Analysts Like MDI Producers
Wall Street turns more bullish on chemicals outlook, raises price targets
Author: Joseph Chang
NEW YORK (ICIS)–Chemicals equity analysts are turning more bullish on the sector, citing a potential bottom in transportation and industrial end markets, an upturn in leading economic indications (LEIs) and price stabilisation.
John Roberts, US chemicals analyst at UBS, significantly raised price targets for Huntsman, Celanese and Eastman on a bottom in automotive and industrial end markets, and based on projected earnings from Q3 2020 onwards to Q2 2021.
“These companies on average have around 30% exposure to transportation and industrial end markets. We believe these markets have hit bottom and expect improvements with an economic recovery will further support stock sentiment and valuation,” said Roberts in a research note.
The analyst took up his earnings multiples on companies – a combination of portfolio mix (Huntsman), and the fact that these earnings, while improved versus the bottom in Q2 2020, should still be much lower than 2019 levels (thus implying normalised profits would be higher).
For Huntsman, the UBS analyst took up his earnings before interest, tax, depreciation and amortisation (EBITDA) estimate for the next 12 months (Q3 2020 – Q2 2021) slightly from $553m, to $561m on a “faster pace of recovery than previously expected”.
Putting around a 10x multiple on EBITDA versus his prior 8x yields his new price target of $23 for Huntsman’s shares versus a prior $18. Huntsman had closed at $18.02 prior to the Monday note.
A higher multiple for Huntsman is warranted, given the company’s transformation as it shed commodity assets and acquired downstream methylene diphenyl diisocyanate (MDI) businesses. Around 70% of Huntsman’s MDI sales are now from differentiated products, said Roberts.
The UBS analyst took up his price target on Celanese from $91, to $112 based on a multiple adjustment on price/earnings (P/E) from around 12x, to 15x, and on Eastman from $68, to $86 based on a P/E multiple increase from around 11x, to 14x. Prior to the Monday note, Celanese closed at $88.52 and Eastman at $69.63. He retains “buy” ratings on all three names.
MDI PRICES BOTTOMING
Alembic Global Advisors analyst Hassan Ahmed bumped up share price targets for Covestro (from €40 to €45), Dow ($45 to $50) and Huntsman ($20 to $22) on a bottoming of MDI prices.
“Asian spot MDI prices seemed to have bottomed and recently started inflecting up. We believe this positive inflection may also begin to manifest itself in MDI margins,” said Ahmed in a research note.
As of 10 June, Asia spot prices for pure MDI on a CFR China basis rebounded to $1,575/tonne from a low of $1,375 on 13 May while polymeric MDI was up to $1,335/tonne from a low of $1,125 on 15 April.
“Our analysis suggests that the worst may be behind the MDI cycle (post Q2 2020), with utilisation rates tightening and margins rising from here,” he added.
On the supply side, Wanhua Chemical’s decision in late 2019 to cancel its 400,000 tonne/year MDI project in St James Parish, Louisiana, US improves the long-term outlook considerably. Historically, industry consultants and Wall Street analysts have overestimated supply-side additions and underestimated capacity closures, he noted.
“On the demand side, our analysis suggests that 6% global demand growth rates are sustainable post-2020,” said Ahmed.
“Signs of life seem to be emerging in the Chinese and US automotive end-markets, with the global MDI industry always rebounding strongly, demand growth-wise, post recessionary periods,” he added.
OUTPERFORMANCE COMING OUT OF RECESSION
The theme of chemical stocks outperforming the broader market in the early stages of a recovery from recession is gaining traction.
“As a rule of thumb, the window for chemicals to participate in an ‘early cycle bounce’ and outperform the S&P 500 typically extends through 4-6 quarters after the end of a recession,” said Laurence Alexander, analyst at Jefferies & Co, in a research note.
“As more evidence emerges that the recovery is becoming more robust, the upstream chemical companies will likely extend their outperformance, given their operating leverage to higher volumes and the potential for fly-ups in margins if peers have unplanned outages – which are more common in the first surge in volumes,” he added.
Thus, the analyst favours BASF, Dow, Huntsman and Methanex, with LyondellBasell and DuPont also likely to benefit.
Key leading indicators on a global and regional basis – the OECD LEIs in particular – are showing “fish hooks” from the bottom, he noted.
“In May, the Global, US and EU LEIs all improved sharply sequentially on both an absolute and year-on-year (YoY) basis. In China, the LEI has already improved to -2.6% on a YoY basis from -13.3% in February,” said Alexander.
“We expect the Chinese LEI to return to positive comparisons in Q3, and the EU (-4.5% YoY) and US (-4.3%) ones in Q4,” he added.
Troughs in earnings per share (EPS) estimates and the initial bounce in LEIs (from trough to flat YoY) tend to be strong signals for both chemical sector returns (15%-20% over 6 months) and for a rotation into upstream chemicals, said the analyst.
While he cautioned that the coronavirus flare-ups, the risk of new lockdowns and a fade in fiscal and monetary stimulus “all muddy the H2 2020 outlook” and that chemical valuation multiples appear stretched, “a turn in LEIs and stabilising estimates are more potent trading signals at cyclical troughs, particularly for upstream chemicals”, said Alexander.
Focus article by Joseph Chang