Top line and profitability struggle to grow: The weakening in the
macro backdrop in H2 2014, particularly in Europe and Latin America,
has been exacerbated by the collapse in the oil price. This has led volume
growth to evaporate and prices have turned negative again. The weakness
of the EUR and GBP against the USD should be positive. In our thematic
report Survival Guide, 5 December 2014 we highlighted the drag on profit
growth from prolonged low growth and oversupply for the coming years.
Therefore, we believe the risk to earnings remains to the downside while
valuations are still above historic levels.
Q4 outlook: Destocking as a result of the fall in the oil price should result in
volumes flatlining in Q4. This compares to 4.5% volume growth in Q4 2013
and 3.5% in the first nine months of 2014. We expect prices to fall by
approximately 2% in Q4 for the Classics given the 7% decline in the value
of the product basket we follow due to the fall in the oil price. On the bright
side, FX tailwinds should add about 3.5% for EUR-based companies. We
expect Q4 operating profit to be up 3% y-o-y, in line with consensus. We are
above consensus for BASF and Solvay and below for Arkema.
We have OW/UW ratings on the following shares in the context of these themes:
* BASF (BASFn.DE, EUR88, OW): Dividend yield to support shares; only c25% of the Oil&Gas division is oil; ethylene and downstream segments to benefit from lower oil price.
* Croda (CRDA.L, 2,800p, OW): Growth recovering; consensus too cautious on 2015 margin, suggesting earnings cycle is turning positive.
* Johnson Matthey (JMAT LN, 3,800p, OW): Legislation will continue to drive growth and margins; strong cash generation to support dividend growth.
* Linde (LING.DE, EUR176, OW): Higher industry discipline; expectations have been re-set; potential to create incrementally more value than peers.
* Solvay (SOLB BB, EUR132, OW): On track to upgrade portfolio; earnings supported by cost savings; shares are the cheapest in the sector.
* Umicore (UMI.BR, EUR33, UW): Earnings risk in recycling; expensive.