Perfect Chemistry

Deutsche Bank analyst John Moten sees improvement ahead for the chemical industry

Professionals know that different industries take turns shining in the stock market. And right now, with signs of a possible economic recovery beginning to sprout, Deutsche Bank Securities Vice President John Moten says it’s time for chemical company stocks to make a move.

Moten, based in New York City, has worked in the securities industry for 16 years, tracking media, healthcare, and biotechnology. In addition, he has covered chemical manufacturers for most of his career.

Chemical stocks happen to be cyclicals, a fancy name Wall Street applies to shares that tend to climb during certain periods of the economic cycle and then trail off at other times. Moten says chemical companies tend to supply the auto and building industries with plastics and paints. The industry also produces fertilizers, pesticides, and, in some cases, seeds for farmers. To create those products, chemical companies require raw materials such as oil and natural gas. During a slump, raw material prices drop and chemical company customers, such as automobile manufacturers, stock up on materials and increase production in anticipation of a turnaround. Moten sees this happening now.

“The chemical industry moves at the early stages of an economic cycle, and is often a lead indicator of business and industrial activity,” he notes. “These stocks typically perform best when we’re coming out of a recession.” Moten also says that companies in the chemical sector haven’t sat idly by while the economy stalled. Instead, they’ve slashed costs and restructured to take advantage of the upswing.

Thanks to belt tightening, an increase in automobile production, and an anticipated rebound in farmers’ demand for fertilizers, Moten thinks the industry could post an overall 5% gain in profits this year, when a good number of industries are struggling to breakeven. He says a 2% to 3% spurt in the nation’s Gross Domestic Product (GDP) for 2002 and 2003 will continue that trend for the chemical industry.

In addition, some of the major companies in the group sell at a discount to the overall market, as represented by the Standard & Poor’s 500 index. As of mid-September, the S&P 500 was selling at an average 25 times earnings for the previous 12 months. By comparison, shares of DuPont (NYSE: DD) were priced at 20 times earnings. In fact, some of Moten’s favorites pay shareholders a sizeable dividend, which, in the case of DuPont, provided investors with a yield as high as 4% through the middle of September.

Besides, Moten thinks DuPont’s restructuring story is compelling. “Business conditions are improving and earnings should accelerate, especially in the second half of 2002,” he says.

Moten is also impressed by PPG Industries (NYSE: PPG), and its commitment to slash debt by some $500 million in the past year alone. The company stands to benefit further from increases in the number of cars rolling off the assembly line. Moten also points out that PPG has a very strong balance sheet, and he expects the company to do well once the industrial sector rebounds.

And while weather conditions may have made 2002

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