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The declines these companies have suffered make sense considering how weak the economy has been until recently. Chemical companies make products that stretch to a plethora of industries, from agriculture to aerospace to auto makers and biotech firms. As a result, chemical companies literally have nowhere to hide during a recession as deep as the one we've just experienced. While there isn't an exchange traded fund (ETF) that specifically tracks chemical makers, the Materials Select Sector SPDR ETF (NYSE:XLB) illustrates the declines endured by chemical firms. XLB is down 20% in the past year and the performance would be far worse if not for the market rally off the March lows.
XLB does count Dupont (NYSE:DD) and Dow Chemical (NYSE:DOW) among its top 10 holdings and these titans are the godfathers of the American chemical industry. Not surprisingly, both companies have faced some pretty strong headwinds, but if the economy really is perking up, that could be banner news for these chemical titans. Let's a take a look at this pair, along with a sleeper pick in the chemical world.
DuPont
-Free Cash Flow: $2.5 billion (2009 estimate)
-Dividend Yield: 5.3%
Dow Chemical
-Free Cash Flow $1 billion (2009 estimate)
-Dividend Yield: 2.8%
Celanese (NYSE:CE)
-Free Cash Flow: $137 million (Q2 total)
-Dividend Yield: 0.60%
The King of The Hill
Dow Chemical is the largest U.S. chemical maker, but that size didn't prevent the company from enduring its share of troubles over the past year. The shares have shed nearly 30% over that time, as the company contended with more drama than an episode of "Beverly Hills 90210." (The old version). First, there was Dow's on again/off again courtship of rival Rohm & Haas. Dow eventually absorbed its rival for $15 billion in a purchase that many believe was necessary to bolster Dow's long-term prospects.
The deal seemed in jeopardy earlier this year when a Kuwaiti investment group scuttled a $17.5 billion joint venture with Dow that would've provided the company with $7 billion, some of which would've been used to complete the Rohm & Haas buy. Dow pursued legal action against Kuwait, but Dow CEO Andrew Liveris has expressed tepid interest in revisiting the Kuwaiti venture.
Amid all that drama came Dow's first dividend cut in 97 years, a reduction that took the payout to 60 cents from $1.68 a share. Despite this, Dow has somehow found its way back into the market's favor and is up more than 50% year-to-date. The company isn't exactly cheap at 21 times forward earnings and the balance sheet has been strained to accommodate the Rohm & Haas buy, but Dow is shedding assets to tidy things up a bit.
If the acquisition is integrated well and demand for Dow's products improves, the company should resume generating free cash at a robust pace - and don't rule out a dividend hike, although that is probably still a few quarters off.
DuPont: A Solid Play in the Chemical Sector
DuPont's bottom line has been impacted by the same weak demand story that has afflicted rival Dow Chemical; even though the company's second-quarter earnings tumbled 61%, they still beat Street estimates. Of course, that beat came as a result of cost cuts, not organic growth. DuPont has been paring its payroll steadily since 2008, shedding 12,000 workers in the process.
While those layoffs are unfortunate, DuPont didn't join the 209 companies that cut their dividends in the second quarter of this year. In fact, DuPont's dividend yield is downright inviting at 5.3%. The company has forecast $1 billion cost savings this year and $2.5 billion in free cash flow, so the payout appears safe.
DuPont is a member of the Dow Jones Industrial Average and has certainly taken part in the recent rally, surging 25% year-to-date. Considering that run, DuPont appears fairly valued at 15.7 times forward earnings and now trades above most analysts' one-year price target of just below $30 a share.
Celanese: The Sleeper
Dwarfed by both Dow and DuPont in terms of market cap and dividend payout, Celanese is facing the same demand problems as its larger rivals. The company's second-quarter earnings plunged 23%, but beat an already low Street forecast. The bright spots for Celanese are coming in the form of strong demand from China and an uptick in demand from the auto industry.
Celanese trades at just 12 times forward earnings and still has some room to run to its 52-week high of $39.87 if it can clear $30 without faltering. The company has also joined the cost-cutting club, laying off nearly 500 workers in the past month alone. Celanese has a tendency to fly under the radar in the chemicals sector, but that makes it a possible contrarian play, although it may still be speculative at this point.
The Bottom Line: Not All the Way Back
As is always the case with any sector tied to basic materials and commodities, demand is the pervasive theme, and if you focus solely on that, it might be too early to jump into the chemicals arena - or too late given these stocks' recent runs. Long-term investors can find safety in DuPont's impressive dividend and while Dow's rebound from the single digits has been noteworthy, more gains could be had as it integrates the Rohm & Haas buy and the balance sheet improves. (For more, see Strategies For Quarterly Earnings Season.)
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