4 Diversified Chemical Stocks to Escape Industry Headwinds

The Zacks Chemicals Diversified industry is hamstrung by sluggish demand in certain markets and consumer inventory destocking. Lower consumer spending due to inflationary pressures in Europe and a slow recovery in China are impacting demand. Still-elevated raw material and logistics costs are also weighing on the margins of the companies in this space.Industry players like Air Products and Chemicals, Inc. APD, DuPont de Nemours, Inc. DD, Innospec Inc. IOSP and Koppers Holdings Inc. KOP are banking on strategic measures, including operating cost reductions and aggressive price hikes to tide over the challenging environment.

About the Industry

The Zacks Chemicals Diversified industry consists of manufacturers of basic chemicals, plastics, specialty chemicals and agricultural chemicals. Companies in this space serve a host of end markets, such as automotive, building & construction, transportation, electronics, aerospace and agriculture. Basic chemicals are produced in large quantities, and include petrochemicals and intermediates (such as ethylene, propylene and benzene), polymers (including plastic resins such as polyethylene, polypropylene and polyvinyl chloride), and inorganic chemicals (such as chlorine, caustic soda and titanium dioxide). Specialty chemicals that include catalysts, specialty polymers and coating additives are used in specific fields based on their performance. Agricultural chemicals include herbicides, fungicides and insecticides that are used to protect crops from disease, pests and weeds.

What's Shaping the Future of the Chemicals Diversified Industry?

Demand Worries From End-market Weakness: Companies in the chemical-diversified space are facing headwinds from a slowdown in certain key markets. The sluggishness in the building & construction market and the destocking in consumer electronics are key concerns. In North America, uncertainties surrounding the U.S. housing market are weighing on building & construction. Softer demand in industrial and consumer durables is hurting chemical volumes. Also, a slower recovery in economic activities in China following the lifting of the restrictions related to the resurgence in COVID-19 infections is hurting chemical demand in that country. The slowdown in Europe resulting from the war in Ukraine and weaker consumer spending due to high levels of inflation has also led to softer demand in that region. The energy and feedstock inflation has resulted in reduced industrial production and consumer spending in Europe. Weaker global economic activities have led to a higher level of near-term uncertainty, which may affect chemical volumes over the near term.Elevated Costs Pose Margin Headwinds: The industry players are exposed to cost pressure associated with raw materials resulting from short supply. These companies also face challenges arising from higher logistics costs. The disruption in the supply chain has pushed up the prices of inputs. Russia's invasion of Ukraine and new government-mandated lockdowns in China have also put more pressure on the global supply chain. These companies are also facing headwinds from elevated energy costs in certain regions. The lingering impacts of these bottlenecks are expected to continue over the short term. Higher raw material, energy and logistics costs are, thus, likely to hurt the margins of diversified chemical companies.Strategic Actions to Aid Results: The companies in this space are taking a host of strategic measures, including cost-cutting and productivity improvement, operational efficiency improvement and actions to strengthen the balance sheet and boost cash flows. In particular, the industry participants are aggressively implementing actions to bring down costs. These include the reduction of discretionary spending. The industry players are also raising selling prices to counter raw material and logistics cost inflation. These moves are likely to help the industry in sustaining margins amid the prevailing challenges.

Zacks Industry Rank Indicates Downbeat Prospects

The Zacks Chemicals Diversified industry is part of the broader Zacks Basic Materials sector. It carries a Zacks Industry Rank #168, which places it at the bottom 33% 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 bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms 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 S&P 500

The Zacks Chemicals Diversified industry has underperformed the Zacks S&P 500 composite while outperforming the broader Zacks Basic Materials sector over the past year.The industry has declined 13.6% over this period compared with the S&P 500's rise of 1% and the broader sector's decline of 15.4%.

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 8.27X, below the S&P 500's 12.75X and the sector's 8.56X.Over the past five years, the industry has traded as high as 12.59X, as low as 5.18X and at the median of 7.63, as the chart below shows.

4 Chemicals Diversified Stocks to Keep a Close Eye on

Innospec: Colorado-based Innospec makes and markets a wide range of specialty chemicals to markets in the Americas, Europe, the Middle East, Africa and Asia-Pacific. It is witnessing a recovery across all its businesses from the pandemic-led slowdown. New contracts in personal care are expected to drive the company's Performance Chemicals division. IOSP's investment in capacity expansion will also offer incremental growth opportunities in this business. Its Fuel Specialties unit is benefiting from the expansion of technologies in areas such as renewable diesel, low-sulfur marine fuel and gasoline direct injection engines. Pricing actions are also contributing to margin improvement. It is also seeing strength in the Oilfield Services unit.Innospec currently carries a Zacks Rank #2 (Buy). The Zacks Consensus Estimate for IOSP's current-year earnings has been revised 3.1% upward over the last 60 days. The company beat the Zacks Consensus Estimate for earnings in three of the last four quarters. It has a trailing four-quarter earnings surprise of roughly 11.9%, on average. You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here.

Koppers: Pennsylvania-based Koppers is a global provider of wood treatment chemicals, treated wood products and carbon compounds. Koppers remains focused on driving improvements through the execution of its strategic initiatives and making progress toward its long-term financial goals. The company should also benefit from its network optimization program. KOP is also benefiting from actions to raise prices to counter higher raw material, transportation and labor costs. It is also seeing strong demand from the U.S. utility market. The company remains committed to delivering strong cash flows and reducing debt.Koppers, carrying a Zacks Rank #2, has an expected earnings growth rate of 6.3% for the current year. KOP beat the Zacks Consensus Estimate for earnings in three of the last four quarters. It has a trailing four-quarter earnings surprise of roughly 13.6%, on average.

Air Products: Based in Pennsylvania, Air Products is a leading industrial gases company. It is benefiting from investments in high-return projects, new business deals, acquisitions and productivity initiatives. It remains committed to its gasification strategy and is executing its growth projects. These projects are expected to be accretive to earnings and cash flows.Air Products is also boosting productivity to improve its cost structure. APD is seeing the positive impacts of its productivity actions. Benefits from additional productivity and cost improvement programs are likely to support its margins. Air Products has also been benefiting from higher pricing. Higher merchant demand is also driving its volumes.Air Products, a Zacks Rank #3 (Hold) stock, has expected earnings growth of 9.5% for the current fiscal year. APD beat the Zacks Consensus Estimate in three of the trailing four quarters. In this time frame, it has delivered an average earnings surprise of roughly 1.3%.

DuPont: Delaware-based DuPont provides technology-based materials and solutions to markets including electronics, transportation, construction and water. DuPont is gaining from healthy underlying demand in several end markets, including water and general industrial. The company is also expected to gain from its productivity and pricing actions. It continues to implement strategic price increases to offset raw material and energy cost inflation. These actions are likely to support its margins.Moreover, DD remains focused on driving growth through innovation and new product development. Its innovation-driven investment is focused on several high-growth areas. It remains committed to driving returns from its R&D investment.DuPont, carrying a Zacks Rank #3, has a projected earnings growth rate of around 6.7% for the current year. DD also beat the Zacks Consensus Estimate for earnings in each of the trailing four quarters, the average being 9.1%.

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