilities, leading to some of the tight markets we see today.

And for all US Treasury Secretary Tim Geithner’s talk of not devaluing the US dollar, it is not this office that controls monetary policy. That’s the domain of the US Federal Reserve, whose chief Ben Bernanke is poised to unleash an estimated $1 trillion of funds into the economy with purchases of debt securities – otherwise known as quantitative easing (QE).

This will hand US chemical producers two gifts – greater pricing power as money creation puts upward pressure on commodity prices, and a weaker US dollar, providing an earnings tailwind for those with significant exports and foreign operations.

While the threat of a potential slowdown in the Chinese economic expansion, another potential US mortgage crisis and European austerity measures are not to be dismissed, the overall balance of forces tilts towards a continuing global economic recovery.

 

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