The chemical industry is riding high on an upswing in the world economy and strength across major end-use markets such as construction, automotive and electronics. Another positive for the industry is a recovery in demand in the energy space – a key chemical end-market that had been out of favor for a spell. The recovery has been driven by the rebound in crude oil prices from their historic lows.

The Zacks Chemicals Diversified industry has outperformed the broader market in a year’s time. The industry has gained around 29.3% over this period, higher than S&P 500’s corresponding return of roughly 26.7%.

Moreover, the Zacks Industry Rank of 45 carried by the Zacks Chemicals Diversified industry is a testimony to the fact that the chemical industry is in fine shape. The favorable rank places the industry in the top 18% of the 250 plus Zacks industries. Our backtesting shows that the top 50% of the Zacks ranked industries outperforms the bottom half by a factor of more than two to one.

Demand 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, high homebuilders’ confidence, low unemployment levels and rising rent costs.

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

A rebound in crude oil prices has also led to a recovery in demand for chemicals in the energy space, an important end-use market. The recent uptrend in oil prices has been supported by a decline in U.S. oil stockpiles and extension of oil production cuts by OPEC and other major world producers until the end of 2018. The recovery in oil prices has also led to a favorable pricing environment for chemical products.

Strategic Actions to Yield Margin Benefits

Cost-cutting measures and productivity improvement actions by chemical companies should reap industry-wide margin improvements in Q4. Chemical companies also remain actively focused on mergers and acquisitions to diversify and perk up growth. Synergies from acquisitions should also lend support to earnings in the December quarter.  

Moreover, a number of chemical makers are 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 Q4.

A Few Concerns

The lingering effects of Hurricane Harvey pose a concern for U.S. chemical companies in Q4. Harvey weighed on U.S. chemical production during Q3, knocking off a sizable chunk of production capacity. A number of major chemical producers had to shutter or cut back ethylene production, leading to reduced supply of this major chemical. Some of these companies are also witnessing a spike in raw material prices, exacerbated by short supply due to hurricanes.

The carry-over impacts of disruptions caused by Harvey (in the form of lost production volumes and costs related to the storm) may pose some earnings headwinds for U.S. chemical makers in Q4.

Q4 Performance So Far

The Q4 earnings season has seen releases from 133 S&P 500 participants as of Jan 26, based on our latest report.  The picture so far is encouraging, with total earnings for these companies having increased 12.3% year over year on 8.8% higher sales.

As per the Zacks Industry classification, the chemical industry is under the broader Basic Materials sector. The Basic Materials sector is among the Zacks sectors that are expected to rack up the strongest gains in Q4. Overall Q4 earnings for the sector are projected to climb 30.4% while revenues are expected to spike 18.9%.

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 delivering 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 notch up positive surprises this earnings season:
 
Huntsman Corporation (HUN - Free Report)

Huntsman, which is among the world's largest manufacturers of differentiated and commodity chemical products, is scheduled to release its Q4 results before the bell on Feb 23. The Zacks Consensus Estimate for the quarter is currently at 65 cents. The stock has an Earnings ESP of +3.27% and carries a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Huntsman has an expected long-term (three-five years) earnings growth of 8%. It delivered positive earnings surprises in each the last four quarters, with an average beat of around 32.7%.

LyondellBasell Industries N.V. (LYB - Free Report)

LyondellBasell is among the leading plastics, chemical, and refining companies globally. It is scheduled to release its Q4 results before the bell on Feb 2. The Zacks Consensus Estimate for the quarter is $2.50.

This Zacks Rank #2 stock has an Earnings ESP of +0.55%. The company delivered a positive earnings surprise of 0.9% over the trailing four quarters. It has an expected long-term earnings growth of 9%.

DowDuPont Inc. (DWDP - Free Report)

DowDuPont produces agricultural chemicals, material science, and specialty chemical products. The company will be reporting Q4 results before the bell on Feb 1. The Zacks Consensus Estimate for the quarter stands at 67 cents.

The stock has an Earnings ESP of +1.37% and carries a Zacks Rank #2. The company has an expected long-term earnings growth of 8.7%. It also delivered a positive earnings surprise of 22.2% in Q3.

Cabot Corporation (CBT - Free Report)

Cabot is a global specialty chemicals and materials company. CBT will report fiscal Q1 results after the bell on Feb 6. The Zacks Consensus Estimate for the quarter is 78 cents.

The stock has an Earnings ESP of +3.21% and carries a Zacks Rank #3. The company has an expected long-term earnings growth of 10%. Moreover, it delivered a positive earnings surprise of 4.3% over the trailing four quarters.