The most difficult thing in picking stocks is trying to sort out all the noise. Revolutions in the Middle East, record snowfall in the U.S. affecting jobs and manufacturing data, bailouts of Greece and Ireland as well as possible bailouts of Spain, Portugal and the not so far away Illinois all add unknowns to the direction of the world economy. That is why it is important to read as much as you can, forming your own opinions based on facts you pick up along the way.
Annual Reports from different industries are a great way to do this. I tend to read the reports of all the companies I own, and a few I follow, looking for areas of strength or weakness that overlap. For example, a few summers back Aqua America (WTR) missed a quarter because heavy rains in Texas had cut into demand. A few days later Sterling Industries (STRL), a Texas based construction company, missed the quarter due to delays caused by the rain. If I had applied what I knew from the Aqua America quarter, there was an opportunity going into Sterling's quarter. With this experience as a model, I have found two U.S. companies, Trinity Industries (TRN) and Enterprise Product Partners (EPD), two businesses that touch large swathes of the American economy. They both point to a boom in the U.S. chemical industry.
Trinity Industries manufactures, owns and operates rail cars in the U.S., as well as running a barge, wind tower and construction business. The rail car business is where the real information on economic health can be found. Most U.S. goods still travel via railroad to get to distribution points and ports, so a rail car manufacturing and leasing company should provide insight on what is being shipped, and what companies are ordering to ship goods in the future. From the conference call is Steve Menzies, Senior Vice President and Group President of the Rail and Rail Car Leasing Groups:
"We have seen continued improvement in demand for railcars that transport chemicals, minerals and agriculture products. Demand for rail cars that has served the lumber, paper, automotive, and coal industries, continues to be weak."
I think everyone has seen the headlines about the high costs of corn, wheat, silver, gold, copper, etc. Much less covered has been the resurgent chemical industry. If shipping these chemicals is strong enough that the industry gets mentioned specifically, maybe U.S. chemical companies are a good investment. However, one small piece of anecdotal evidence is not the basis for an investment, so one must continue to look.
Enterprise Products Partners owns and operates the largest pipeline network in North America. This MLP, with assets mainly located around the Gulf Coast, moves more natural gas, natural gas liquids (NGLs) and oil than any other company. In the recent 2010 Q4 report, EPD reported record volumes across a host of segments, including NGLs and petrochemical products. NGLs are a feedstock that chemical companies turn into chemicals, much like oil is refined into gasoline and diesel. The press release is littered with references to the strength in the petrochemical industry, with EPD's President Mike Creel specifically saying the company benefited from " increased demand for NGLs by the U.S. petrochemical industry." If this was not proof enough, the Q3 transcript tells an even more bullish story for chemical manufacturers. Talking about the ethane market, another feedstock in chemical production, the company's Executive VP and COO Jim Teague said:
"The significant ethane advantage over other feeds is not just limited to the domestic market. U.S. ethane cracking is near the bottom of the global production cost curve according to CMAI. U.S. ethane cracking economics beat European and Asian naphtha cracking economics and even competes with Saudi propane and condensate cracking economics according to CMAI data. What that tells us is that not only will U.S. chemical companies be profitable in the domestic market, but they will be competitive globally with downstream ethylene exports, and that essentially takes the target off the U.S. as an export destination for foreign produced chemicals, again we see this story as a positive story not only for NGL producers but also U.S. petrochemicals."
If that statement is not a screaming endorsement of U.S. chemical companies, I do not know what is. Pipelines are expensive, and take a long time to build. EPD does not follow short term trends or chase small opportunities to make money. If they see opportunity in serving this industry, it is not something to be ignored.
U.S. chemical makers are at the beginning of a cyclical upswing. Costs are down domestically due to rock bottom natural gas, NGLs and ethane prices, while costs are rising overseas as natural gas is used more for power generation and transportation. Exports are up, and President Obama's push for new exports will be a wind at the backs of these companies. A free trade pact with South Korea will help further these gains.
Chemical companies are buying more NGLs and ethane, as EPD is telling us, and spending on new rail cars to ship more chemicals, as TRN is telling us. Perhaps you read Dow Chemical's (DOW) recent quarter, or see Eastman Chemical (EMN) at new all time highs, and already knew that chemical makers were in the driver seat now. But if you read the conference calls of Trinity Industries or Enterprise Products Partners, you would have also known how strong the chemical industry in the U.S. has become. It's true most of these companies are at or near 52-week highs, but the data from industries serving the U.S. chemical industry says this is the start of a multi-year expansion. I like names with market caps between $1 and $5 billion and manufacturing facilities around the Gulf Coast. Try looking at Chemtura (CHMT), Cabot Corp (CBT), Georgia Gulf (GGC), Cytec (CYT) and OM Group (OMG). Eastman Chemical is also a solid company, although it has already run a lot.