Will Chemical Price HikesTranslate Into Higher Profits?

Two weeks ago, in previewing second-quarter earnings, I said that “multiple chemical companies have been able to push through price increases,” allowing them to pass along increases in raw material prices.

Yesterday, Dow Chemicals (DOW) announced its intention to raise prices by as much as 25% next month to offset higher energy and hydrocarbon feedstock costs. The company will also charge a $300 surcharge for shipments by truck and a $600 surcharge for shipments by rail.

Dow’s announcement came a day after similar notifications by E. I. DuPont’s (DD) Titanium Technologies unit and Air Products (APD). DD will charge an additional six cents per round on coatings, plastics, specialty, paper and laminate titanium dioxide grades. APD will hike prices and energy surcharges on all of its liquid and bulk products. Both companies plan to implement the price increases on July 1.

A week ago, Praxair (PX) stated its intention to charge 10% to 20% more for nitrogen, oxygen, argon, hydrogen, and carbon dioxide, and 15% to 30% more for helium. In addition, the company will increase monthly fees by up to 15%.

Why Are Prices Being Raised

There are two factors at work. The first is that oil is staying in the upper $130s despite Sunday’s conference and congressional hearings. Petroleum provides the basis for many chemicals. Plus, chemical companies use a lot of energy in creating and transporting their products.

The other factor is that many chemical companies have been successful in exhibiting pricing power. Nine of the 11 chemical makers within the S&P 500 are expected to generate earnings growth this quarter. The notable exceptions are DOW, which is being adversely affected by slowing U.S. auto sales, and Ashland (ASH]], which is being hurt by weakness in the construction sector.

Analysts have yet to make any changes to their profit projections in reaction to the latest round of price increases. Prior to the announcements, earnings estimates had been trending upwards on APD, PX and DD. Full-year forecasts for ASH and DOW were recently cut, though the revisions were made by only a portion of the covering analysts for both companies.

Price Increases By Themselves Are Not Enough

Changes to profit projections are important because they imply that the price increases are filtering down to the bottom line. A company can raise prices but see a decrease in gross margins if the price increases are not big enough to fully offset the higher input costs. In the case of DOW and ASH, weakening demand in some of their end markets is limiting the amount by which they can raise prices.

Therefore, investors would be wise to focus on those companies with rising profit expectations. APD and PX, fit this description. They are both are Zacks #2 Rank (”buy”) stocks and are expected to generate double-digit earnings growth this quarter.

DD is also a Zacks #2 Rank stock because of rising expectations, but the company is only expected to report modest growth for the second-quarter.

ASH and DOW are Zacks #3 Rank (”hold”) stocks. Both are projected to report year-over-year declines in profitability.

All five companies are classified in (Chemicals-Diversified). This group contains seven Zacks #1 Rank (”strong buy”) stocks: Airgas (ARG), BASF AG (BASFY), Compass Minerals (CMP), Eastman Chemical (EMN), Innophos Holdings (IPHS), Koninklijke (RDSMY) and Koppers Holdings (KOP). EMN belongs to the S&P 500 and is forecast to report 17% growth this year.

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