INSIGHT: Poor margin growth creates new problems

25 August 2008 14:32  [Source: ICIS news]

By Hilde Ovrebekk

LONDON (ICIS news)--The chemicals industry is bracing itself for the downturn and operating margins are starting to show the difficulties faced by companies over the next couple of years.

Following disappointing second-quarter results from Ciba on 20 August and LyondellBasell a day later, analysts said the industrial slowdown was just beginning and trading conditions were expected to worsen over the next year.

Producers have been continually trying to raise prices to correct margins, but with mixed fortunes.

Dow Chemical said in mid-August that it intended to increase European polyethylene (PE) prices by €50/tonne ($74/tonne) in September due to lost margins, despite a recent fall in the price of oil, stating that in January to May it had seen a huge margin compression.

Buyers, facing their own margin struggles, reacted strongly, calling the proposed hike an insult.

The problem next year will be the increased capacity due to come on stream in Asia and the Middle East, and a potential lack of demand in Europe as a recession looms.

As a result, there has been a spate of downgrades in ratings, earnings forecasts and outlook for chemicals companies, the latest for Ciba and LyondellBasell.

So, what happens then? Demand is still growing for chemicals around the world but it has showed the first signs of slowing down, says Tobias Mock, credit analyst at Standard & Poor's. It could take longer before the overcapacity is consumed.

The industry is used to cyclicality, says Mock, and margins in the past have been pretty good.

However, during previous downturns global competition has not been as intense as it will be in coming years.

And, at the moment the margin impact is stronger in Europe than it has been elsewhere as companies in the region have been badly hit by negative currency effects caused by the weaker dollar.

Ciba’s first-half sales, for instance, fell 5% in local currencies but when currency effects were taken into account they dropped 7%. 

Producers are then faced with the task of making up for lost margins elsewhere in the business, and what normally goes first is a cut in capital expenditure (capex).

What the European chemicals industry will look like in five years is hard to say.

But without the additional cost available to upgrade plants or invest in new facilities, the industry may have to deal with an ageing population of plants.

This is an industry where you continue to need investment, says Andrew Spiers, senior vice-president of global chemicals at Nexant Chemsystems.

 

He says money needed for capex and other essential programmes such as maintenance may be more difficult to ask for.

 

Certain locations will need  investment to stay in the game, and at some point in future there may be difficult decisions to make, such as idling plants or selling on. In the long term, this downturn may bring on some consolidation, says Spiers.  

 

And as credit ratings fall, this will boost companies' cost of borrowing, further increasing pressure on margins.

 

So, European chemicals producers' futures seem dependent on a number of factors out of their control, including of course oil price volatility.

 

A longer than expected economic downturn may have dire consequences for some, especially those with unfavourable product mixes.

 

($1 = €0.68)

 

Click here to find out more on the European polyethylene margin report

To discuss issues facing the chemical industry go to ICIS connect


By: Hilde Ovrebekk
+44 20 8652 3214



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