U.S. Chemical Industry Export Surplus Under Threat

Among thousands of applications, the U.S. chemical industry plays an important role in developing metal alloys, catalysts and agents for the environment and energy sectors.  For example, solar photovoltaic producers use hydrochloric acid, trichlorosilane gas and nitrogen trifluoride, to name just three of dozens.   Chlorine is vital to produce the polyester layers that make up light weight wind turbine blades. 

The domestic market for industrial chemicals is robust, but the export market is very important to the sector.  The U.S. ran a $33 billion surplus in industrial chemicals in 2017.  The potential for natural gas exports by the U.S. shale gas producers could help boost the U.S. industrial chemical export surplus to as much as $73 billion by 2020.     China with its growth aspirations is an important customer of the U.S. chemicals industry.  As an example, according to the American Chemistry Council (ACC), China imported 11% of plastic resins produced in the U.S. in 2017, valued at $3.2 billion.  In total the U.S. shipped about $21.5 billion worth of chemicals and plastics to China in 2017. 

Unfortunately, the chemical industry finds itself caught between an aggressive U.S. politician and his shrewd and fearless Chinese adversary.  The dust-up threatens the U.S. industrial chemicals surplus.

In April 2018, in response to Donald Trump’s allegations of China’s unfair trade practices and vocalizations about tariffs, China imposed its own retaliatory tariff policy.  Chemicals of all sorts are among the many U.S. products upon which China will impose new import tariffs that could be as high as 25%.  The ACC estimates the new tariffs could impact up to $5 billion of the U.S. chemical industry exports.

The U.S. chemical industry has been surging ahead in recent years led by the shale gas segment.  Beginning 2011 through the beginning of 2018, the U.S. chemical industry has commenced over 300 capital projects valued at $194 billion in capital investment.  Much of the investment is related to export markets.  Chemical sector investment has become a significant driver of U.S. employment growth, reaching 811,000 jobs in 2017 after dropping to a low of 785,000 jobs in 2011.

A portion of the capital investment for new chemical production, factory restarts and equipment upgrades was already in locations outside the U.S.  However, with the imposition steel tariffs by the U.S. and retaliatory chemicals tariffs by China and others could push more investment outside the U.S.  For example, DowDupont has already indicated that the investment case has been improved for location outside the U.S.  A new chemical plant in a country like Argentina or Canada avoids both the U.S. tariff on China steel and the China tariff imposed on Yankee chemicals.

SMALL-CAP CHEMICAL COMPANIES
Company	U.S. Base	SYMB	Mkt Cap	Sales	Operating Margin	Debt/ Equity
Trinseo, S.A.	PA	TSE	$3.2 B	$4.5 B	9.7%	177.9
H.B. Fuller Co.	MN	FUL	$2.7 B	$2.5 B	6.6%	218.6
Stepan Company	IL	SCL	$1.7 B	$2.0 B	7.3%	37.5
Innospec, Inc.	CO	IOSP	$1.9 B	$1.4 B	10.2%	26.5
Kronos Worldwide	TX	KRO	$2.9 B	$1.7 B	19.6%	62.9
Ferro Corporation	OH	FOE	$1.8 B	$1.4 B	11.8%	210.8
Innophos Holdings	NJ	IPHS	$1.0 B	$762 M	10.3%	102.6
Kraton Corp.	TX	KRA	$1.5 B	$2.0 B	10.5%	233.8
Koppers Holdings	PA	KOP	$870 M	$1.5 B	9.4%	639.9
Omnova Solutions	CO	OMN	$459 M	$787 M	7.4%	675.5

Some U.S. chemicals companies will weather this self-inflicted threat better than others.  We expect the largest U.S. chemicals producers, which already operate globally, to easily navigate the choppy supply chain and demand conditions.  DowDupont (DWDP:  NYSE), Ecolab (ECL:  NYSE), Praxair (PX:  NYSE), Air Products (AIR:  NYSE), and Eastman Chemical (EMN:  NYSE) are among the largest chemicals producers in the world.  However, smaller U.S. chemical companies may face greater obstacles as a consequence of less experience in locating production in foreign countries and more limited access to capital. 

Those with lower leverage, such as Innospec (IOSP:  Nasdaq) and Kronos Worldwide (KRO:  NYSE) may find their historic frugally will serve them well if the U.S. administration continues to escalate the tariff war with China.  Both have experienced rising stock prices since the beginning of 2018, despite the gloomy tariff headlines.  Others in the U.S. chemical sector with more levered balance sheets, such as Koppers Holdings (KOP:  NYSE) and Omnova Solutions (OMN:  NYSE), face greater risk during periods of economic uncertainty.  Shareholders in both companies have seen their shares trade sideways or move downward in recent months.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.