US-China tariff escalation threatens H2 recovery

The US-China trade war escalation, with both parties ramping up tariffs, threatens to dampen or kill the second-half earnings recovery many chemical companies and analysts had been expecting.

Following a devastating December 2018, when orders, especially from China, simply stopped, the first quarter of 2019 was expectedly weak as destocking continued to run its course.

However, on the Q1 earnings conference calls, most companies pointed to improving trends in the second quarter and the belief that business in the second half would be much more robust, especially as China’s economy was starting to see some “green shoots” and the US and China were reportedly nearing a trade deal.

Kiss that rosy scenario goodbye for now. Expect Wall Street to take down earnings per share estimates for 2019 and 2020 on tariff headwinds and a deterioration in China and world business sentiment.

The third round of tariffs on both sides are being ramped up. In this round, the US raised tariffs on $200bn in Chinese products from 10% to 25% as of 10 May, while China in retaliation is boosting tariffs on $60bn in US products from rates of 5-10% to 5-25% as of 1 June.

This third round of tarrif hikes directly impacts $8.8bn in US chemicals and finished plastics exports to China based on 2017 figures, and $13.2bn in China exports to the US, according to the American Chemistry Council.

In the trade war escalation in the third round, for bulk commodity chemicals, the US exports to China most impacted are ethylbenzene and paraxylene (PX), both of which now go up to the 25% tariff tier versus 10% previously.

On the other side, China exports to the US 
most impacted include caustic soda and titanium 
dioxide (TiO2) – also now under 25% tariff versus 
10% previously.

And on 14 May, the US released a proposed list of new tariffs of up to 25% it is preparing to impose on another $300bn in Chinese imports.

This would include essentially all other imports not covered by the previous three rounds of tariffs with certain exceptions, and could be imposed towards the end of June following a public comment period.

The impact on bulk commodity chemicals 
from China in this fourth round of US tariffs is negligible but the round does include additional finished plastics products.

FINANCIAL MARKETS HIT

Equity markets worldwide have taken a hit. Even after the US market rebound on Tuesday, 14 May, the US S&P 500 is down 3.8% and the China’s Shanghai Composite off 6.6% since 3 May, the last day of trading in the US before Trump’s threat on 5 May to raise tariffs on 10 May.

While a subsequent broader market rally on 14 May lifted the chemical sector, chemical stock prices in many cases are still down significantly since Trump’s tariff threat.

And the blow to business sentiment bodes poorly for the outlook for the rest of 2019.

Global fundamentals on the manufacturing side have been deteriorating already, with the eurozone in contraction mode, China remaining weak and the US clearly losing momentum, as evidenced by their respective manufacturing purchasing managers’ indexes (PMIs). If the PMIs as leading indicators for manufacturing activity are all pointing down, where is the supposed second-half recovery going to come from?

Jefferies analyst Laurence Alexander also sees weakness in the OECD leading economic 
indicator (LEI) series, although sequentially month to month, Asia and Europe have been improving recently.

“The OECD LEI series continues the slow roll underway since early 2018. On a year-on-year basis, the global series continues to fade, with the indicators almost back to levels where global recession fears would appear warranted based on historical performance,” according to Alexander. “Even without the trade dispute, the LEIs we track suggest volumes in Q3 [2019] could disappoint,” he added.

On a positive note, though, at least there has been a clear shift in policy on the part of central banks. Since December 2018, the US Federal Reserve has flipped from planning three more rate hikes in 2019 to zero.

It also announced plans to stop shrinking its balance sheet later in the year.

Meanwhile, the Chinese have undertaken stimulus measures to stabilise its economy and players anticipate more to come if the US tariffs start to bite harder. Yet on balance, with the escalation of US-China tariffs and slowing manufacturing momentum, 2019 on balance should be a far more challenging year for the global economy as well as chemical companies.

MEETING CONSENSUS?

Current 2019 consensus earnings estimates for US-based chemical companies, which already show declines versus 2018, will be hard to meet.

In this analysis, we look at what it would take for companies to meet their 2019 consensus earnings per share (EPS) targets, with the first quarter already in the books.

We compare what companies would need to earn from Q2-Q4 2019 to meet consensus, and how this compares to Q2-Q4 in the year-ago period.

In a clearly worse macro environment for the rest of 2019 versus 2018, a number of companies would have to actually beat last year’s Q2-Q4 performance to meet consensus. Others would have to come close with modest single-digit year-on-year declines in EPS.

Looking at the big picture and potential additional negative 
impacts from the tariff escalation, that is a tough ask for the economically sensitive chemical sector.

CORRECTION

The Commentary on page 5 of the 10 May issue incorrectly listed the US bulk commodity chemicals impacted in the escalation of the 3rd round of China’s retaliatory tariffs as including ethylene dichloride (EDC), polypropylene (PP) and butadiene (BD). Rather, these US products were impacted in the 2nd round. This has been corrected in this article, along with the chart depicting US chemicals most impacted in the 2nd and 3rd rounds combined.