Factors to Consider Before Investing in Chemical Stocks
A High Level of Competition
When it comes to bulk, commodity, and integrated chemicals, an investor would observe that one company's products are indistinguishable from those of another company. Because of this, a customer can quickly switch from chemicals made by one manufacturer to chemicals produced by another.
The producers of bulk/commodity/integrated chemicals face fierce competition due to the commoditization and lack of differentiation of their products, and they have no pricing influence over their clients.
In the market, they are price takers because the lowest-cost producer establishes the market price, and every other producer is obligated to match it to keep their customers from switching to the lowest-cost producer.
The Economies of Scale Are High for Low-Cost Producers
As said in the above point, due to the non-differentiable nature of their products and the ease with which customers can switch suppliers, resource chemical companies compete with one another on price.
The technology to produce common chemicals is also well-developed and widely accessible. Therefore, becoming the lowest-cost manufacturer on the market is the primary source of competitive advantage for any producer of commodity chemicals.
This is so that everyone can benefit in the long run because the lowest-cost producer establishes the market price, and everyone else must match it to succeed.
Capital Intensity
As mentioned, commodity chemical companies typically have a sizeable manufacturing facility to take advantage of economies of scale and run profitable operations. It is thought that a commodity or integrated chemical manufacturer must reach an actual minimum threshold before it can even be pertinent to its industry. Therefore, being a top player where efficiencies of scale help to decrease the cost of manufacturing is crucial for the commodity chemical industry.
An investor would understand that a company operating in the commodity chemical sector must build a sizeable plant to maintain operations, necessitating a significant investment.