The Zacks Chemicals Specialty industry is mired with challenges from sluggish demand, largely due to the slowdown in Europe and a slow economic recovery in China. Margins of companies in this space also remain under pressure due to the still-elevated input, supply chain and logistics costs.
Industry players like Axalta Coating Systems Ltd., Hawkins, Inc. and AdvanSix Inc. are banking on strategic measures, including operating cost reductions, to tide over a persistently challenging environment.
About the Industry
The Zacks Chemicals Specialty industry consists of manufacturers of specialty chemical products for a host of end-use markets such as textile, paper, automotive, electronics, personal care, energy, construction, food & beverages and agriculture. These chemicals (including catalysts, surfactants, specialty polymers, coating additives, pesticides and oilfield chemicals) are used based on their performance and have a specific purpose.
Specialty chemicals can be single molecules or a combination of molecules referred to as formulations, and they provide a vast range of effects upon which various industries rely. Their compositions significantly influence the performance of the finished products. Specialty chemicals have applications in the manufacturing process of a vast range of products, including paints and coatings, cosmetics, petroleum products, inks and plastics.
What's Shaping the Future of the Chemical Specialty Industry?
Headwinds From Demand Slowdown: Companies in the chemical specialty space are facing headwinds from demand softness in building and construction as well as industrial end markets, especially in Europe and China, due to the economic slowdown. Elevated borrowing costs and inflation have taken a bite out of the residential construction industry. Manufacturing activities have also weakened amid softer demand for goods and higher borrowing costs.
A slower recovery in economic activities in China is hurting demand in that country. The ongoing geopolitical tension, high inflation and elevated interest rates have also dampened demand in Europe. While customer inventory de-stocking is almost complete, some lingering impacts of the same in certain markets are expected to continue over the near term. The demand slowdown is likely to weigh on volumes of chemical specialty companies.
Cost Pressure Still a Concern: Specialty chemical makers are facing headwinds from raw material cost inflation, and supply-chain and freight transportation disruptions. The closure of a large swath of factories to stem the spread of the COVID-19 outbreak disrupted the global supply chain.
The Russia-Ukraine conflict and new lockdowns in China put further pressure on the global supply chain. These affected the availability of key raw materials for the chemical specialty industry. Some companies are also facing challenges from elevated logistics and labor costs. While raw material costs have moderated somewhat lately, driven by the easing of supply-chain disruptions, they remain higher than the pre-pandemic levels. The lingering impacts of inflationary pressures are expected to continue over the short haul and weigh on the margins of chemical specialty companies.
Self-Help Actions to Aid Results: The companies in this space are executing a raft of self-help measures — including cost-cutting and productivity improvement, expansion into high-growth markets, restructuring, operational efficiency improvement, and actions to strengthen the balance sheet and boost cash flows — in a bid to stay afloat amid the prevailing headwinds. The industry participants are aggressively implementing actions to cut costs. The measures are likely to help the companies sail through the ongoing challenges.
Zacks Industry Rank Indicates Bleak Prospects
The Zacks Chemicals Specialty industry is part of the broader Zacks Basic Materials sector. It carries a Zacks Industry Rank #218, which places it in the bottom 13% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates a gloomy near term. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.
Industry Underperforms Sector and S&P 500
The Zacks Chemicals Specialty industry has underperformed both the Zacks S&P 500 composite and the broader Zacks Basic Materials sector over the past year.
The industry has lost 9.2% over this period compared with the S&P 500’s rise of 25.7% and the broader sector’s increase of 0.7%.
Industry's Current Valuation
On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, which is a commonly used multiple for valuing chemical stocks, the industry is currently trading at 19.77X, above the S&P 500’s 18.87X and the sector’s 11.47X.
Over the past five years, the industry has traded as high as 20.19X, as low as 7.1X, with a median of 10.59X.
3 Chemical Specialty Stocks to Keep a Close Eye On
Hawkins: Minnesota-based Hawkins is a leading specialty chemical and ingredients company that formulates, distributes, blends and manufactures products for its customers. Hawkins is seeing strong growth in its Water Treatment segment, reflecting its strategic emphasis on the water treatment sector, including the successful integration of recent acquisitions.
The acquisition of Industrial Research Corporation aligns with Hawkins’ growth strategy in central and northern Louisiana, eastern Texas and southern Arkansas, complementing its existing operations and enhancing its market presence. HWKN recently acquired Wofford Water Service, extending its reach in Mississippi and supporting the company’s expansion in the southern United States, where its Water Treatment business had been limited previously. HWKN’s judicious pricing strategy to counter cost inflation is also supporting results. It also remains committed to enhancing shareholders’ value.
Hawkins, carrying a Zacks Rank #1 (Strong Buy), has expected earnings growth of 15.3% for the current fiscal year. The Zacks Consensus Estimate for HWKN’s earnings for the current fiscal has moved up 12.8% over the last 60 days.
AdvanSix: New Jersey-based AdvanSix is a manufacturer of nylon 6 resin, chemical intermediates and ammonium sulfate fertilizer. It is benefiting from its differentiated product portfolio, exposure to diverse end markets and favorable demand and pricing. ASIX is expected to gain from improved nylon demand conditions and the growth of its differentiated products.
The favorable agricultural industry fundamentals also bode well for ammonium sulfate. AdvanSix has a healthy balance sheet and generates substantial cash flows, which allows it to drive shareholder value and fund growth initiatives.
The consensus estimate for ASIX’s current-year earnings has been revised upward by 27.3% over the last 60 days. AdvanSix carries a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
Axalta Coating Systems: Pennsylvania-based Axalta is a global coatings company engaged in the manufacturing, marketing and distribution of coatings solutions. AXTA is benefiting from the strength in refinish and light vehicle businesses, which is offsetting the weakness in industrial markets.
The acquisition of CoverFlexx Group will enhance Axalta's refinish business by incorporating the extensive range of automotive refinish and aftermarket coatings, including primers, basecoats, clearcoats and various detailing products of the former. Axalta has also strategically expanded its portfolio by acquiring Andre Koch AG, a well-established Refinish distribution partner headquartered in Switzerland.
Axalta, carrying a Zacks Rank #3 (Hold), has expected earnings growth of 31.8% for the current year. The Zacks Consensus Estimate for AXTA’s current-year earnings has been revised upward by 4.5% over the last 60 days.
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