• US natural gas-linked investment is alive and well. In early 2013 we authored a comprehensive research note entitled “The $100 billion wave”, wherein we made the case for a substantial acceleration of capital investment in the petrochemical industry as well as the re-direction of investment dollars to the US Gulf Coast at the expense of Asia, the Middle East, and especially Europe. Specifically, we had forecast $100bn of incremental US capital investment between 2013 and 2025. On balance, we consider this shale gas-inspired paradigm to be still intact today, although certain new projects have entered stage left, while a few have exited stage right. At this juncture, the initial wave of US capital investment is in full swing, so there will be ample opportunity for ribbon cutting photos as new plants come online in 2017-2018. What is more interesting to us though is the future. Herein, we pause to assess “wave two” projects that will influence the supply-side of the US ethylene market in the decade to come.

• We draw seven key conclusions from our analysis: (1) the US Gulf Coast will remain a preferred destination for capital investment in the chemicals industry, based on advantaged production economics and a more favorable fiscal policy outlook; (2) natural gas-linked petrochemicals will continue to propel growth in capital budgets, outpacing investment in fertilizers and specialty chemicals; (3) wave two investments set to come online in 2020+ will extend…

• Wave two is building on the horizon. We are beginning to see signs of a second supply wave in the US ethylene market in 2021-2022. Shell has finalized plans to move ahead with its Monaca, Pennsylvania facility, while Exxon and SABIC have announced a major world-scale project in Corpus Christi, Texas, Total has decided…

• Wave one is cresting now. We are just beginning to feel the initial impact of a long-awaited US ethylene supply wave that extends through 2019+. The North American market is already digesting last year’s start-up of Braskem’s facility in Mexico as well as…

• What about current market conditions? While we remain braced for a cyclical downturn extending into 2019, we have taken note of three marginally positive developments on the US Gulf Coast in recent days. First…

• We are overweight ethylene exposure notwithstanding cyclical pressure. Is ethylene out of favor? Well, yes, you might say that. In fact, we believe our 8 May 2017 upgrade of LyondellBasell was the first sell-side research action of its kind (i.e. excluding initiations) in nearly five years. Indeed, the stocks of three major US ethylene producers – Buy-rated Dow Chemical, LyondellBasell and Westlake Chemical – appeal to us for different reasons though collectively we view all three as inexpensive, especially on a relative basis. Our Dow Chemical Buy thesis (PT $72, 18% upside) is predicated on…

•  Overall, we remain Market Weight on US Chemicals exposure, albeit with a healthy appetite for risk. Based on 10-year average data, we consider the US chemicals sector to be overvalued by 22% on an absolute basis, yet fairly valued relative to the S&P500 index. Since relaunching coverage in early October 2016, we have been wary of the potential effect of an interest rate cycle on trading multiples, particularly the risk of compression to P/E multiples among higher quality specialty chemical names, many of which have enjoyed multiple expansion of 30-50% over the past 5 years. Meanwhile, through our bottom-up work on cash flow and valuation, we have established a preference for commodity-linked exposure, primarily through diversified chemical names trading at or near pure-commodity chemical multiples. In this context, our top picks overall are Buy-rated Dow Chemical (DOW), Eastman Chemical (EMN), and Huntsman (HUN) where we see potential upside of 18%, 13% and 20%, respectively, on a 12-month basis.  

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