If you're looking for a chemical company that may provide the right mix for your portfolio in an improving economy, consider

Arch Chemicals

(ARJ)

.

This relatively new, specialty chemicals company was spun off from

Olin

(OLN) - Get Report

in 1999. Arch focuses on four specialties: microelectronic chemicals, which account for 17% of revenue; water treatment chemicals, 23%; personal care, 25%; and performance chemicals, 26%. The company employs about 3,000 people and operates 12 manufacturing facilities.

Finding the Right Formula

Like many chemical companies, Arch has been feeling the pinch of a slowing economy. Over the past two years, the rising costs of raw materials and energy have hurt both revenue and margins. However, better times appear to be on the horizon.

"Chemical production in general has turned positive year over year for the first time in January since late 2000," says Christopher Crooks, chemicals analyst at Commerce Capital Markets. "There is strong operating leverage here to an economic recovery, lower raw material costs and portfolio moves ahead." He rates the stock market outperform with a $26 price target. His firm has not done investment banking for Arch.

Arch has been working hard to reposition itself to take advantage of a recovery. It recently sold its Hickson DanChem chemical operations for about $25 million and used the proceeds to reduce debt. It also cut about 200 jobs and decided to consolidate its personal care manufacturing division.

The moves should boost the impact that the economic recovery will have on Arch's bottom line. "We view both the DanChem sale and the restructuring as positive steps toward paying down debt and improving margins," notes Crooks. "There are a number of catalysts in Arch's business lines that should allow for organic growth while the company will also benefit from the cyclical recovery."

Head and Shoulders Above the Rest

Although the company's short-term outlook remains guarded, it expects an improvement in sales and profits in the second half of 2002. Arch expects to earn 50 to 75 cents a share this year, vs. 15 cents in 2001.

"Like most specialty chemical companies, the first-half 2002 economy will be tough, but recovery is expected in the second half based on current indicators," Crooks explains. "Anecdotal evidence across the industry and from our contacts suggests that orders may be returning slowly in a few sectors as inventories have been worked down, including in the paint-coatings area for Arch."

Arch's once-profitable microelectronics business will just break even in 2002, but quarterly profits should return by the fourth quarter. The company has a leading position in the sector as it shifts to smaller circuit line-widths. Arch is also a leader in chemical mechanical planarization (CMP) wafer polishing, which is used in the newer copper-based circuits for semiconductors. An alliance with Wacker Silicone has helped Arch garner more than 30% of the market for this emerging technology.

Plus, the chemical company's water treatment business is booming. Its best-known product line, HTH swimming pool treatments, continues to grow, getting a boost from an expanded alliance with

Wal-Mart

(WMT) - Get Report

and other big-box retailers. Arch recently eliminated the distribution middlemen and now sells directly to retailers. In addition, the company added 17 new products to its retail water-treatment line, which should boost sales as well as revenue and margins.

Finally, Arch's personal care and biocide products could provide upside this year. The company produces a wide range of chemical products from cosmetics to wood treatments and specialty and industrial coatings. It recently won a $102 million contract from the U.S. Air Force for a specialty chemical propellant, and it continues to supply the antidandruff ingredient in Head & Shoulders shampoo.

Small-Cap Elixir

Although Arch stock isn't cheap -- currently trading at nearly 50 times 2002 earnings -- growth in the second half and into next year makes the stock an intriguing longer-term play. The recent $25 million in debt reduction shored up the company's balance sheet, with a debt-to-capital ratio less than 20%.

The stock may be stuck in the low $20s until the recovery is more certain, but $30 seems possible as the environment improves. Until then, the 3.5% yield is attractive and provides support for the stock.

The yield, combined with the possibility of 20% appreciation, makes Arch interesting for investors who can tolerate short-term volatility based on economic uncertainties. I like the long-term potential for Arch's products and give the stock a solid two barrels. (For an explanation of our barrel rating system,

see our description.)

News in the Barrel

I had a chance to catch up with a host of companies at last week's SunTrust Robinson Humphrey institutional investor conference. Here are some quick observations.

The good news from

Cost Plus World Markets

(CPWM)

is that most future growth will be away from California. While California has been good for Cost Plus, geographic diversity will help the company become less dependent on the volatile West Coast market. I was also surprised that the average visit to a Cost Plus store is nearly 50 minutes, a big number for a specialty retailer.

I'm impressed with the advances in cryogenic therapy being developed by

TheStreet Recommends

Endocare

(ENDO)

. Treatment of prostate cancer remains Endocare's breadwinner, but the application of similar technology to liver cancer and breast cancer holds tremendous potential.

Speaking of new medical technologies,

SurModics

(SRDX) - Get Report

remains intriguing. Its partnership with

Johnson & Johnson

(JNJ) - Get Report

is on track, and additional partnerships with other stent manufacturers are pending or in early stages. A base in the low $40s provides a good entry point for longer-term investors.

The room for the

NetBank

(NTBK)

presentation was packed, especially telling as the last one scheduled that day. The bank continues to grow and stay focused on customer relationships, and, if the crowd is any indication, investor interest is high.

After listening to

Quanta Systems

(PWR) - Get Report

and analyzing the

Aquila

(ILA)

earnings shortfall, I think Aquila's ability to win a proxy fight is weakening and an outright takeover of Quanta by Aquila is increasingly unlikely. Although I like Quanta's business as the economy recovers, I think the stock will tread water over the short term.

Finally,

Witness Systems

(WITS)

used the conference to dampen expectations for the second quarter, and that took a toll on the stock. The stock is up from its

first mention last October, but it has lost significant ground in the past two weeks. Though the business model is intact, short-term weakness is possible.

Do you have candidates for Bottom of the Barrel? If so, shoot me an email with the company's name, why you think it qualifies, and your full name and hometown. If I profile your suggestion, I'll send you a

TSC

gift to commemorate your pick.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to

Chris Edmonds.