Pick Your Poison: Which Chemical Companies Should You Buy?

Shweta is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Chemicals are used in almost every industry, making the chemical industry highly sensitive to economic slowdown. In the last year the Eurozone financial crisis and concerns about the U.S. fiscal cliff caused underperformance in this industry. However, as these concerns decrease, the industry is expected to grow by 4.3% this year. Three chemical companies are trying to tap the growing market. Sherwin-Williams (NYSE: SHW) and LyondellBasell (NYSE: LYB) are trying to gain a larger market with acquisition and new product introduction. On the other hand, PPG Industries (NYSE: PPG) is implementing share repurchase to offset margin concerns. Will their strategies be what they need to thrive?

Continuous growth through expansions

Sherwin-Williams’ growth is driven by rising sales volume from its paint stores group. The demand for architectural paint is growing at pace with the housing market, which is its primary customer. Looking at this growth potential, the company will add around 75 new stores in the current year. Furthermore, it will add around 75-100 new stores annually, on average, in the coming couple of years. It is expected that the demand for architectural paint will rise to around 740 million gallons in 2015 from around 636 million gallons in 2012. The company will benefit from this rising demand of paint, as it generates around 70% of its sales from paint store and consumer paint groups.

Moreover, Sherwin’s acquisition of Comex for $2.34 billion will expand its paint store group. This deal is expected to close this year. Through this acquisition, Sherwin will add 318 stores in Canada and the U.S. to its paint store group. Although Comex has lower margins in comparison to Sherwin, this addition will improve its footprint in the Mexican market. Comex has around 3300 points of sale in Mexico, similar to Sherwin’s U.S. store numbers. Sherwin currently has a profit margin of around 10% in the Latin American market and the acquisition will improve that number. It is expected that Comex will generate revenue of around $1.4 billion this year, making this an excellent investment for Sherwin.

New products providing competitive edge

PPG Industries has the second largest global market share in packaging coatings, mainly of metal cans used in the packaging of food and beverages. In this metal can coating industry, the top three players have more than 90% of the beverage market and 75% of the food cans market. Valspar is the leading player and Akzo is the third. PPG Industries has around 20% global market share in the packaging coating industry.

However, the recent concern for the company was the banning of Bisphenol A, or BPA, as content for inside coating. This chemical is considered a health risk for fetuses, infants and young children, as it contains a toxic substance. Hence, the company has started using BPA-NI instead. This material is safer in comparison to BPA and will open new opportunity for the company. As there is technical expertise required to shift towards BPA-NI, market share will further be consolidated among these top three players. It is expected that PPG Industries will capture around 40% of the market for BPA-NI as inside can coating. This will result in around 67% of sales increment, amounting to more than $400 million annually.

In other news, PPG Industries closed the acquisition deal of North American architectural coatings business, AkzoNobel, in April 2013. It is the second largest acquisition for PPG Industries in its history. This acquisition added around 1000 stores in North America and will help PPG Industries to expand its coating business in Canada. With this acquisition, its U.S. architectural addressable market has grown by 100%. This deal is expected to generate total synergy of $200 million through 2015.

Olefins prices a near term concern

LyondellBasell is a leading producer of high density polyethylene, or HDPE, which is the third biggest plastic material used in the world. It is expected that demand for HDPE will be 38 million tons this year, showing growth of 4% year-over-year. This rising demand will increase the sales volume for the company.

However, in the second quarter, the company is expected to face margin issues from its olefins segment. In the second quarter, naphtha, which is used to produce olefins, declined in price by around 9% from the first quarter level. Despite savings, olefins prices declined more than 9%, offsetting naphtha’s cost benefits. It is expected that in the second quarter the company will generate EBITDA from European olefins around $194 million, a reduction from $225 million in the first quarter.

Lyondell had total cash of $2.88 billion by the end of the first quarter of 2013. The company planned to utilize this cash for share repurchases. It will repurchase 10% of its total 574 million outstanding shares at a cost of around $3.7 billion. It is scheduled to start in the second half of 2013 and finish within the following 12 months. This was earlier expected to take 18 months for completion. The faster time frame will be of greater benefit to the company’s EPS.

Bottom line

Sherwin is increasing its paint store group by increasing the number of stores, and its acquisition of Comex will expand its footprint in Mexico. PPG Industries is expected to take larger market share in BPA-NI products. Furthermore, its acquisition of Akzo's North American business will improve its addressable market. I recommend buying these two stocks. Lyondell is expected to experience decline in earnings due to the fall in olefins prices. However, its repurchase program will benefit its stock price in the future. I recommend holding this stock.

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Shweta Dubey has no position in any stocks mentioned. The Motley Fool recommends Sherwin-Williams. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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