Jefferies: Fed's Rate Path Is Key to Chemical Sector Performance

The future trajectory of the U.S. chemical sector hinges critically on the Federal Reserve's interest rate policy in 2027, according to a new analysis from Jefferies. The firm notes that the sector is largely pricing in a "higher-for-longer" rate environment, which could postpone a recovery in durable goods.

Two Scenarios for Investors

Jefferies outlined two distinct potential outcomes based on the Fed's priorities. The first is a continuation of the current higher-for-longer rate scenario. The second involves a policy shift that stimulates interest-rate sensitive areas of the economy, such as housing, by boosting the "home equity wealth effect."

The firm recommended different stocks for each potential environment. For a sustained higher-rate scenario, Jefferies highlighted buy-rated names like LIN, CTVA, IFF, and KWR. Conversely, if the Fed shifts its focus, the firm sees potential in CE, HUN, EMN, MEOH, CBT, DCI, and AVNT.

Borrowing Costs and Valuation Headwinds

Persistently high interest rates since 2022 continue to pressure corporate balance sheets. Jefferies found that for approximately half of the chemical companies it covers, refinancing existing debt at current levels would create an earnings headwind equivalent to more than 1% of EBITDA.

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The analysis estimates that every 100-basis-point increase in borrowing costs would reduce earnings per share (EPS) for most chemical companies by 1%-3%. Such a rise would also diminish discounted cash flow (DCF) based valuation multiples by about 5%, a figure that could climb to roughly 8% for companies with net debt exceeding 3x EBITDA.

Sector Appears Richly Valued

Jefferies' valuation models suggest the chemical sector may be overvalued relative to historical norms. A regression model calibrated to data from the 1980s to the 2000s indicates a warranted next-twelve-month price-to-earnings (P/E) multiple of 14x-15x. This stands in contrast to the sector's current average multiple of 18.4x.

The firm provided the following DCF-based valuation benchmarks for different sub-sectors:

• Ruler Stocks: Approximately 19.0x next-twelve-month EPS, assuming 5%-6% net income growth.
• Cyclical Specialty Chemicals: Around 16x, falling to about 11x if a recession appears likely within 2-3 years.
• Commodity Chemicals: Between 11x-12x, dropping to 4x-5x if a near-term recession becomes probable.