Q1 (March Quarter) 2016 Earnings Preview

Deutsche Bank Markets Research North America United States Industrials Chemicals / Specialty Industry Chemicals Date 18 April 2016 Forecast Change Q1 (March Quarter) 2016 Earnings Preview Positive Q1 results due to demand, price increases and costs. Outlooks positive ________________________________________________________________________________________________________________ Deutsche Bank Securities Inc. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015. David Begleiter Research Analyst (+1) 212 250-5473 david.begleiter@db.com Jermaine Brown Research Associate (+1) 212 250-3624 jermaine-r.brown@db.com Top picks Dow Chemical (DOW.N),USD52.37 Buy DuPont (DD.N),USD65.27 Buy Source: Deutsche Bank Chemicals sector trading above its historical multiples and the market The US Chemicals sector is trading at 16.9x forward EPS, a 13% premium to its 15-year average. The sector also currently trades at a 1% premium to the S&P 500 on forward EPS vs a historical discount of 4%. We view multiple expansion as unlikely until concerns over currency, crude oil Chinese and Latin American growth abate. Longer term, we remain positive on US Chemicals due to a number of structural tailwinds including the US ethane advantage, and solid balance sheets which are supporting aggressive shareholder remuneration. We maintain our equal weight stance on the group due to lack of clarity on global macro conditions. We expect US chemicals to have positive March quarter results as low NGL feedstock prices, polyethylene price increases, healthy auto and housing demand, in-line China demand, better than expected FX and cost actions more than offset weak ag and Latam demand and oil price volatility. Overall, we expect companies to provide modestly positive Q2 and '16 outlooks. Our top picks are DD, DOW and EMN. US housing continue to be relative bright spots DB’s economics team forecasts US GDP growth slowed to 0.5% in Q1 vs 2% in Q4’15). In ‘16, US GDP is forecasted to grow 1% in Q2 and 1.4% for the full year on strong housing/construction activity (housing starts up 14% YoY in ‘16E), partially offset by weaker manufacturing on lower oil and a stronger dollar. Europe is continuing to show signs of recovery with 1.5% forecasted growth in Q1 (vs 1.3% in Q4’15), 1.4% in Q2 and 1.5% in ‘16 (vs 1.5% in ’15). DB’s economics team forecasts China’s GDP growth to be 6.8% in Q1 vs 6.8% in Q4’15 and 6.9% in ’15. This marks its slowest quarterly growth since Q1’09 and slowest annual growth in 25 years. Coatings companies stand to benefit from lower oil prices Since the start of ‘16, US Chemicals are up 6.3% vs 0.8% for the S&P. Notable outperformers during this period have been the coatings producers (VAL, 29%, Hold), PPG (13%, Buy), Sherwin-Williams (SHW, 10%, NR) and Axalta (AXTA, 10%, Buy) which are benefitting from lower raw material costs. Going forward, coating companies (PPG, Axalta and Valspar) are poised to benefit further from lower oil prices as propylene, a derivative of crude oil and a key feedstock for coating intermediate chemicals, is down 34% YoY and 58% from ’14 highs. In addition, TiO2 prices continued to weaken in Q1 falling 5%, 3% and 4% QoQ in NA, Europe and Asia, respectively. TiO2 prices are down 40-50% since ’12. Ethylene producers hit hard on lower oil prices Notable underperformers during this period have been the ethylene producers: Westlake (WLK, -14%, Hold), Lyondell (LYB, -2%, Hold) and Dow (-1%, Buy). US ethylene producers are being adversely impacted by the decline in oil prices (down 60% from ’14 highs) and the subsequent narrowing of the natural gas-based cost advantage vs oil-based producers in Europe and Asia. While lower oil prices have and will pressure US ethylene margins, the impact is being partially offset by near record low ethane and propane prices. Ethylene margins rise 0.3 c/lb in Q1 to 16 c/lb. Expected to rise 3.8 c/lb in Q2 US contract ethylene margins rose 0.3 c/lb to 16 c/lb in Q1. Ethylene pricing fell 0.8 c/lb or 3% QoQ in Q4 to 26.75 c/lb. Ethylene production costs fell 1 c/lb QoQ to 9.8 c/lb and fell 0.5 c/lb, or 5%, vs 10.3 c/lb a year prior and remain depressed, as ethane prices remain near all-time lows (vs 16 c/gal in Q1, a high of 39 c/gal in ’14 and a 10-yr average of 52 c/gal) due to oversupply and a shift