In March, we noted to investors that when looking at potential ways to invest for an infrastructure boom, they shouldn’t neglect U.S. specialty and commodity chemical companies. We pointed out that chemicals -- from commodities like PVC for piping to higher-tech specialty chemicals such as lubricants, industrial gases, and adhesives -- are omnipresent necessities for all kinds of construction projects.
The political landscape has shifted somewhat since we wrote, optimistically, that “Unless partisanship escalates in the run-up to mid-term elections, there is a good chance that common interests across the political divide could help advance an infrastructure bill.” The current administration’s strategic approach focuses on wrong-footing opponents and opening negotiations with outrageous demands, and makes predicting the future an even tougher task than usual. However, we think that prospects for bipartisanship in the lead up to this fall’s elections have faded. Consequently, we would be surprised to see a major infrastructure push from the administration.
Even so, though, U.S. chemical companies are enjoying a number of tailwinds. Ten years ago, these companies were suffering from weak demand (due to a sub-par global economic recovery from the Great Recession). They were also dogged by overseas competitors bolstered by cheaper feedstocks (most chemicals are derived ultimately from hydrocarbons, mostly Oil and natural gas). Other competitors in many places, such as China, enjoyed the patronage of their governments. So U.S. chemical companies languished, with aging manufacturing infrastructure and a lack of capital investment.
Over the past decade, this has all begun to change. For years, “crackers” (big industrial facilities that turn hydrocarbons into the precursors for industrial chemicals) had been aging and closing. Now there are six new large projects under construction across the U.S. Since 2010, $185 billion worth of new plant construction has been announced, accounting for about half of all investment in American manufacturing. It is a leading export sector, with annual exports exceeding $500 billion.
The fundamental tailwind behind this renaissance, of course, is cheap natural gas made available to U.S. chemical manufacturers thanks to the development of hydraulic fracturing and horizontal drilling. This in turn has led to a trend of industry restructuring. The most significant recent example was the merger of Dow and DuPont (NYSE:DWDP). Each company had major agricultural, materials science, and specialty chemical divisions; the next strategic step will be to combine them and spin them out as stand-alone, pure-play companies in their respective fields.
So technological advancement, cheaper feedstocks, newly streamlined and focused businesses, and significant capital investment are all contributing to a positive backdrop for U.S. chemicals, even in the absence of a major infrastructure initiative. There are challenges -- such as a workforce whose skills may have been dulled by the industry’s long fallow period -- but they are not insurmountable.
The fly in the ointment is trade. Of China’s announced retaliatory tariffs, 40% cover chemical products. As we’ve pointed out in recent letters, we continue to believe that a full-blown “trade war” is unlikely to develop, and that current public statements from both sides are merely negotiating tactics. Of course, such rhetoric can always heat up, particularly when it is intended for domestic political consumption, as may occur in the U.S. with this fall’s approaching Congressional mid-term elections. (However, we note that that’s just rhetoric for the base -- a base which likes to hear tough talk on trade but in the last analysis cares most about a healthy economy and good jobs.) We will keep you informed if we believe that the trade conflict is moving beyond a war of words and into more substantive actions which will have negative consequences.
Investment implications: Even without a big infrastructure push from the Federal government, U.S. chemical companies are enjoying tailwinds. Should the market turn for leadership towards more commodity and industrial oriented stocks, chemicals could also benefit. Investors could consider DowDuPont [NYSE: DWDP], about to divide itself into agricultural, materials, and specialty chemical products; PPG Industries (NYSE:PPG) [NYSE: PPG], which makes coatings; and RPM International [NYSE: RPM], whose offerings focus on repair and maintenance.
Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time. In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies mentioned in this article, since Guild may not believe that particular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.