ANALYSIS - Chemical industry upbeat but cautious on 2010

NEW YORK (Reuters) - The next 12 months hold much opportunity for investors in the U.S. chemical industry as its members hope to ride a wave of cautious economic optimism and capitalize on growing consumer confidence.

After two years of frenzied stock swings, debt downgrades, and slumping revenue and profit, some of the industry's biggest players are charily confident that a long-awaited economic uptick is coming next year.

While in 2008 and 2009 consumers eschewed many of the products made from chemicals, including automobiles and electronics, analysts expect 2010 to bring a resurgent economy and shopper.

"History tells us that the best time to (become) a chemical investor is in the depth of a trough," Alembic Global Advisors analyst Hassan Ahmed said.

Indeed, despite jumping more than 50 percent so far in 2009, the Dow Jones U.S. Chemicals index is still about 30 percent off an all-time high touched in 2008.

Commodity chemical makers are generally seen as good investments as recessions begin to abate because demand begins to rise for plastics, clothing and other basic items that their products they go into.

As a full-blown recovery emerges, specialty chemicals -- which go into electronics, adhesives and other high-technology products -- are generally seen as places for investors to shift their funds as discretionary income returns.

Huntsman, Solutia and Cabot are among the larger specialty chemical makers, while Air Products and Chemicals, Praxair and Eastman Chemical are some of the bigger commodity chemicals makers.

Investors often prefer companies with a mix of both commodity and specialty chemicals, such as Dow Chemical and DuPont.

Few chemical companies provide specific financial forecasts. But DuPont says it expects earnings to grow by at least 7.7 percent in 2010, and Dow bullishly told investors last month that its profit could start to jump next year and increase more than six times by 2012.

CONSERVING CASH, BUILDING MARGINS

After coming through a tough recession, many chemical companies will spend carefully in 2010, and most have stated they will work to cut costs next year.

But fast-growing markets like the Middle East will probably still see a lot of capital expenditure dollars.

Dow Chemical, for instance, is busy building the Ras Tanura refinery in Saudi Arabia, but the chemical giant is unlikely to spend more money in the United States in 2010, industry observers say.

Prices for chemicals probably will not rise in 2010 due in part to excess capacity and relatively low energy prices.

That is not the best news for an industry focused largely on cash generation and retention.

But low prices also encourage consumers to buy more, and those companies with excess capacity would have the ability to take market share when the economy recovers.

In the past 18 months, chemical prices did not drop as much as energy costs, which helped the industry's margins hold steady or improve slightly in 2009.

Cost cuts should continue in 2010, but not at the same pace as 2008 and 2009. Many in the industry have laid off thousands of workers and are working to shed billions of dollars from their cost structure.

"As long as we don't see a big spike in raw material (costs) ... I do think you're going to see margin expansion in 2010," Credit Suisse analyst John McNulty said.

Margins may also benefit if chemical makers close some of their U.S. plants, whose average age is about 30 years, since it takes a lot of maintain those inefficient facilities.

ON THE FEDERAL LEVEL

The chemical industry is worried that it could suffer from pending U.S. climate change legislation, although many of its members support doing something about global warming.

While the legislation has yet to be finalized, chemical makers are worried they could be penalized just for using carbon, rather than emitting it.

For instance, chemical companies use natural gas to make plastic, but the carbon in the natural gas is locked into the plastic, not emitted into the atmosphere. If the industry is charged merely for using the carbon, it would substantially boost costs.

It's "too early to tell" where President Obama is on cap-and-trade legislation, said Cal Dooley, president of the American Chemistry Council trade group.

But he said the ACC was concerned that Obama's Environmental Protection Agency may preempt Congress and regulate carbon emissions to the point that it would not be viable for chemical makers to stay in the country.

(Reporting by Ernest Scheyder; Editing by Lisa Von Ahn)

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