The industry is divided into commodity chemicals (45%) and specialty chemicals (55%). The commodity segment tends to be more concentrated; cost reductions, improving yield from better technology and economies of scale are important. In the specialty segment, margins are higher due to better pricing and more efficient operations.
OPPORTUNITIES
Demand for fertilizers is driven by crop prices that are currently at high levels. At these levels, fertilizer demand should be steady at worst, and with reduced capacity, prices should stay firm. The use of ethanol as fuel is also keeping prices high.
The chemical industry is a large consumer of oil, natural gas and energy. Raw material costs have been at historically high levels, which was a very serious challenge for the chemical industry. However, oil and gas prices are falling, and this could provide a temporary windfall for the next 6-9 months.
Many chemical and fertilizer companies have excellent balance sheets and cash flows. This bodes well for the industry in this time of tightened credit and financial instability. Among our Buy-rated stocks in this space are Agrium, Inc. (AGU) and CF Industries Holdings, Inc. (CF).
WEAKNESSES
Demand growth is near 0% currently. Demand for chemicals tracks global industrial production and global GDP very closely. Housing and auto markets could continue to weaken. Nearly 10% of chemical demand is directly tied to the housing sector, and an additional 10% is tied to the auto sector. The global slowdown in economic growth will directly affect the chemical industry.
Prices may fall in this industry. Pricing power is a function of three variables: inflation, capacity utilization and raw material price changes. Inflation is low (but could increase with aggressive monetary policy), capacity utilization levels are weakening, and oil prices are falling. This suggests a high probability of falling prices.
There is the chance of accelerating capacity growth in 2009-2011, assuming that projects do not get cancelled. This is at a time when demand is slowing and operating rates are falling.
Within this space, we do have a Sell recommendation. It is on Georgia Gulf Corporation (GGC)...zacks.com
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