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US Chemicals: Forecasting earnings strength in Q1'14

04/10/14 -

US Chemicals – Forecasting earnings strength in Q1’14

  • Higher prices outpaced costs to result in margin gains; volume fears overblown
  • Above consensus in Q1’14 and FY14 for AXLL, DOW, HUN, LYB, MEOH and WLK
  • We see best near-term risk/return at Overweight rated AXLL, MEOH and WLK

Summary

Chemical shares experienced decent gains in Q1’14 rising by around 1.3% while outperforming the broader market by 0.2%. Significantly higher y-o-y ethane costs being outpaced by higher product prices should, in our view, result in y-o-y margin expansion for most in the US commodity chemical space. That said current consensus Q1’14 expectations are only looking for 14.2% y-o-y gains in EPS for the group – quite undemanding in our view keeping in mind 19.5% ethane based ethylene derivative margin expansion y-o-y and higher volumes. While volume weakness related fears linger in the market we highlight that the data points otherwise - US chemical rail car loadings which historically are a good coincident volume indicator rose by 0.9% y-o-y in Q1’14.

We would remind investors that a variety of companies under our coverage – LYB, MEOH, and WLK – will have incremental capacity coming on-line in 2014 earnings accretion from which is still not fully baked into the consensus 2014 numbers, in our view.

We are meaningfully above consensus in Q1’14 and 2014 for Axiall, Dow Chemical, Huntsman, LyondellBasell, Methanex and Westlake Chemical – all rated Overweight. Additionally Dow Chemical, DuPont, Praxair and LyondellBasell appear to be closest to their short interest 52-week highs while Huntsman, Westlake Chemical, Methanex, and Tronox are furthest away. A Q1’14 earnings beat from Dow Chemical, DuPont, Praxair and/or LyondellBasell could result in substantial share price outperformance, in our view.     

Despite what we consider to be a very favorable US commodity chemical macro environment we cannot ignore market sentiment particularly with the “hangover” of the sharp chemical correction of H2’11 fresh in our minds. Using 2011 share price highs and lows and reported 2011 EPS to establish floor and ceiling price-to-earnings multiples and in-turn assigning these multiples to our 2014 EPS estimates we see the best risk/return profile at Methanex, Westlake Chemical and Axiall Corporation (in that order) - all names trading close to floor valuation levels with substantial upside potential.

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