The Chemical industry has been near the top of the Zacks industry
ranks for several months now. As the world economy has recovered so
has demand for the basic building blocks of most of the products we
buy. Since these firms tend to be big buyers of oil, one might
think that their margins would get squeezed by higher oil prices,
but that has not been the case so far.
Earnings for the group are growing nicely, and are growing much
faster than are sales. In other words net margins are going up, not
down. Earnings have come in much higher than expected, and as a
result analysts are raising their estimates for both this year and
next.
I want to highlight some of the Chemical firms that currently hold
the Zacks #1 Rank, or Strong Buy. This designation is given to only
the top 5% of all stocks, and is based primarily on estimate
revisions and earnings surprise. It has one heck of a long-term
record, particularly if you are willing to trade in and out of
stocks, and have a holding period of only a few months.
I will start with the largest of these firms, and then move to some
of the smaller names. Prices are as of the close 5/17/11.
BASF (BASFY, $89.14). This is a giant firm based
in Germany. This year, it is now expected to earn $8.93 and those
earnings are expected to rise to $9.80 in 2012. That is up from
$7.61 in 2010.
Just last month, it was only expected to earn $8.30 in 2011 and
$8.88 in 2012. Three months ago, it was expected to only earn $7.18
for 2011 and $6.89 for 2012. Remember, an estimate in motion tends
to stay in motion, so the odds are that the current expectations,
particularly for this year, will prove to be too conservative.
In other words, its “true” P/E will turn out to be less than the
10.0x implied by the current estimate. Its balance sheet is solid,
if not exactly pristine. BASFY has a 2.57% dividend yield, but
unlike most domestic firms, the payout comes but just once a year,
so you will have to wait almost a full year to get a dividend on
this one.
Dow Chemical (DOW, $38.37) is the largest
U.S.-based chemical firm. It is expected to earn $2.80 this year,
with EPS growing to $3.49 next year. That is relative to $1.97 in
2010. Just a month ago, the expectations were for it to earn $2.57
in 2011 and $3.36 in 2012.
In the first quarter, earnings beat expectations by 22.4%. Based on
this year’s earnings it is trading at 13.7x, which is reasonable,
but not bargain basement. Looking out to 2012, the multiple falls
to 11.0x.
The firm just boosted its dividend by 66% to $0.25 per quarter,
from $0.15, but that is still below its payout before the financial
crisis hit ($0.42). That puts the dividend yield at a very
respectable 2.74%. It would not surprise me if the old dividend
level were regained within two or three years.
Celanese (CE, $49.13) is a much smaller firm than
either BASF or DOW, but it is also benefiting from the same trends.
It is currently expected to earn $4.36 for this year, rising to
$4.92 next year, up from $3.37 in 2010. Just a month ago, the
estimates stood at $3.89 and $4.52, respectively. That was before
it beat the consensus expectations by 15.7% in the first
quarter.
Celanese does not provide the same sort of dividend income as the
other two, with a nominal payout of just $0.05 per quarter. It is
trading at 11.3x this year, and 10.0x next year’s earnings
estimates, and the estimates are marching higher. Its balance sheet
is a bit on the questionable side, but that leverage has allowed it
to earn a very strong 63.7% ROE over the last twelve months.
Huntsman (HUN, $18.86). Smaller still than
Celanese, and much more commodity-oriented, Huntsman has been
knocking the cover off the ball. In the first quarter, it posted a
95.8% positive surprise. In other words, it earned almost twice
what the street was expecting. That was the fourth time in a row
that HUN posted a major positive earnings surprise.
Earnings are currently expected to rise from $0.83 in 2010 to $1.76
in 2011 and $2.08 in 2012. Before its earnings were announced, the
expectations were for $1.41 this year and $1.79 next year. HUN has
a quarterly dividend of $0.10, which at current prices provides a
yield of 2.1%. The P/E ratios are very reasonable at 10.7x this
year and 9.1x 2012 expectations. The balance sheet, like that of
CE, is a bit on the aggressive side.
Olin (OLN $22.76) is not a pure play in chemicals
-- it also has a big division that makes ammunition (Winchester) --
but it seems to be doing just fine as well. The company just posted
a positive surprise of 16.7% in the first quarter, its 8th straight
quarter of beating expectations.
Earnings are expected to rise from $1.15 in 2010 to $1.93 in 2011
and $2.33 in 2012. Last month, it was only expected to earn $1.71
this year and $2.14 in 2012. Three months ago, the expectations
were for just $1.29 and $1.50, respectively. While OLN is the
smallest of the five, it has the strongest balance sheet, and the
best dividend yield. Its $0.20 quarterly payout translates to a
3.51% yield. That dividend, however, has not been raised for over a
decade.
In short, the Chemical industry offers a nice combination of
rapidly rising estimates for both this year and next, along with
reasonable P/E ratios. In the short term, EPS growth will be rapid,
but because these firms are classic cyclicals, it would be a
serious mistake to extrapolate those growth rates beyond 2012.
I think we are still very much in the early stages of the world
economic recovery (and for the Chemical firms, it is the health of
the world economy -- not just the U.S. economy -- that matters).
These firms will probably see some further growth in 2013 and 2014,
only to see earnings fall sharply in the next downturn.
All five pay dividends, although the dividend profiles are very
mixed. The payout ratios are low, especially based on 2012
earnings, so there is room for dividends to rise. While these firms
have had a nice ride over the last year, they are not trading for
excessive valuations. Thus there could well be more room for them
to run. In short, these firms might be the right solution for your
portfolio.
BASF AG-ADR NEW (BASFY): Free Stock Analysis Report
CELANESE CP-A (CE): Free Stock Analysis Report
DOW CHEMICAL (DOW): Free Stock Analysis Report
HUNTSMAN CORP (HUN): Free Stock Analysis Report
OLIN CORP (OLN): Free Stock Analysis Report
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