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The Curious Chemistry of the Chemicals Business

Economic moats are tough to come by in this capital-intensive industry.

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Executive Summary
In aggregate, the growth in the chemical industry is strongly correlated with macroeconomic growth, as chemical companies are the basic ingredient suppliers for almost all industrial aspects of a modern society. Most of their outputs feed into automotive, construction, industrial, and consumer product chains rather than being the end products themselves. The profitability of the industry is notoriously volatile, as capital-intensive chemical companies stand between hydrocarbon producers (crude oil and gas) and industrial and consumer product manufacturers, processing crude oil and natural gas into generic commodity chemicals (for example, ethylene, propylene, plastics, or glass) without much differentiation or specialty materials (for example, UV coating or super glues). We award economic moats to companies that have a clear advantage over their peers in terms of a unique asset base or high switching costs that give them pricing power over end customers. The moat rating has a material impact on how we value these companies since we are willing to pay more for a company with a long-term, sustainable competitive advantage than a cyclical company without one.

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