The chemical industry has so far enjoyed a positive run this year, helped by an upswing in the world economy and continued strength across major end-use markets such as construction, automotive and electronics.

The Zacks Chemicals Diversified industry has outperformed the broader market year to date. The industry has gained around 23.6% over this period, higher than S&P 500’s corresponding return of roughly 14.5%.

Strategic Measures to Reap Margin Benefits

Chemical companies continue to shift their focus on attractive, growth markets in an effort to cut their exposure on other businesses that are grappling with weak demand. Moreover, they remain actively focused on mergers and acquisitions to diversify and perk up growth. Synergies from acquisitions should lend support to their earnings in Q3.  

Moreover, cost-cutting measures and productivity improvement actions by chemical companies should continue to yield industry-wide margin improvements in Q3. A number of chemical makers are also taking appropriate pricing actions (reflected by hikes in chemical prices in the recent past) in the wake of a sharp rise in raw materials costs. This is also expected to support their margins in Q3.

Strength Across Major End-Markets

Chemical makers continue to see strong demand from construction and automotive sectors – major chemical end-use markets. The underlying trends in the housing space remain healthy, backed by steady buyer demand, low mortgage rates, rising rent costs and easy loan availability.

The automotive sector also continues its good run, supported by an improving job market, rising personal income, improved consumer confidence, low fuel prices, and attractive financing options.

Harvey-Stoked Disruptions Pose a Headwind

Hurricane Harvey weighed on U.S. chemical production during Q3, knocking off a sizable chunk of production capacity. Harvey led to the shutdown of several chemical plants along the U.S. Gulf Coast – the epicenter of the U.S. specialty chemicals and petrochemicals industry.

In particular, the storm-ravaged Texas that accounts for nearly three-quarters of the U.S. production of ethylene, which is among the world’s most important petrochemicals. A number of major chemical producers had to shutter or cut back ethylene production, leading to reduced supply of this major chemical. As such, the impacts of disruptions caused by Harvey pose some earnings headwinds for U.S. chemical makers in Q3.

Q3 Performance So Far

The Q3 earnings season has seen releases from 87 S&P 500 participants as of Oct 20, based on our latest report. The picture so far is encouraging, with total earnings for these companies (representing 24.7% of the index’s total market capitalization) having increased 9.4% year over year on 7.3% higher sales.

As per the Zacks Industry classification, the chemical industry is under the broader Basic Materials sector. The earnings picture for the sector for Q3 looks tepid with a projected decline of 9.3%. This is in contrast to a 7% increase in earnings in Q2.

How to Pick the Winners?

Given the large number of players operating in the chemicals space, picking the right stocks is apparently not an easy task. But our proprietary methodology makes it fairly simple. One can trim down the list with the combination of a favorable Zacks Rank – Zacks Rank #1 (Strong Buy), #2 (Buy) or #3 (Hold) – and a positive Zacks Earnings ESP.  You can uncover the best stocks to buy or sell before they report with our Earnings ESP Filter.

Earnings ESP – the percentage difference between the Most Accurate Estimate and the Zacks Consensus Estimate – is our proprietary methodology for determining stocks that have high chances of notching up earnings surprises in their next announcements. Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as much as 70%.
 
Below we list four chemical stocks that have the right combination of elements to rack up positive surprises this earnings season:
 
FMC Corporation (FMC - Free Report)

FMC Corp., a leading diversified chemical company, is scheduled to release its Q3 results after the bell on Nov 6. The stock has an Earnings ESP of +0.88% and carries a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

FMC Corp. has an expected long-term (three-five years) earnings growth of 11.3%. The company delivered a positive earnings surprise of 2.1% in Q2.

Westlake Chemical Corporation (WLK - Free Report)

Westlake is a vertically integrated manufacturer and supplier of petrochemicals, polymers and fabricated products. The company is scheduled to release its Q3 results before the bell on Nov 7.

This Zacks Rank #1 stock has an Earnings ESP of +5.14%. Westlake delivered positive earnings surprises in three the last four quarters, with an average beat of around 17.7%.

Cabot Corporation (CBT - Free Report)

Cabot is a global specialty chemicals and materials company. CBT will report fiscal Q4 results after the bell on Oct 31.

The stock has an Earnings ESP of +1.62% and carries a Zacks Rank #1. The company has an expected long-term earnings growth of 10.7%. It delivered a positive earnings surprise of 6.4% over the trailing four quarters.

Ingevity Corporation (NGVT - Free Report)

Ingevity provides specialty chemicals, carbon materials, and technologies. The company will report Q3 results after the close on Nov 1.

The stock has an Earnings ESP of +2.94% and carries a Zacks Rank #2. The company has an expected long-term earnings growth of 12%. It delivered positive earnings surprises in each the last four quarters, with an average beat of around 7.9%.

Bottom Line

While the chemical industry remains hamstrung by a few challenges, the current momentum is on track to continue through 2017. Strategic initiatives including continued focus on cost and productivity and expansion of scale through acquisitions should help chemical makers weather the macroeconomic and industry-specific headwinds.

Amid this backdrop, a sneak peek at the space for some potential winners backed by a solid Zacks Rank and a positive Earnings ESP could be a great idea for investors looking to gain from this earnings season.