Commentary: US petrochemical sector faces headwinds

Joseph Chang

20-Mar-2015

The US petrochemical sector should show solid profitability in 2015 but down from robust 2014 levels. Headwinds from crude oil and the strong US dollar will weigh on earnings

The winds are shifting for the fortunes of the US petrochemical sector. While the US cost advantage in producing ethylene and derivatives from cheap natural gas liquids (NGLs) remains entrenched, the crude oil price decline will take down prices and margins. You should fully expect margin compression in 2015 on the integrated polyethylene (PE) side for US producers compared to a robust 2014. Profitability should still be solid – just not spectacular.

Currency will also undoubtedly prove to be a headwind in 2015 for a number of US-based multinational chemical companies, as the US dollar surges against the euro, Japanese yen and other currencies in Southeast Asia and Latin America.

 

 Headwinds will come from oil and currency

Copyright: Alamy 

Not only will products sold abroad translate into less US dollars, but producers in Europe and Asia also will gain competitiveness selling into US markets. The overall US manufacturing sector that depends on exports will likewise take a hit from the stronger dollar at the expense of competitors abroad.

The US dollar has been exceptionally strong versus other currencies, as the US Federal Reserve plans to start raising interest rates as the economy continues to improve. This is in contrast to what virtually every other nation is doing – lowering rates or embarking on quantitative easing (QE), or money printing operations.

The EU and Japan in particular are employing aggressive QE measures to avoid deflation and boost stagnant economies. The euro had been approaching parity with the US dollar at around $1.09/euro after being as high as $1.39/euro in May 2014 – a huge move for a major currency.

Wall Street analysts have been trimming profit estimates for US-based chemical companies following Q4 2014 results, with oil and currency being cited as the usual culprits.

John Roberts, analyst with UBS, took down his 2015 earnings per share (EPS) estimate on Dow Chemical from $3.05, to $2.90 on 16 March, “primarily for price lag due to the most recent dollar strength”. However, he made no change to his 2016 EPS forecast of $4.00, as “we believe prices for oil-linked chemicals adjust within months for FX (foreign exchange), since oil is dollar-based globally”.

“Following the Q4 reporting season, and similar to the outlook shared for 2014, the general tone is again cautious. Macros aren’t cooperating as hoped, with only the US (again) the bright spot. Europe, after showing signs of a recovery in H1 [2014], pulled back in H2 and the euro plummeted. As a result, many companies have sized material headwinds from FX for 2015,” said Frank Mitsch, analyst with Wells Fargo.

“Lower oil is a boon to consumer-oriented chemical names (coatings, specialty plastics, etc), and not quite a bust to commodity names. Although margin is likely to compress along the ethane-PE chain, the petrochem names are still operating at attractive profit levels,” Mitsch added.

Across Wells Fargo’s US chemicals coverage universe, which includes coatings producers PPG Industries and RPM International, along with plastics compounder PolyOne – companies that stand to benefit from lower oil prices – he expects EPS to rise an average of 7% in 2015 – a more optimistic view versus the consensus at around +3%, Mitsch noted.

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