Q3 (September Quarter) 2017 Earnings Preview

Deutsche Bank Markets Research North America United States Industrials Chemicals / Specialty Industry Chemicals Date 15 October 2017 Results Q3 (September Quarter) 2017 Earnings Preview Hurricane headwinds in Q3 should become tailwinds in Q4.Top Pick: DWDP ________________________________________________________________________________________________________________ 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) 083/04/2017. 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 David Huang Research Associate (+1) 904 520-5307 david-a.huang@db.com Top picks DowDuPont (DWDP.N),USD71.43 Buy Ashland (ASH.N),USD66.46 Buy Eastman Chemical (EMN.N),USD88.65 Buy Source: Deutsche Bank Chemicals sector trading above its historical multiples and the market The US Chemicals sector is trading at 18.4x forward EPS, a 23% premium to its 15-year average. The sector currently trades at a 5.7% 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 companies in the chemicals sector based on: 1) forward P/E multiples (vs. historical ranges and the market); 2) forward EV/EBITDA multiples (where leverage diverges from that of peers, also vs historical averages); 3) our calculation of cash return on cash invested and 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. See pp. 32-8. Hurricane Harvey, which made landfall on August 25, cast a long shadow over US chemicals in Q3. Due to the hurricane and its aftermath many US chemical companies experienced negative impacts from shuttered plants, lost production, tight raw material supply conditions, higher distribution and logistics costs and supply chain disruptions. As a result no less than a dozen US chemical companies preannounced earnings shortfalls or talked down numbers for the quarter. The good news is that underlying demand ex Harvey remained solid in Q3 and Q4 should see benefits from the hurricane in the form of price increases, restocking and rebuilding. Top picks: DWDP, EMN, ASH. Global GDP growth is expected to accelerate from 3.1% in ’16 to 3.6% in ’17 DB’s economics team forecasts US GDP growth slowed to 2.0% in Q3 from 3.1% in Q2. For Q4, US GDP growth is forecast to accelerate to 3.1% as most of the lost output and delayed purchases in Q3 due to hurricane related disruptions are expected to be made up in Q4. In Europe, DB’s economics team forecasts Q3 GDP growth of 0.6% QoQ. For Q4, Europe GDP growth is forecast to slow slightly to 0.5% QoQ. China’s GDP growth slowed to to 6.6% in Q3 from 6.9% in Q2. For ’17 DB’s economics team forecasts US GDP growth of 2.4% (vs 1.8% in ’16), Europe GDP growth of 2.2% (vs 1.8% in ’16), China GDP growth of 6.7% (vs 6.7% in ’16) and global GDP growth of 3.7% (vs 3.1% in ’16). Ethylene chain margins compress in Q3 US contract ethylene margins compressed 3.7 c/lb in Q3 to 14.8 c/lb on flat prices (at 31.9 c/lb) and higher production costs (up 3.7 c/lb to 16.4 c/lb and up 34% YoY). Meanwhile, polyethylene (PE) prices rose $0.02/lb in Q3 (to $0.75 for HDPE) as Hurricane Harvey resulted in extensive capacity shutdowns leading to material becoming short or non-existent in some cases. In Q4, we expect US ethylene chain margins to improve as hurricane-induced tight supply/demand fundamentals support elevated PE pricing. We expect hurricane impacts and supply/demand tightness will linger thru October and pass starting in November. Differentiated / specialty chemical companies forecast to post 10% EPS growth In Q3,we expect Specialty and Differentiated Chemical companies to post 10% YoY EPS growth driven by solid demand, FX tailwinds, cost reductions and share