Chemicals: Q4 (December Quarter) 2016 Earnings Preview

Deutsche Bank Markets Research North America United States Industrials Chemicals / Specialty Industry Chemicals Date 23 January 2017 Results Q4 (December Quarter) 2016 Earnings Preview Expecting in-line Q4 results. '17 outlooks likely cautiously optimistic ________________________________________________________________________________________________________________ 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 Katherine Griffin Research Associate (+1) 212 250-7265 katherine-a.griffin@db.com Top picks Dow Chemical (DOW.N),USD57.38 Buy DuPont (DD.N),USD73.03 Buy Ashland (ASH.N),USD110.00 Buy Source: Deutsche Bank Chemicals sector trading above its historical multiples and the market The US Chemicals sector is trading at 16.8x forward EPS, a 12% premium to its 15-year average. The sector currently trades at a 4% 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 report in-line December quarter results as steady global demand, improving Ag trends, restructuring savings and share buybacks are offset by higher feedstock costs, lower derivative prices and FX headwinds. On Q1 and ’17 guidance, we expect US chemical companies to be cautiously optimistic as expectations of improving global demand and selling price increases more than offset higher raw material costs, FX headwinds from a stronger dollar and macro and geopolitical uncertainties. Our top picks are Dow and DuPont (on the assumption their merger is approved) and Ashland. Global GDP growth is expected fto accelerate from 3.0% in ’16 to 3.4% in ‘17 DB’s economics team forecasts US GDP growth slowed to 1% in Q4 from 3.5% in Q3. For Q1’17, US GDP is forecasted to grow 2% as solid housing/construction activity (housing starts up 12% YoY in ‘17E) is partially offset by sluggish industrial and manufacturing activity. In Europe, growth continues, albeit modestly with 1.8% GDP forecasted growth in Q4 (vs 1.4% in Q3) and 1.1% in Q1. DB’s economics team forecasts China’s GDP grew 6.7% in Q4 vs 6.5% in Q3. For ’17 DB’s economics team forecast US GDP growth of 2.4% (vs 1.5% in ’16), Europe GDP growth of 1.3% (vs 1.7% in ’16), China GDP growth of 6.5% (vs 6.7% in ’16) and Global GDP growth of 3.4% (vs 3.0% in ’16) Ethylene chain margins under pressure in Q4 US contract ethylene margins fell 4 c/lb in Q4 to 17.4 c/lb as higher ethane and propane feedstock costs (up 2 c/lb QoQ in Q3 to 12.3 c/lb, up 2.7 c/lb YoY) more than offset the impact of extended planned outages at Dow’s Plaquemine LH-3 unit and Lyondell’s Corpus Christi unit. Looking ahead to Q1‘17, we expect US ethylene margins to be flattish as higher feedstock costs offset the impact of seasonally strong demand. In ’17, we expect US polyethylene margins to come under pressure from new capacity and fewer outages. Differentiated / specialty chemical companies forecasted to post 6% EPS growth In Q4, we expect Specialty and Differentiated Chemical companies to post 6% 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, Ashland, Trinseo Dow/DuPont: We expect both Dow and DuPont to post solid Q4 results driven by positive mix uplift at Dow and aggressive cost reductions at DuPont. While DuPont’s ’16 guidance was raised by less than its Q3 beat ($0.10 vs $0.13), we believe this is understandable as $0.08 of EPS was pulled into Q3 due to t