Recovery from trough of current cycle will be slow and uncertain

07 May 1992 00:00  [Source: ICIS news]

Increasing pressure on prices and the growing negative effects of recession typified operating conditions for the chemical industry in 1991. There are few signs of any real improvement as yet and there is considerable nervousness in the industry, although it is widely felt that the bottom of the cycle has been passed. The consensus of opinion is difficult to disagree with and it is that recovery will be a long and slow process.

The financial results of the leading companies which are presented in this issue of Insight show the extent of the downturn but also indicate that it has been less severe than that in the early 1980s. There are a number of reasons for this including the fact that most companies were better placed at the turn of the decade to weather the forthcoming storms and that some of them acted to trim expenditure at the first signs of market weakness.

Company results show extent of decline in petrochemicals

The low point of the petrochemicals cycle is particularly apparent, with companies heavily involved in commodity products reporting the steepest drop in earnings. The table published on page two of this issue shows the extent of the decline for companies such as Dow, DSM and Occidental and the losses of BP Chemicals, Norsk Hydro and Union Carbide. However, it masks the fact that most companies in commodities saw the profitability of these operations plummet.

The early part of the year was characterised by uncertainties surrounding the outcome of the Gulf War but its successful conclusion did not bring the predicted market upturn. Business conditions did not improve as expected and it appears as if the bottom of the cycle was reached in the third quarter or thereabouts. Spending was constrained throughout the year and companies took charges against earnings to cover the cost of reducing employee numbers and, in some cases, reorganising particular business.

Further details will be available in Insight later this year

Most companies have released their annual results although Elf Aquitaine's chemicals subsidiary Elf Atochem, EniChem and Montecatini have yet to do so. I shall give more detail later in the year when Insight's rankings of the major chemical producers are published and further information will be available in the 16th edition of Company Analysis.

Only five companies have reported an increase in sales but, in general, the falls were fairly modest indicating that demand has held up relatively well. The same cannot be said for profitability. Only two companies, Ciba-Geigy and Rhône-Poulenc, report an increase in profits, of 23.9% and 17.8% respectively. Four companies, Exxon, Bayer, Akzo and ICI contained the fall to under 10% but six of those listed reported a decline in profits of more than 50%.

Good performances from Ciba-Geigy and Rhône-Poulenc

The performances of Ciba-Geigy and Rhône-Poulenc stand out in a difficult and demanding year. Much of their success is due to the contribution of health care operations but each firm is working hard to contain costs throughout its operations. At Ciba-Geigy, the reorganisation which was begun in July 1990 and which is designed to make the organisation more flexible and responsive to market needs is paying dividends and the company attributes four fifths of the profit increase to operational improvements (Insight 484/6).

Rhône-Poulenc's figures boosted by health care result

Rhône-Poulenc has benefited markedly from the pharmaceuticals merger with Rorer and will do so in future from recent acquisitions, such as those of the speciality chemicals operations of RTZ and GAF and that of Connaught Biosciences. Last year the full impact was apparent of its strategy to grow in health care and income from this sector was 110% higher than the year before, more than sufficient to offset the rather poor performance in chemicals.

Pre-tax profits for Bayer fell by 4.8% to $2116 million and it was alone among the three German majors in holding its dividend. The strength of the health care sector was important in this regard but the earnings decline was less than in 1990 largely because of cost containment measures and the efforts made to streamline the business.

Dow retains best margin; Ciba-Geigy's performance stands out

Sales and profits of leading companies in 1991
Hoechst 31147 +5.2 16912 -20.3 5.4 -24.2
BASF 30778 n ch 13932 -23.2 4.5 -23.2
Bayer 27989 +1.8 21162 - 4.8 7.6 - 6.5
ICI 23346 -3.2 15762 - 9.9 6.8 - 6.9
Du Pont1 21092 -5.3 6973 -53.7 3.3 -51.1
Dow Chemical 18807 -4.9 16882 -34.1 9.0 -30.8
Rhône-Poulenc 16181 +6.9 8542 +17.8 5.3 +10.2
Ciba-Geigy 15538 +7.0 9444 +23.9 6.1 +15.8
Shell1 11208 -8.9 433 -95.6 0.4 -95.1
Exxon1 10649 -4.5 5143 - 1.5 4.8 + 3.1
Elf Aquitaine1 na -- 6183 -43.9 -- --
Akzo 9871 -2.3 6775 - 8.3 6.9 - 6.2
Monsanto 8864 -1.5 4422 -45.4 5.0 -44.6
Sumitomo Chem 8696 +1.6 4345 -11.8 5.0 -13.2
Solvay 8146 -0.2 3984 -21.8 4.9 -21.7
BP1 5728 -3.2 - 136 nc -- nc
DSM 5475 -8.0 3022 -39.9 5.5 -34.7
Norsk Hydro 5107 -1.1 - 363 nc -- nc
Union Carbide 4877 -7.7 -1163 nc -- nc
Occidental1 4575 -9.2 433 -79.7 0.9 -77.7
Footnotes: 1 Chemicals only. 2 Pre-tax profit. 3 After tax operating profit. 4 Net
profit. 5 Pre-tax operating profit. 6 Replacement cost operating profit. nc = not
comparable. n ch = no change. Comparisons based on domestic currencies; dollar
conversions reflect rates ruling on 31 December 1991.

These are continuing and the company has announced that a further 3000 jobs will be lost this year.

BASF does not expect much improvement this year

The outlook for Europe's major chemical companies was perhaps encapsulated best by Mr Jurgen Strube, chairman of BASF, when he said at his company's annual press conference in March that there was little likelihood of a rapid improvement in fortunes or general economic revival in 1992. Based on the evidence of the first few weeks of the year he said that earnings remained unsatisfactory and that there was no improvement in incoming orders.

BASF, whose sales held at the 1990 level but whose profits were 23.2% lower than in 1990 at $1393 million, has reported divisional earnings for the first time as have Bayer and Hoechst. The results for BASF show that income fell from all businesses apart from agriculture and chemicals. The decline in plastics and fibres was DM 455 million ($300 million) leading this business to a loss of $34 million. Losses were even greater in consumer products and were due to the difficult situation at BASF Magnetics GmbH which lost $154 million.

Selling price index for its entire product range fell by 10%

With the optimism for economic recovery confounded following conclusion of the Gulf War, Mr Strube notes that the marked decline in raw material prices from March and increasing imports from American and Asian suppliers helped depress prices for the remainder of the year. The selling price index for the parent company's entire product range fell by 10% but this masked the particularly difficult situation in petrochemicals.

The drop in sales revenue from polyolefins as a result of a fall of some 30% in product prices had a disastrous effect on margins. With feedstock prices holding, the average operating margin fell by 30%. BASF sells approximately 1 million tonnes of poly-olefins in a year and the margin decline in these sectors had an unmitigated effect on income.

Structural adjustments have added to the cost burden

Structural adjustments at the company have added to the cost burden. These have taken place in the tapes sector and elsewhere and will involve the sale of the North American oil and gas operations to allow concentration on the European pipeline business and the Midal and Stegal projects. Such reshaping exercises are rightly seen as investments for the future, although the positive influence of them in terms of an earnings improvement will not be seen until later in the decade.

The company also has an ambitious capital investment programme which includes investment in Europe at the Antwerp site. Capital investment was 7.7% higher in 1991 at $3.2 billion although this figure does not include spending on the Midal/Stegal pipeline proposals or at the Schwarzheide site in eastern Germany. BASF has to take the longer term view now regarding this investment which is costing it dear. Investment losses at BASF Schwarzheide GmbH in 1991 were DM 206 million.

Hoechst evaluates spending plans

Capital investment has also continued at a high level at Hoechst, where spending in 1991 was $2.4 billion, 5.5% higher than in 1990. However, the company is assessing investment proposals with a much more critical eye in view of the uncertain outlook. Hoechst was buoyed in 1991 by its health sector, which returned an operating profit of $816 million against $617 million in 1990, and which absorbed more than half the total research expenditure of $1.8 billion.

Hoechst sales rise of 5.2% was aided by a number of factors

Hoechst has assumed first position in the Insight table, which ranks the leading companies in terms of sales, following the 5.2% rise in turnover to $31.1 billion. This increase is, perhaps, surprising but was built on a volume increase of 2% which in itself was largely attributable to pharmaceuticals. Total sales of Celanese Mexicana were included for the first time in 1991 and there was some positive impact from movements in exchange rates. Taking these and other factors into account, Hoechst puts the sales rise at a little under 2%.

Pre-tax profits were 20.3% lower but at $1.7 billion Hoechst retains third position in the profits league table after Bayer and Dow. Profits for polymers, chemicals and colour as well as fibres were down sharply. Operating profit in the European Community, which accounts for 51% of turnover, was 19% lower while the decline in North America was of a similar magnitude despite a 7% increase in sales in Deutschemark terms.

Akzo, Bayer and ICI contained the fall in gross margin

Only two companies, Ciba-Geigy and Rhône-Poulenc saw their gross margin improve, by 15.8% and 10.2% respectively, while three other European companies, Akzo, Bayer and ICI, contained the fall to less than 10%. The steepest declines among the major European concerns were those of 34.7% at DSM and 95.1% at Shell while BP Chemicals and Norsk Hydro reported losses.

The US companies reported significantly lower profits before taxes reflecting the difficult operating conditions and the costs of restructuring which in most cases were substantial. Dow Chemical's pre-tax margin fell by 30.8% and Monsanto's by 44.6% while that for Occidental Chemical was 77.7% lower. The three companies took charges against earnings throughout last year. Dow's amounted to $370 million in the fourth quarter largely to cover the closure of facilities in Canada.

Restructuring of Monsanto's chemicals unit has begun to show results

At Monsanto, charges related to the restructuring programme were $446 million. The chemicals unit bore the brunt of related costs and reported a loss of $154 million, although these began to show their worth in the fourth quarter during which operating income improved significantly compared with the similar period of 1990. At Du Pont, charges to the chemically-related businesses were taken in the fourth quarter and amounted to $483 million.

Dow retains the highest margin in the industry despite the fact that a loss was reported for the fourth quarter and that the margin for the year declined by 31%. There are a further nine companies in the table with margins that exceed 5%, including Sumitomo Chemical of Japan. The fourth quarter loss at Dow ended a very disappointing year, according to Mr Frank Popoff, president and ceo, and one in which pricing was the major challenge. Sales volumes for Dow were 1% lower as a result of the protracted US recession but pricing affected by weak industry fundamentals declined by 4%. Lower prices accounted for 90% of the reduction in profits over the year or close to $800 million.

Dow's specialities accounted for 57% of operating income

Poor returns from commodity products have highlighted the value of closely targeted diversification into the right higher value specialities and pharmaceuticals. This has certainly been the case at Dow where the three consumer speciality businesses reported sales and earnings which were 16% higher in total. This segment accounted for 57% of operating income in 1991.

By contrast Dow's plastics businesses generated sales 8% lower than in 1990 and profits 50% down. The high volume thermoplastics, which include polyethylene and polystyrene, accounted for more than 75% of this fall in sales and profits. Chemicals and performance products profits were 65% lower with the steepest fall in chemicals and metals. Sales were lower for performance products but there was a 4% improvement in profitability.

Pricing remains the main challenge of 1992

Clearly, Dow remains in a strong position and must be heartened by the resilience during the current downturn of its strategy to grow in consumer specialities. However, Mr Popoff is right when he says that pricing remains the main challenge of 1992. Operating rates of about 85% compare favourably with those of 65% experienced during the 1982 recession and this suggests that there could be a quick return to acceptable margins once demand recovers. For a low cost producer such as Dow this may well be the case although others will find the climb back to acceptable levels of profitability more difficult.

Among the chemical subsidiaries of the oil majors, Exxon Chemical stands out for its performance in 1991. Despite the weaker economic conditions and soft margins in a number of the major products due to poor prices, volume sales remained relatively strong. The profit decline over the year was only 1.5% and this was due to the fact that US earnings were $14 million lower at $340 million. Foreign earnings were $174 million, $6 million higher than in 1990.

Shell lost $112 million outside the USA

Shell lost a total of $168 million on its chemical operations in the fourth quarter as a result of overcapacity and oversupply in its main markets. US earnings for the year were $155 million but the loss outside the USA was $112 million which compares with a profit of $680 million in 1990. Shell says that bulk petrochemical prices fell by 10% overall, and that prices for most derivative polymers fell even more sharply. The 1991 figure includes $84 million in restructuring charges.

The full effects of overcapacity and sharply lower European prices are reflected in the results from BP Chemicals which reported a loss of $12 million for the year. The figures illustrate the company's heavy dependence on the UK and the depth of the recession in the British market. The operating loss in the UK was $136 million while profit from the rest of Europe was 38% lower at $129 million. Losses in the USA were not as bad as in 1990 while the downturn in the rest of the world was about 36% to $17 million.

BP Chemicals' cost containment measures involve the entire workforce

BP Chemicals met most of its objectives last year except in terms of financial performance, says chief executive, Mr Brian Sanderson. The aim this year is to improve performance overall and reduce costs where necessary. Cost containment measures are not being imposed on the businesses but are part of a continuous process of benchmarking which is designed to involve employees at all levels.

Companies capital expenditure will fall further this year...

There is little reassurance to be gained from companies' forecasts of capital expenditure over the coming year and every indication that spending will fall further until there are much clearer signs of economic recovery. The situation in countries such as Britain is similar to that in 1982, when a spending trough was reached, although it is certainly less severe, and it has to be hoped that as the industry generally geared itself for recession at an early stage it will be one of the first sectors to see the benefits of recovery.

Capital spending declined by about 3.5% in the European Community last year and by 10.5% in the USA, according to industry association estimates, and while the outlook is uncertain, expenditure seems set to fall further. While there may well be an upturn in the USA, spending in Japan is forecast to slump by 18% while capital expenditure growth in Germany is likely to be flat. Industry spending in the OECD nations was 2.5 lower in 1991 and is likely to fall by a further 5.5% this year.

...but in Britain, smaller firms are more optimistic

The figures which have been produced by Britain's Chemical Industries Association (CIA) in its annual survey of investment intentions show that while larger companies are pessimistic about growth over the next two to three years there is a little more optimism among smaller concerns. This has much to do with perceived changes in the industry's customer base and the growth in more specialised products and services and products of high quality.

Fixed capital expenditure in the UK last year is estimated by the CIA to have been £1860 million ($3477 million) which is 13% lower than in 1990. With the country still in the depths of recession the forecast for 1992 is for a fall of 10% allowing for inflation to $3290 million followed by a slight rise in 1993. The expenditure total over the period 1992 to 1994 is $10.1 billion.

Predicted spending is 30% higher than during last recession

Predicted expenditure over the three year period is the lowest since 1984-86 but is, nevertheless, 30% higher than during the last recession in 1981-83. Britain's ability to climb out of its deepest recession since the 1930s is certainly the major factor influencing companies forward plans at present and future expenditure will be governed by the speed of recovery. There are, however, numerous other factors at play which will affect spending decisions.

These include the impact of recently introduced environmental legislation and of the integrated pollution control concept, the issue of competitive pricing of utilities such as electricity, gas and water and the lack for some firms of adequate road and rail infrastructure. There is also growing concern over the UK tax regime which is seen as increasingly unfavourable.

Expenditure related to environmental matters rises sharply

Many companies have spent heavily to comply with and outstrip current environmental legislation but capital expenditure related to the environment continues to rise. The CIA has not repeated its special environmental expenditure survey, the results of which were published last year, but has gathered more information on expenditure in 1991 and that expected until 1994.

Environmental protection spending last year accounted for 10% of total spending but companies expect this to rise significantly and to account for 25% by 1994.

Industry will spend more than $2 billion on the environment over next three years

Environmental expenditure is one of the largest cost burdens the industry faces but it is vital for future competitiveness. The share of firms' expenditure allotted to safety, health and the environment has risen threefold since 1982 and is now 25% of the total. Total expenditure related solely to the environment over the 1992-94 period is projected at more than $2 billion.

There is evidence in the CIA's figures of a swing away from petrochemicals towards speciality chemicals and pharmaceuticals. Spending in petrochemicals accounted for the largest proportion of the total last year but over the three year period covered by the survey, its share is expected to decline to put it in third place behind pharmaceuticals and specialities. This trend is also reflected in the heavy element of spending on R&D facilities.

Engineers' market has fallen by more than 50% since 1989...

The CIA data are for all fixed capital spending, which includes buildings, vehicles and rolling stock among other items. However, if these are removed from the picture then it is clear that the market for engineering contractors has declined much more dramatically. As Mr Bill Chatman, who is chairman and ceo of Foster Wheeler Ltd, points out, following the high level of activity in 1989, the engineering contractor's market fell by more than one third in 1990 and a further 20% in 1991.

Foster Wheeler's figures show that, as far as the process plant contractor is concerned, the industry reacted relatively early to the expected downturn and the number of major projects dwindled in 1991 from the number sanctioned in 1989. Its data and that from the CIA appear to be diverging which suggests that companies are spending larger amounts in areas that do not involve a process plant contractor, such as the environment and R&D establishments.

...but Foster Wheeler hopes for return of confidence in 1993

A fairly sanguine view is taken of the industry's development and Foster Wheeler expects the next upturn in UK authorisations in 1993-94. Britain's manufacturing base has not been damaged as severely as in the recession of the early 1980s and there is greater likelihood of increased downstream demand returning relatively strongly. Added to this is the fact that the perceived cost of environmental protection measures may well help to bring about some further rationalisation and help restore confidence and some plant building opportunities.

Mr Chatman rightly says that future petrochemicals expansion in Britain is dependent on capacity levels in Europe as a whole but it must also allow for the knock-on effect of new capacity in the Far East, plans for central and eastern Europe and plastics recycling. However, the North Sea still provides a real feedstock cost advantage over the rest of Europe. On balance, he expects debottlenecking of petrochemical projects to proceed by the end of 1993 or beginning of 1994.

The character of the industry's customer base is changing slowly

As the CIA's investment intention survey indicates there is a definite trend in UK chemical industry investment towards higher value added products such as specialities and pharmaceuticals and increasing investment in research and development facilities. There are certainly recessionary effects at play but the industry's customer base is slowly changing and demanding products which are more specialised and of higher quality.

The UK industry makes 70% of its sales in manufacturing but this sector of the British economy is changing rapidly as it confronts the advent of the single European market and increasing technical complexity. With these changes the prospects for growth of high volume products is waning while there are increasing opportunities for growth in value added.

This will demand closer cooperation with the customer

The CIA has identified some of these in a recent study of the customer industry base, where it also considers the relative health of various sectors of the British economy. The chemical industry has a clear role to play helping customers solve their own problems in the development of new technologies. However, this will accelerate the need for change within the industry itself and necessitate closer customer-supplier relationships, technical support and further development of partnership sourcing and joint R&D projects.

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