INSIGHT: Specialty chemicals look to pricing power

08 May 2008 17:08  [Source: ICIS news]

By Lucy Craymer

 

LONDON (ICIS news)--If European specialty chemical companies were being given report cards they would be receiving As for effort but their marks for performance would probably be further down the alphabet.

 

And as analysts go over first-quarter results with a fine toothcomb searching for clues on the outlook of these companies, the question is: who makes the grade?

 

Or rather, do companies have the pricing power to meet the increased cost of key raw materials and production, ING analyst Paul Satchell asked on Thursday.

 

Satchell said the industry had lost a lot of its pricing power over the last five years as it matured and consumers looked for competitive value rather than innovation.

 

“Previously, having the better product won the day,” he said adding that now prices played a significant role in where downstream suppliers sourced their material.

 

But chemical companies, especially those in the specialty sector, need to hike prices if they want to counter the swathe of economic difficulties, from the weaker US dollar to slower demand for products and increased feedstock costs.

 

Specialty producer are less immune to the weak US dollar because their products are more easily transportable and so are often sold in dollars outside the region, said Satchell.

 

Those produced on a euro cost basis are often sold for US dollars in other regions, meaning companies are forced to squeeze margins to compete with those who produce in dollars, he explained.

 

The weakened US dollar further impacted European companies because when dollar sales were converted back into euros for reporting purposes they were worth considerably less than they were a year ago.

 

Swiss specialty chemical companies Ciba and Clariant, and their French counterpart Rhodia, have already restructured, divested and hedged currency to counter this and so now a lot of their future earning ability hangs on whether they can persuade their customers to pay more.

 

And in the last quarter it was Clariant, which showed it was able to change its business model and increase its ability to do this.

 

“Clariant was able to raise prices by 4% in the first-quarter, the highest in memory,” a Citigroup analyst report said.

 

Its results reflect this. Defying expectations it posted a marginal year-on-year rise in its first-quarter operating income to Swiss francs (Swfr) 140m ($134.6m/€86.9m).

 

Prior to this, Clariant had looked to be the weakest in terms of pricing power but it managed to turn itself around, Satchell said.

 

“It is trying to build service in as part of its product model,” Satchell said, explaining how Clariant was now supplying support services to encourage buyers to use it as a supplier.

 

But Citigroup analysts are “sceptical” that Clariant can maintain targets.

 

“We believe that a lack of fundamental pricing power in large areas of its portfolio will continue to put pressure on margins,” they said in a report.

 

“The company’s increasing focus on adding service content to its product offering is, in our opinion, only likely to increase the long-term cost structure of its portfolio without adding much to top-line growth,” it added.

 

But Clariant’s CEO Jan Secher said the company was committed to an improved operating margin and a continued strong cash flow from operations by the end of the year.

 

Rhodia too managed to increase its prices but it was not enough. Its 4.8% increase only offset 75% of the increased raw material costs and currency impact.

 

The increases in key feedstocks prices were described as “unrelenting”, Rhodia said.

 

As a result, the company’s first-quarter operating income took a hit and was down 6% to €99m year-on-year.

 

Rhodia CEO Jean-Pierre Clamadieu continued to argue that the company had the pricing power to continue to increase prices to “defend Rhodia margins”. But Citigroup analysts are less sure.

 

“Rhodia had demonstrated strong pricing power in the first half of 2007, but this ebbed somewhat,” a report from the bank said on Thursday.

 

“US polyamide competitors used their currency and cost advantages to undercut Rhodia’s pricing. Management expects to eliminate the lag but we are sceptical given uncertain demand,” it said.

 

Clamadieu said the company was also trying to sell as much as possible in the currency that the product is produced in or the region where it is sold.

 

This means the company is in discussions to change some contracts in Europe, which had been agreed on in dollars but that Rhodia would now like to be sold in euro.

 

In the medium term we need to increase production in Asia as products are sold in US dollars, he added.

 

But while the company expects its 2008 earnings before interest, tax, depreciation and amortization (EBITDA) to be within 5% of what it achieved in 2007, Citigroup is forecasting a 10% year-on-year EBITDA decline.

 

After the first-quarter it is Ciba wearing the dunce's cap with a 20% fall in its first-quarter operating profits to Swiss francs (Swfr)107m ($103m/€66m) year on year.

 

Much of this has been blamed on technical problems “at three major sites” and start-up costs at Ciba’s new Singapore plant.

 

And after the poor start to 2008, Ciba CEO Brendan Cummins has highlighted sales prices as an area that needs work.

 

“A number of sales price increases have already been initiated to mitigate the impact on the margins of the raw material cost increases,” Cummins admitted.

 

“However, there is always a lag between the increased costs and their taking full effect in the form of increase sales prices."

 

The weak US dollar, high raw material costs and the slowdown in the economy are all causes for concern for the European specialty producer and it is the strength of their pricing power that will see them make the grade.

 

($1 = €0.65/$1 = Swfr1.05)

 

To discuss issues facing the chemical industry go to ICIS connect

 

By: Lucy Craymer
+44 20 8652 3214

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