From its nadir in 2009, the chemical industry's recovery was nothing short of spectacular. It has put in respectable gains in more recent years, too, although pockets of outperformance have tended to mask less impressive growth for many. It was a similar story in 2013. This year, however, valuations appear less eye-watering than a year ago and an upturn in Europe seems increasingly likely, implying gains might be more broad-based in 2014.
Short order books that limit earnings visibility have kept us on the sidelines for a number of months, and we remain largely neutral on the sector. That, however, could change as we see further evidence of an uptick in volumes on the continent, which would significantly increase the probability of earnings upgrades. This is crucial. All the big players have some kind of exposure to the region, but it's been a particular thorn in the side for Synthomer (SYNT), where a construction squeeze has hit demand for polymers used in flooring and coatings.
In fact, the European coatings market is still around 20 per cent below pre-crisis levels, according to N+1 Singer. That's been bad news for Elementis (ELM), too. Fortunately, the company generates lots of cash and promises to pay shareholders half of whatever's left at the year end. Include special payouts - another is odds-on in 2014 - and the dividend yield comes to about 4 per cent. Croda (CRDA), kicked out of the FTSE 100 index just before Christmas, and Victrex (VCT) also make oodles of money in Europe, but it could be more.
The apparent change of fortune for Europe's automotive industry is clearly an advantage, and the benefits should be obvious if it lasts. Greater demand for catalytic convertors is fuel in the tank for manufacturer Johnson Matthey (JMAT). A rush to buy trucks ahead of new stringent emissions legislation on 1 January beefed up third-quarter results, and new rules for diesel cars in September will increase Matthey's revenue per car by a fifth.
Finally, we are almost certain to lose AZ Electronic Materials (AZEM) very soon following an agreed cash offer from Merck worth 403.5p a share. And as the IC's Takeover Tip of the Year for 2012 disappears - better late than never - there's a temptation to look elsewhere in the sector for the next bid target. Alent (ALNT), formerly one half of Cookson, is the closest comparison, but Victrex and Croda could also attract attention - not to mention Synthomer, which has been linked with both BASF and Dow Chemical in the past.
| Company name | Share price (p) | Market value (£m) | PE ratio | Dividend yield (%) | Share price change in 2013 (%) | Last IC view |
| Alent | 326 | 908 | 13 | 0.1 | 15.0 | Hold, 340p, 6 Dec 2013 |
| AZ Electronic Materials | 394 | 1,499 | 19 | 2.1 | 13.1 | Bid situation, 396p, 7 Dec 2013 |
| Croda International | 2,443 | 3,317 | 19 | 2.5 | 3.4 | Hold, 2,520p, 23 Jul 2013 |
| Elementis | 260 | 1,193 | 11 | 2.0 | 15.7 | Hold, 246p, 30 Jul 2013 |
| Johnson Matthey | 3,440 | 7,049 | 21 | 1.7 | 38.1 | Hold, 3,161p, 25 Nov 2013 |
| Synthomer | 274 | 931 | 14 | 2.1 | 34.9 | Hold, 274p, 31 Jan 2014 |
| Victrex | 1,890 | 1,604 | 22 | 2.3 | 13.5 | Hold, 1,654p, 10 Dec 2013 |
FAVOURITES:
Takeover possibilities aside, Alent could do well in 2014. Look out for news on several product launches when final results are published in March, and for the benefit of rising automotive demand on the bottom line. It's also worth noting that a forward PE ratio of 13 is substantially less than the 20 times earnings Merck is paying for AZ.
OUTSIDERS:
We rated Synthomer a short-term sell in August, given the miserable outlook in its key European market. Well, the prognosis has improved, so it's time to upgrade the shares to hold. They have, however, rallied recently to an all-time high. While a forward PE ratio of little more than 12 might appear cheap, any rebound in the European construction industry this year will be modest at best.
