Finding High Growth In Chemicals

As industrial production has ramped higher since the bottom of global slowdown, a variety of manufacturing sectors have seen their share prices rise. The broad-based Industrial Select Sector SPDR (NYSE:XLI) has nearly doubled since its recessionary lows. However, not all sectors of industrial production are equal. As both businesses and consumers are beginning show signs of decreasing spending, many analysts are predicting a slowdown for the sector. Despite this slowdown, the chemicals subsector is experiencing a major boom. For investors, the recent chemical resurgence could be one of the best ways to play the industrial sector going forward. (The manufacturing sectors has a strong correlation to the strength of the economic, for more read Vital Link: Manufacturing And Economic Recovery.)

TUTORIAL: Economic Indicators

Low Feed Stock Costs
Responsible for making many of the components that go into thousands of common products, the chemicals industry has been on quite a tear over the last year. The Dow Jones Chemicals Titans 30 Index is up 34%, besting the performance of the S&P 500. The sector continues to offer growth prospects in the wake of a slowing economy.

Margins at U.S. chemical companies are at their highest points in years due to a glut of natural gas. Cheap natural gas has given American chemical stocks a large cost advantage over European rivals, many of whom make chemicals from crude oil. One of the most basic of commodity chemicals, Ethylene, which is found in plastic, paint, glue and other products, has seen its price rise nearly 70% over the last eight months. Global utilization rates for ethylene are forecasted to grow to 90% by 2013, up from 84% in 2009. By using natural gas as feed stock for their "crackers," U.S. chemicals producers are able to take advantage of high global ethylene prices at significant profit margins. This has spurred a frenzy to build new chemical plants. Analysts estimate that there is room for multiple crackers to be built in the U.S. and still be profitable. In addition, chemical companies have cut costs to the bone during the economic downturn. This has created huge amounts of operating leverage which will ultimately help chemical companies widen their margins.

Just like the real estate, the economic downturn is helping fuel a wave of mergers and acquisitions as stronger and better capitalized firms are buying their weaker rivals. Recently, Berkshire Hathaway (NYSE:BRK.B) agreed to buy Lubrizol (NYSE:LZ) for $9 billion. India's Reliance Industries has plans to invest up to $12 billion into various chemicals business and DuPont (NYSE:DD) has offered to buy Denmark's Danisco for $6 billion. Analysts expect this wave of deal making to continue as strong chemical companies, flushed with cash from their high margins, look for new ways to deploy their earnings. (To help you understand the complexity of mergers and acquisitions, read Mergers And Acquisitions: Understanding Takeovers.)

Better Portfolio Living Through Chemistry
Adding the chemicals industry could be a great way to play the long term growth of industrials sector. Despite, the potential slowdown of the U.S. economy, low input costs via natural gas as well as the sectors newly found high margins, make it a growth opportunity. While there is no chemicals sector ETF yet, the Vanguard Materials ETF (NYSE:VAW) and Materials Select Sector SPDR (NYSE:XLB) do provide exposure to the chemicals industry. For investors, some of the best opportunities could be in individual stocks.

One of the more interesting picks in the sector, isn't a chemical company at all, but will profit from the recent cracker building frenzy. Construction firm Fluor (NYSE:FLR), which does engineering work for many large energy and chemical companies, reported that five of its major clients are thinking about re-opening or building new ethylene plants. The firm, along with Chicago Bridge & Iron (NYSE:CBI), will be a major benefactor of the of ethylene resurgence.

Chemicals company Ashland (NYSE:ASH) recently announced that they had agreed to buy privately held International Specialty Products for $3.2 billion. The deal would strengthen Ashland's position in specialty chemicals. The company's Vavoline oil brand is well known and the company is seeing great growth in its water treatment segment.

Polymer exports will continue to be the industry's strength as global auto demand approaches 76 million units. Both Dow Chemical (NYSE:DOW) and Germany's BASF (OTCBB:BASFY) are among the world's top petrochemicals and plastics producers. The abundant supply of U.S. shale gas should help keep their margins high. Dow is estimated to reach a 31% increase in revenue in 2011 according analysts.

Bottom Line
As many industrial stocks have lost some luster in the face of a slowing global economy, the chemicals industry is just ramping up. Higher margins due to low feed stock prices - as well as superior cost cutting - have the sector riding high. For investors, adding stocks such as titanium dioxide play Kronos Worldwide (NYSE:KRO) to a portfolio could be the boost they are looking for. As long as natural gas stays low, look for the chemicals sector to be leaders. (If you are interested in adding the chemical sector to your portfolio, ensure you have a well balanced portfolio. Check out Diversification: It's All About (Asset) Class.)

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