Chemicals: Q3 (September Quarter) 2015 Earnings Preview

Deutsche Bank Markets Research North America United States Industrials Chemicals / Specialty Industry Chemicals Date 13 October 2015 Results Q3 (September Quarter) 2015 Earnings Preview Mixed Q3 results as low cost NGLs offset by FX/Ag. Outlooks likely cautious ________________________________________________________________________________________________________________ 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, CFA Research Analyst (+1) 212 250-5473 david.begleiter@db.com Ramanan Sivalingam Research Associate (+1 ) 212 250-8619 ramanan.sivalingam@db.com Jermaine Brown Research Associate (+1) 212 250-3624 jermaine-r.brown@db.com Top picks Albemarle (ALB.N),USD50.26 Buy Dow Chemical (DOW.N),USD46.51 Buy Eastman Chemical (EMN.N),USD70.89 Buy Source: Deutsche Bank Chemicals sector trading in-line with its historical multiples and at a modest relative discount to the market The US Chemicals sector is trading at 14.2x forward EPS, a 5% discount to its 15-year average. The sector also currently trades at a 8% discount to the S&P 500 on forward EPS vs a historical discount of 4%. We view multiple expansion as unlikely until concerns over Chinese and European 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 mixed September quarter results as low ethane/propane feedstock costs, cost actions and share buybacks are offset by subdued Asia Pacific demand, FX (Brazil in particular) and Ag headwinds and lower TiO2 selling prices. These headwinds have already been seen in preannouncements from DuPont, FMC, Huntsman and Platform, as well as the disappointing FQ4 results and FY16 guidance from Monsanto. Overall, we expect Q4 guidance and early reads on ’16 to be cautious. Our top picks are Dow and Eastman. We believe Dow will post strong Q3 results aided by its ability to crack a large amount of propane (propane prices fell 11% QoQ). Auto and US housing continue to be relative bright spots DB’s economics team forecasts US GDP growth slowed to 1.7% in Q3 and and will increase 2.3% Q4 vs 3.9% in Q2. For 2015, US GDP is forecasted to grow 2.4% underpinned by strong housing / construction activity (housing starts to rise 19% YoY in ‘15E), improving consumer spending and solid auto production (+2.7% YoY in ‘15E). Europe is continuing to show signs of a nascent recovery with 1.4% GDP growth in Q2 (vs 2.1% in Q1), a forecasted 1.9% in Q3 and an estimated 1.5% in ‘15 (vs 0.9% in ’14). According to recently released data, China’s GDP growth slowed to 7% in Q3, its slowest growth since Q1 ‘09. Ethylene margins fall 4 c/lb in Q3 to 19.6 c/lb US contract ethylene margins fell 3.9 c/lb in Q3 to 19.6 c/lb on lower ethylene prices (down 3.9 c/lb, or 11%, QoQ, to 30.3 c/lb) partially offset by lower ethylene production costs (down 0.1 c/lb to 9.6 c/lb). Ethylene production costs remain near record lows, and are down significantly vs 14 c/lb a year ago, as ethane prices were near all-time lows of 19 c/gal in Q3 (vs 18 c/gal in Q2, a high of 39 c/gal in ’14 and a 10-yr average of ~60 c/gal) due to oversupply and a shift to higher propane cracking (18.9% of ethylene crack in Q3 vs 17.9% in Q2). We expect ethane prices to remain in a range of 15-20 c/gal range thru ’15 equating to 10 c/lb ethane-based ethylene production costs and resulting in ethylene cash margins of 20 c/lb in Q4 vs prior peaks of 10-15 c/lb. Coatings companies and Ashland are beneficiaries of lower raw materials Coating companies (PPG, Axalta and Valspar) are poised to benefit from lower oil prices as propylene, a key feedstock for coating intermediate chemicals, fell 21% QoQ in Q3 and are now down 62% from ’14 highs. In addition, TiO2 prices continued to weaken in Q3 falling 3%, 7% and 5% QoQ in NA, Asia, and Europe respectively. Ashland is another beneficiary of lower oil as it buys 170MM gals of Group II base oil/yr (Group II was down 36% YoY in Q3). September quarter: Differentiated and Specialty chemical EPS +9% YoY In Q3, we expect Specialty and Differentiated Chemical companies to post 9%