INSIGHT: Chem makers face credit squeeze

06 May 2008 17:34  [Source: ICIS news]

LONDON (ICIS news)--There are already signs that some chemical producers could struggle as they work to complete expansion projects in the teeth of the credit crunch and the expected sector slowdown.

Credit rating agency Standard & Poor’s warned last week that its ratings of some firms in Europe and the Middle East would be under pressure if an industry downturn took hold.

That is widely expected given the build-up of olefins and polyolefins capacity in the Middle East and Asia and the threat to supply/demand balances and operating rates.

The jury is out on the extent of the slump but industry executives are talking about tough times persisting for about two years. So if your credit is overextended now then the next 24 months could be tough indeed.

S&P flagged up the pressure on Kazanorgsintez almost immediately after its initial report when it highlighted the fact that Russia’s largest polyolefins producer had requested a covenant waiver on an outstanding portion of a $200m loan.

The company was put on S&P’s CreditWatch, meaning that the ratings agency could not be certain that the Tatarstan producer would have sufficient funds to cover payments on the notes maturing in 2011 if early redemption was requested.

Kazanorgsintez is adding new polyolefins capacity and getting into polycarbonate production although its intermediate and polycarbonate plants are about a year behind schedule.

Yet Kazanorgsintez, alongside some other players in chemicals, most notably those in upstream petrochemicals and plastics, have been riding the good times and have proved that they are able to generate considerable amounts of cash.

Indeed, that is what this business is all about. The cash flows in the good times but the tap can, quite easily, be turned off.

Kazanorgsintez is not so much short of the ability to generate cash as of cash itself. There is also no indication that this is a sign of times changing and the business environment turning for the worst. Yet the threat is there.

Kazanorgsintez had a cash flow of just $5m at the end of March according to S&P. It can ride out its present troubles but will have to hope that the world does not turn too quickly, or too sharply, against it.

S&P is also a little more concerned now than recently about five other issuers of debt in the European chemicals sector.

The list includes INEOS, Dynea, LyondellBasell, Lucite and Cognis. These companies, and Kazanorgsintez, are likely to be vulnerable, the ratings agency suggests, because their balance sheets “do not allow for a prolonged downturn, significant earnings deterioration or refinancing needs”.

It is encouraging, however, that 80% of the 28 companies S&P covers in Europe and the Middle East appear to be in a relatively strong position.

The others are generally more exposed because their owners have more aggressively sought expansion, either through acquisition, as in the cases particularly of INEOS and LyondellBasell, or through increased spending on capital equipment.

The highest ranked companies on S&P’s list of issuers on chemicals from Europe and the Middle East chemicals are BASF, SABIC and Qatar Fertilizer Co (QAFCO).

S&P not surprisingly expects chemicals players to be more conservative financially and to move away from the aggressive debt financing of 2006/07 in preparation for the downcycle.

It expects a demand slowdown in Europe to hit the sector first and before operating rates start falling in some products because of overcapacity.

To weather the storm companies will have to fall back more on their competitive advantages in technology or service and either absorb or pass on raw material cost inflation.

Geographic diversity is also expected to be a saving grace. North American producers particularly in the latest reporting period have highlighted ongoing performance and growth in Asia, Eastern Europe and to some extent in Latin America.

It may not be long before European producers say the same thing.

Companies of most types are being hit by raw material cost inflation. The specialty makers, alongside the region’s petrochemicals players, are expected to be hit by higher costs in 2008.

They are also more sensitive, S&P notes, to the depreciation of the US dollar, but would benefit from weaker petrochemical prices.

Volumes have held up reasonably well in the first quarter for Europe’s chemicals players but the rest of the year, particularly the second half, is likely to be tougher.

In the last economic downturn in 2001, S&P says its rated issuers faced about four quarters of weak volumes. An estimate of the extent and depth of the forthcoming downcycle has yet to be made.

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By: Nigel Davis
+44 20 8652 3214

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