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FTSE 350: Chemicals could be better off out of the EU

The sector will be in search of higher-margin business strands this year, and regulatory clarity on the post-Brexit landscape
January 26, 2017

Much has been made about the possible trading impact on UK manufacturing of the Brexit vote. Yet in this respect the advantages of being in the single market aren’t always obvious. Although demand for chemicals is increasing year on year, the EU chemical industry’s share of the global market continues to shrink. However, the outlook for Europe’s chemical producers is slightly better than at this point last year. Cefic, the European chemical industry council, expects a marginal increase in EU chemical production in 2017, following a year in which output stagnated.

The UK government’s Environmental Audit Committee recently opened an inquiry into the future of chemicals regulation and policy post-Brexit. A question that highlights some of the practical challenges of Brexit is whether the UK will enshrine domestic legislation commensurate with the EU’s Registration, Evaluation, Authorisation and Restriction of Chemicals (REACH) framework to be able to sell into the EU single market. This will be a key focus for the industry once the government triggers Article 50. Industry bodies are already lobbying Westminster to provide support and legislation to protect the industry. There’s a strategic angle in play as many figures in both government and Whitehall believe an independent UK capability in chemical manufacture is essential in terms of national security.

The problem for the industry is largely the cost of doing business in the trading bloc, particularly for bulk chemical producers, although the sector constituents in the FTSE 350 offer a degree of resilience through increasingly specialised – and often higher-margin – products. That’s certainly the case for Johnson Matthey (JMAT), a speciality chemicals group that is also one of the world’s leading manufacturers of catalytic converters. The investment case has improved markedly due to an increased focus on automotive emissions technology following the VW scandal, while strong sales in its battery material segment suggest where future growth is likely to come from.

Price (p) Market value (£m)PE (x)Yield (%)1-year change (%)Last IC view
Croda International3,3254,36423.52.211.9Hold, 3,288p, 27 Jul 2016
Elementis2701,25119.72.332.9Buy, 212p, 04 Aug 2016
Johson Matthey3,1766,147172.332.7Hold, 3,231p, 21 Nov 2016
Synthomer3751,27415.82.426.1Hold, 387p, 09 Aug 2016
Victrex1,9601,67920.22.430.5Buy, 1,770p, 06 Dec 2016

 

Favourites: Polymer products group Victrex (VCT), in keeping with a sector-wide trend, has been in pursuit of more profitable business strands, moving away from standard polymers to higher-margin components. However, demand for its high-performance PEEK polymer products remains buoyant, and the group expects continued volume increases in its core business. The shares are priced for growth at 19 times forecast earnings, but we keep the faith.

Outsiders: Elementis' (ELM) earnings discount to peers has evaporated since its last half-year figures, and analysts at Berenberg note that the strong US dollar is putting pressure on its crucial chromium market. Still, oilfield revenues should start to become more predictable now that crude prices have stabilised, while the end of a period of destocking in China should prove favourable for the coatings business.