Chain reaction

13 September 2004 00:01  [Source: PCE]

Fine and speciality chemicals firms are struggling to make money, but with feedstock prices high, companies further down the chain suffer. PCE looks at what’s been going on

The best business analysts have sophisticated models for forecasting economic patterns. They don’t just rely on historical data because they know that’s not necessarily a good guide to what will happen next.

Certainly, anyone looking only at the recent slew of first half reported profits in the fine and speciality chemicals sector would despair for the sector’s future. Some of the best known names in the industry are struggling to cut costs as revenues and profits tumble. The fall-out from the rash of over-building in the late 1990s is still working its way through the system and the extra competiton from increasingly sophisticated – in terms of technology and marketing savvy – players from China and India is making it hard for western fine chemicals firms to make money.

And this year, fine chemicals firms have had to endure higher raw material costs. The big, diversified speciality producers have some measure of resistance to high raw material costs as well as pockets of stronger growth where margins can be made, but the smaller companies are still exposed.

While there is considerable momentum upstream pushing down the chain, higher prices for one chemical maker are higher costs for another. So when you get far down the chain to custom synthesis, for example, there is a squeeze going on, with high raw material costs on one side and customers on the other that are very resistant to price rises.

But there are signs, albeit tentative, that things may be changing. Certainly the sentiment at the last big industry trade show – Chemspec Europe, held in Amsterdam in late June – was more positive than it has been for a while.

The big news at that show was that Sigma-Aldrich of the US had made yet another fine chemicals acquisition, in a move which analysts suggest could mean the fine chemicals sector has begun to move away from the bottom of the cycle.

St Louis, Missouri-based Sigma-Aldrich went three years without making an acquisition, but in the past three months has snapped up two good businesses, demonstrating that there are opportunities in pharmaceutical intermediates where the prospect of profitable growth is possible.

At Chemspec, Sigma said it would buy Tetrionics, a producer of a broad range of molecules, but with emphasis on high potency and cytotoxic compounds, a focused and high-value field in itself. In April, it acquired Ultrafine of the UK, another company that is active in niche, high-value pharmaceutical intermediates markets.

These purchases will fuel Sigma-Aldrich’s growth strategy and its shift towards pharmaceuticals intermediates synthesis. But, more importantly they are widely expected to do so profitably.

Historically, Sigma-Aldrich has grown steadily stronger, but recent growth has been hard to find. Stumbling economies and the pharmaceutical industry’s woes have hit intermediates manufacturers and laboratory chemicals suppliers alike.

Tetrionics adds new niche expertise, president of Sigma-Aldrich Fine Chemicals, Frank Wicks, said when the acquisition was announced. High potency drugs are one of the fastest-growing segments of the pharmaceuticals industry, with roughly 25% of all new drugs under development falling into the category. Wicks and others express confidence that as populations in the developed world age, demand for drugs of this type will increase.

When combined with the earlier purchase of Ultrafine, Sigma-Aldrich has reached its goal of adding 2% to its annual internal growth through acquisitions this year. Importantly, Tetrionics is expanding production facilities, thereby adding growth potential in this fast moving and highly specialised market.

Sigma Aldrich’s positive analysis of the long-term future of the market is probably not misplaced. The biggest customer group – Big pharma – is showing signs of a revival.

Consultancy IMS Health has reported an 8% growth in drug sales in 13 key markets in the 12-month period from June 2003 through to May 2004, closing at $330bn. IMS said retail pharmacy sales for these key markets had an 8% growth at constant exchange rates to May 2004. Sales in the top five European markets showed a 6% constant exchange rate growth. North America posted a 10% growth in sales in the 12 months to May. The key therapy growth area for North America was the central nervous system group, with 23% growth. Japan’s overall growth was estimated at 3%.

Having said that, a lot of good companies are having to make difficult decisions to keep their businesses healthy.

Among them is Siegfried, the Swiss fine chemicals firm, which has just announced it is to lose 130 jobs as part of a cost-cutting exercise in its pharmaceutical business. This followed the posting of half-year results showing profits down by more than half.

Higher costs in pharmaceutical chemical production, lower capacity utilisation and inventory reductions led Siegfried to post profits for the first half of SF20.1m (€13m/$16.1m), down by 53% compared with the same period in 2003. However, last year’s first half included a one-time licensing income of $6m.

Group sales were barely down at SF172.3m, just 2.4% off last year’s heady levels, as the successful launch of a major product by the Siegfried Generics business unit almost fully compensated for the loss in sales of the Siegfried Actives unit.

To assure profitability and sustainable savings of SF25m/year, Siegfried will carry out a comprehensive restructuring of its pharmaceutical business – Siegfried Division. The 130 jobs will go from the firm’s facilities at Zofingen in Switzerland and Pennsville in the US, says Siegfried Division’s chief executive officer Douglas Günthardt. Restructuring costs of SF15m will accrue during the second half of 2004.

The Siegfried Division expects lower revenues and operating profits for the second half of 2004. Inventory reduction will continue for the rest of the year. EBIT will remain above 10% (before reorganisation costs). Based on these results, the Siegfried Group expects a consolidated net profit of CHF15-20 million. A return to growth is expected by the second half of 2005.

A major new product was brought into production at the beginning of 2004 and the division’s pipeline remains solid for the mid-term.

The development department in Zofingen is booked solid, and management expects this to contribute to positive revenue growth for custom manufacturing by the second half of 2005. Thanks to the reorganisation, operating results will improve in 2005.

Also reporting first half results recently was Degussa, which did a lot better in the second quarter as volume demand increased, even though prices were under pressure. Given the threat to margins from higher feedstock costs, however, management provided a cautious outlook.

On the cost front, the company is already feeling the unpleasant impact of higher raw materials costs, but second quarter sales growth of 6% (to E2.9bn/$3.6bn) was driven almost entirely by volumes. Profit growth was significant at 13%, to E264m, aided by restructuring and tighter cost control.

The outlook is a lot brighter with global economic recovery the driving force. Yet the company notes in the second half the recent sharp hike in raw material costs will dampen EBIT momentum. The strength of the euro hurts a company such as Degussa too, although the year-on-year impacts will weaken over the remainder of 2004.

Clariant’s second quarter financial results reflect gathering strength in speciality chemicals markets, but also ongoing price pressure. Management has achieved a great deal this year with key asset sales and financial and business restructuring so the company is in a much stronger position from which to fight back. The so-called transformation programme that has targeted costs across the board has begun to bear fruit.

Chief executive Roland Loesser says Clariant now is back on a strong financial footing and its growth rate and operating result ‘give us a lot to be proud of’. But Clariant still has problems.

Profits in the second quarter were up 8% for pigments and additives, 24% for masterbatches, 2% for functional chemicals and 14% for the continuing life science and electronic chemicals division operations. Late last month Clariant announced the sale of its AZ Electronic Materials business to private equity firm Carlyle and this is now classed as a discontinuing operation.

A major divestment for Clariant was the sale of its Lancaster Synthesis catalogue business unit to Johnson Matthey for some SF32m (€21m/$26m). Clariant acquired Lancaster in 2000, when it bought UK-based BTP. The deal marked the end of its build-up of a substantial fine chemicals and custom synthesis business through the late 1990s.

Lancaster’s operations are a neat fit with Johnson Matthey’s research chemicals business, and should allow the UK company to improve its market share and increase operating efficiencies. Loesser says: ‘We have come to an agreement with Johnson Matthey in a mutually beneficial way – it is an excellent company.’ He added that the disposal is part of Clariant’s strategy to sell businesses that are non-core.

‘Clariant paid top dollar for those assets just before the fine chemicals industry went into a prolonged downturn,’ says one analyst. The analyst says the disposal of Lancaster, which is expected to be completed by the end of September, reflects Clariant’s radical restructuring plan announced last August. The plan aims to improve group profitability through the disposal of more than SF1.5bn of assets, closure of plants and jobs cuts.

Clariant has sold its AZ Electronic Materials business unit to US-based private equity firm Carlyle Group for SF518m. AZ supplies materials to the semiconductor and flat panel display industries. It has 800 staff at production and R&D sites in France, Germany, Japan, Korea, Taiwan and the US. The business reported a 2003 operating profit of SF41m on sales of SF441m.

Clariant’s hard-pressed life sciences and electronic materials division is in future to specialise in custom synthesis for the life science industries.

Meanwhile, Lonza reported a 37% fall in first half operating profits as it continued to suffer in an overcapacity-ridden market. In addition to the expected problems in custom synthesis, Lonza’s results showed there are now problems filling bio-based production capacities.

Getting out of this bind will take time, although producers can be relatively confident of better times in 2005.

But, as Lonza management has pointed out, so much is up for review. Speciality producers have to look to costs as do all other makers of chemicals and Lonza has already said that this year will be one for rebasing the business to match market conditions.

It is likely for most fine chemicals manufacturers that the strategic review process for all businesses will be ongoing until the end of the year at least. But that way they will be ready when the upturn gathers momentum.

CLARIFICATION: The June issue of PCE carried a feature on the demand for pharmaceutical fine chemicals and plant under the title “Pharma boom”. The picture on page 3 was meant to illustrate the type of equipment the article refers to without suggesting that this particular piece is installed in China. The picture shows part of an EMS Dottikon facility in Switzerland.

A sure-fire move

Lanxess will have its work cut out to prove itself as an independent entity after being spun out of Bayer. But most analysts agree that its mix of speciality assets are strong enough to give it a good chance of success

The management board of German chemicals and life sciences group Bayer said Lanxess will be spun off to the group’s shareholders and have a separate stock exchange listing from January next year. Bayer had been considering an alternative option of launching Lanxess through an initial public offering (ipo). However, although this option was considered carefully, Bayer chief executive officer Werner Wenning made it clear this had now been dropped in favour of a prompt decision to offer Lanxess to existing company shareholders.

Stockholders will be asked to give their consent to this move at an extraordinary stockholders’ meeting in mid-November. Details of how the spin-off will be carried out will be given in the notice of the meeting.

Lanxess designated chief executive officer Axel Heitmann said his firm will continue working to get the new company off to a good start.

Lanxess, which has been operating separately from Bayer since 1 July, could have a market value of at least €1bn, according to estimates given by Bayer earlier this year. The Lanxess business, which includes Bayer’s intermediates, performance chemicals and performance plastics activities, reported first quarter earnings before interest and tax (Ebit) of €75m on a turnover of €1.48bn. It has around 20 000 employees and generates annual revenues of approximately €6bn.

Until the stock market flotation, Lanxess will operate under the umbrella of the Bayer holding company.

Bayer will in future concentrate its resources on the innovative areas of health care, nutrition and high-quality materials and thus, it hopes, establish a sound basis for sustainable growth. I’m convinced that both companies will enjoy considerable success in the future,’ said the Bayer chief executive.

Heitmann says he is satisfied with the progress of the carve-out process so far. In just over half a year, the activities of Bayer Chemicals and Bayer MaterialScience transferred to Lanxess, and parts of the service companies have been molded together to form a new organisation. ‘What we have to do now is use our strengths to their full advantage so as to achieve a competitive result and to ensure Lanxess a smooth transition to becoming an independent company outside the Bayer Group, he said. ‘That’s why it’s still important to seize every single possibility for cutting costs and grasp every new market opportunity.’

Despite a 2.1% decline in sales to €1.478bn (2.2% up in local currencies), the consolidated business results for Lanxess in quarter one 2004 showed a 5.4% improvement in Ebitda to €136m. Compared to the same period in 2003, Ebit grew by €58m to €75m.

The Lanxess portfolio makes it one of Europe’s biggest speciality chemical firms, producing basic and fine chemicals, colour pigments, plastics, fibres, speciality rubbers and rubber chemicals, leather, textile and paper chemicals, material protection products and water treatment products.

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