Commentary: Wall Street to slash 2015 earnings estimates for US chemical companies

Although commodity chemical margins are widely expected to fall in 2015 for US producers, that does not appear to be fully reflected in earnings estimates just yet

Wall Street analysts are finally starting to cut 2015 earnings estimates for US chemical producers in the wake of the crude oil collapse but more are likely to come. The fall in oil is already being reflected in declining chemical prices worldwide and US petrochemical producers that use natural gas liquids (NGLs) face margin compression.

Don Carson, analyst at Susquehanna Financial Group, slashed his 2015 profit projections for Dow Chemical, LyondellBasell and Westlake Chemical prior to the companies reporting Q4 2014 results.

Carson took down Dow’s 2015 earnings per share (EPS) estimate down from $3.30, to $2.70, Lyondell’s from $10.05, to $8.45, and Westlake’s from $6.50, 
to $5.10.

“We are marking to market our 2015/2016 earnings estimates for ethylene/polyethylene (PE) producers… based on our downwardly revised integrated unit cash margin projections,” said Carson.

The analyst’s earnings projections are based on WTI crude oil prices of around $50/bbl and an oil-to-natural gas ratio of around 15x which although higher than the 10-11x long-term average, is lower than the 20-25x in recent prior quarters.

“While integrated PE margins are assumed to narrow from record-high 2014 levels they should stabilize closer to 2012/2013 levels which were already well above normalized levels and in-line with previous peak levels,” said Carson.

Full year 2015 ethane-based integrated low density PE (LDPE) margins are expected to fall $0.10/lb, to $0.51/lb, he noted.

However, the analyst expects “the US to maintain a significant cost advantage versus Asia and Europe even if the oil-to-gas ratio were to stabilize at current levels, and [expects] a widening advantage in the back half of the year as rising propylene supplies lead to lower co-product credits and higher naphtha-based production costs for ex-US producers”.

Although commodity chemical margins are widely expected to fall in 2015 for US producers, Wall Street consensus profit estimates still reflect only minimal declines from 2014 or even increases. Look for that to change following reporting of Q4 2014 results.

HIGHER OIL/HIGHER PROFITS THEORY
Meanwhile, one Wall Street analyst has an interesting theory on why higher oil prices tend to be better for chemical profitability in the long term versus lower oil prices.

UBS analyst John Roberts points out that higher oil prices, even if they can be fully passed along to customers by chemical companies, would reduce profit margin, pressuring management to take steps to improve productivity and shift to higher margin products.

Take for example a starting cost of $50, a selling price of $100, resulting in a profit of $50, or a 50% margin. Let’s say the cost rises to $100, and the company passes on the entire cost for a selling price of $150. While the profit remains the same at $50, the profit margin (profit/selling price, or $50/$150) would actually decline to 33%, prompting management measures.

“As a result, management will undertake additional productivity programs, and resources will be reallocated from lower price/margin product to higher price/margin products to provide some mix benefit,” said Roberts.

An improved mix could result in somewhat higher selling prices and somewhat lower costs. Assuming a higher selling price of $155 (+$5) and a lower cost of $95 (-$5), the profit would rise to $60 versus $50, for a higher margin of 39% versus 33%.

“Profit margin would increase to 39%, but would still be below the starting point. But absolute profit would be 20% higher ($60 versus $50),” Roberts pointed out.

It’s an interesting theory – certainly not conventional thinking and excellent food for thought.

Subscribe to ICIS Chemical Business