Q3 (September Quarter) 2016 Earnings Preview

Deutsche Bank Markets Research North America United States Industrials Chemicals / Specialty Industry Chemicals Date 17 October 2016 Results Q3 (September Quarter) 2016 Earnings Preview In-line Q3 results on low cost NGLS, PE price increases and steady demand ________________________________________________________________________________________________________________ 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) 057/04/2016. David Begleiter Research Analyst (+1) 212 250-5473 david.begleiter@db.com Top picks Dow Chemical (DOW.N),USD53.38 Buy DuPont (DD.N),USD69.03 Buy Eastman Chemical (EMN.N),USD63.73 Buy Trinseo (TSE.N),USD54.53 Buy Source: Deutsche Bank Chemicals sector trading above its historical multiples and the market The US Chemicals sector is trading at 15.8x forward EPS, a 6% premium to its 15-year average. The sector currently trades at a 14% discount 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 value the sector based on the strong correlation (R2>75%) we have found between chemical sector valuations and returns on capital. Key risks for the sector include an economic recession and a surge in natural gas prices We expect US chemicals to have in-line to slightly positive October quarter results as low ethylene feedstock prices, polyethylene price increases and low but steady demand in the US, Europe and Asia are partially offset by continued weakness in ag and Latin America markets and a weaker Mexican Peso. These headwinds have been seen to a certain extent in earnings shortfalls at OMN and FUL (August qtr ends) and a preannouncement from PPG. Overall, we expect Q4 guidance and early reads on '17 to be cautious given tepid demand and macro uncertainties. Our top picks are DD/DOW, EMN and TSE. US auto & housing continue to be relative bright spots DB’s economics team forecasts US GDP growth slowed modestly to 1.3% in Q3 vs 1.4% in Q2. For Q4, US GDP is forecasted to grow 1.8% as solid housing/construction activity (housing starts up 12% YoY in ‘16E) are partially offset by weaker manufacturing. In Europe, growth continues, albeit modestly with 1.4% GDP forecasted growth in Q3 (vs 1.2% in Q2), 1.4% in Q4 and 1.6% in ‘16 (vs 1.6% in ’15). DB’s economics team forecasts China’s GDP grew 6.5% in Q3 vs 6.7% in Q2 and will grow 6.6% in ‘16 vs 6.9% in ’15. Commodity chemical producers poised for solid Q3 US contract ethylene margins, aided by outages, rose 4.1 c/lb in Q3 to 21.4 c/lb on higher ethylene prices (up 2.75 c/lb QoQ in Q2 to 33 c/lb) and lower production costs (down 1 c/lb QoQ to 10.7 c/lb). Coupled with a 5 c/lb PE price increase in September (after unchanged prices in April thru August) and solid demand, we expect US ethylene chain producers Dow and Lyondell to post strong Q3 results. Looking ahead to Q4, we expect US ethylene margins to be flattish and PE prices to fall on looser s/d fundamentals as planned and unplanned outages come back on stream coupled with seasonally weaker demand. Differentiated / specialty chemical companies forecasted to post 9% EPS growth In Q3, we expect Specialty and Differentiated Chemical companies to post 9% YoY EPS growth driven by solid demand, flat-to-slightly higher feedstock costs, cost reductions and share buybacks. We expect ethylene producers to post YoY lower growth due to lower oil prices partially offset by buybacks and growth projects. Top Picks: Dow/DuPont, Eastman, Trinseo Dow/DuPont: We expect both Dow and DuPont to post solid Q3 results driven by strong ethylene chain fundamentals at Dow and aggressive cost reductions at DuPont. While DuPont’s Q3 EPS guidance of $0.19 was below consensus of $0.34, this is due in part to well-documented Ag weakness in Brazil which is pushing some sales into Q4. Eastman: We expect Q3 results to be in-line to slightly better than expected