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The U.S. chemical industry consists of 170 major companies, with several of them having international operations. The products manufactured by these companies span a wide range: From chemicals used in household products like soaps and detergents, to agrichemicals and specialty chemicals used in aerospace, health care, technology, telecom, and other industries. Employing over a million people and contributing substantially to exports, the annual output of the U.S. chemical industry is estimated to be around $400 billion. Chemical companies are the second largest energy consumers in the manufacturing sector.

The economically sensitive U.S. chemical industry was hit hard during the Great Recession. Industry titans like Dow Chemical (NYSE:DOW) and DuPont (NYSE:DD) saved billions of dollars in costs through restructuring, plant closures, and layoffs.

With costs cut to the bone and economic growth perking up, conditions are ripe for chemical company profits to ramp higher. Merger and acquisition activity is continuing at a rapid pace. Investments in chemical industry sector funds appear quite timely.

Chemical Company Profits Poised to Rise from Improving Demand and Falling Costs

The demand outlook for individual segments of the chemical industry is improving.

Agricultural Chemicals: Worldwide population growth and higher per-capita income in emerging economies are lifting commodity crop prices and driving demand for agrichemical products, as farmers seek high quality seeds and greater yields. Agrichemical companies like Monsanto (NYSE:MON), DuPont, Potash Corporation (NYSE:POT), and Agrium (NYSE:AGU) stand to benefit from these secular trends.

Polymers and Paints: The automotive industry, which accounts for 10% of U.S. chemical companies’ demand, has rebounded. Industry analysts are projecting global auto demand to touch 76 million units, with China accounting for 18 million units and the U.S., 13 million units. Dow Chemical, BASF Corp. (OTCQX:BASFY) and PPG Industries (NYSE:PPG) stand to benefit from increased demand for plastics and coating materials used in automobiles.

Building Materials: The U.S. homebuilding sector is a major consumer of chemicals. Off late, the U.S. housing industry is showing some signs of improvement. The National Association of Home Builders expects annual housing starts of single-family homes to rise 21% to touch 575,000 units in 2011. Building products manufacturer U.S. Gypsum (NYSE:USG), roofing products manufacturer Owens Corning (NYSE:OC), and paint manufacturers Sherwin Williams (NYSE:SHW) & Valspar (NYSE:VAL) can fare well if the NAHB’s expectations come true.

Against the backdrop of rising product demand, chemical company profits are receiving a boost from low natural gas prices, since the commodity is used as a feedstock and an energy source. Natural gas prices have not recovered since the Great Recession due to abundant supplies. Gas prices are nearly 50% lower than where they were in July 2008.

Mergers & Acquisitions Appears Set to Continue at a Good Clip

Chemical companies have been active in M&A for some time. Dow Chemical acquired Rohm & Haas for $15.3 billion in March 2009 to expand its specialty chemical line. CF Industries (NYSE:CF) bought Terra Industries in April 2010 for $4.7 billion to strengthen its position as a global fertilizer company. Eying growth in emerging Asian economies, Agrium purchased Australia’s AWB Ltd in December 2010.

Recently, DuPont has offered to buy Denmark’s Danisco for $5.8 billion, to expand into biofuels and food enzymes. Air Products & Chemicals (NYSE:APD) ended its attempt to take over Airgas (NYSE:ARG) only after the latter succeeded in getting court approval of its poison pill provision.

Auguring well for continued M&A activity, many of the chemical companies carry hoards of cash on their balance sheets and view acquisitions as a way to grow their businesses.

In sum, chemical companies have a lot going for them and the possibility of takeovers adds to the investment appeal. Sector rotation practitioners can find interesting opportunities among chemical industry investments.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am currently invested in Fidelity Select Chemicals.

Source: Chemical Stocks Primed to Ramp Higher