By Richard O'Reilly, CFA While prices for natural gas -- a key production input, or feedstock, for chemical producers -- have retreated from the lofty levels of the first quarter, Standard & Poor's remains cautious on most major chemical company stocks. Despite the pullback, natural-gas prices remain near historically high levels -- and that's reducing the competitiveness of the U.S. petrochemical industry, which uses natural gas for about 70% of its feedstock, while producers in other parts of the world are more dependent on oil.
S&P expects industry output, as measured by the Federal Reserve's production index for chemicals and products, to rise modestly in 2003, after a flat performance in 2002. Chemical output in April, 2003, was down 0.2% from the year-earlier level and off its recent high posted in July, 2002.
PRICE SURGE. We expect production gains to be modest in the near term, mirroring the U.S. economy's projected growth rate. The industry's operating rates should rise as a result of greater output combined with small additions in capacity. In April, 2003, the utilization rate was 74.1%, vs. 74.5% in the year-earlier period.
After a poor pricing environment in 2002, petrochemical and plastic prices have surged this year, though they've eased somewhat in recent weeks. The producer price index for chemicals and products in April, 2003, was up 8.2% from the year-earlier level, and it has climbed since its recent low at the start of 2002.
Prices for resins have moved well higher this year before a recent pullback. Other key products are also fetching higher prices: Caustic soda has climbed since the 2002 second quarter as a result of recovering demand, and makers of titanium pigment are also hiking prices. But we believe that still high feedstock costs will crimp industry profit margins through most of 2003.
PRIME PICK. We're bullish on one stock in the chemicals group: industrial-gases producer Praxair (PX), which carries a 5-STAR (strong buy) ranking. We think fundamentals for the industrial-gas segment remain favorable. We also believe that the stock's
S&P earnings and dividend ranking of A (the dividend was raised in early 2003, for the 10th consecutive year) adds to the investment appeal.
We maintain our opinions of 1 STAR (sell) on Georgia Gulf (GGC) and 2 STARS (avoid) on both DuPont (DD) and Eastman Chemical (EMN), as we consider them overvalued compared to the broader market. Analyst O'Reilly follows chemicals stocks for Standard & Poor's