How chemical companies can plan and manage investor relations for the market upswing

Chemical bonding

08 December 2008 00:00  [Source: ICB]

Given the state of the global economy, a company's business plan and investorrelations strategy should be linked to prepare for the inevitable upturn

THE GLOBAL financial crisis and the onset of recession have slashed chemical and material stocks recently. The S&P Chemical Index is trading at a multiyear low, and approximately 50% below its peak. Several chemical stocks have been trading at levels last seen more than a decade ago, with some specialty chemical stocks trading at levels normally reserved for commodity stocks at the bottom of a cycle.

There is consensus that the industry has yet to feel the full brunt of a global recession. We expect headwinds in the stock market to continue into 2009, with some chemical companies facing heavy selling pressure. Executives need to act now to stem the decline in their firms' stock prices, reduce their vulnerability to unsolicited takeovers, and prevent activist shareholders from taking the initiative. However, they face a growing gap between investors and management in their perception of chemical industry equity values.

Today's institutional investors are more sophisticated than just a decade ago. They are well versed in companies, their businesses, and the markets in which they compete. Long gone are the days of one-sided investor meetings in which executives talked while investors took notes. Now, investor meetings involve a dynamic two-way flow of valuable information.

Against this backdrop, management teams need to recognize that investors will hold them to a higher standard than in previous downturns. Investors will not hesitate to challenge company perspectives, especially where they perceive inconsistencies. As a result, companies once commanding premium specialty chemical equity valuations will have to work hard to earn even what was deemed a modest commodity chemical valuation just a few quarters ago.

What can companies do? We believe firms need to take three essential steps: first, ensure that internal perceptions of performance and prospects are aligned with external realities second, determine how to survive in the short term while positioning to benefit when markets inevitably rebound and third, ensure that internal business strategies and external investment theses are integrated and transparent to investors.

PERCEPTION IS EVERYTHING

Given the severity of the downturn, it is likely that internal perceptions of business performance and prospects are out of alignment with the new competitive environment and more critical investor expectations. Many chemical companies face the increasingly difficult competitive environment from a position of weakness.

Even during the "good times," some firms focused on cost reduction rather than top-line growth. Others chose to boost the top line, but did not deliver the expected growth in earnings and return on invested capital. In several instances, "strategic" acquisitions have been made that were neither strategic nor accretive. These issues inevitably affect investor expectations and feed through to equity valuations, along with other factors such as the degree of hedge fund activity (that is, short selling).

Once companies have a realistic view of their performance and potential, they should be in a better position to formulate effective strategies and contingency plans for 2009.

For many companies, cost reduction is clearly at the front of their minds in any downturn, and opportunities to improve efficiency are likely to exist in the organization. However, the critical challenge will be to balance the need to weather the short-term crisis while retaining a secure platform for growth. Sophisticated investors will be concerned about potential constraints to longer-term value creation, particularly in firms that are already lean from previous cost cutting.

Pricing can affect financial performance to an equal or possibly larger extent than cost reductions, and price erosion can lead to pressure for budget cuts in areas key to growth. In good times, companies can capture value through price increases, particularly with new and differentiated products. As the recession takes hold, however, products that are not sufficiently differentiated will be vulnerable, and companies will have to decide how to modify price/service differentiation to reclaim value.

The changes that have taken place in the global economy add urgency to reassessing companies' business fundamentals and ensuring that the right strategies are in place. But these actions will not be sufficient to close the gap between investors' perception of equity values and management's.

Closing the valuation gap requires linking business strategies and investor relations strategies. A chemical company's strategic plan and its investor relations investment thesis are essentially one and the same. Investors oriented toward the longer term accumulate shares of a given chemical company based on their view of its intermediate term earnings and cash flow growth prospects, which largely dictate future stock price movements. To fully comprehend the company's growth prospects, institutional investors not only need to understand end-market demand trends, they also need to understand thoroughly the company's strategic plan and associated milestones against which to measure performance.

Investor relations officers (IROs) can provide this understanding, and help to close the gap between investors and managers. Today, however, few IROs are involved in executive strategy sessions and board presentations, nor are they sufficiently involved in the strategic planning process.

When sales and earnings fell in previous recessions, many executives resigned themselves to forgoing travel to meet current and prospective institutional investors, rationalizing, "We don't have a good story to tell today." This is ill advised because management silence is tantamount to capitulation, which can fuel further equity price declines.

Today, progressive managers realize that a tough economic climate is a chance to differentiate the firm from the competition. Once plans for 2009 are made, companies need to update their road show presentations and mount an aggressive marketing campaign aimed at investors and sell-side analysts.

INTELLIGENCE SHARED

The more transparent and helpful a management team, the more inclined investors are to share valuable intelligence in return. Institutional investors are a great source of competitive intelligence, given their broad dialogue with chemical industry peers and large end-users. Many company executives will admit privately that some of their best strategic ideas resulted from dialogue with institutional investors during nondeal marketing road shows.

Kline & Company and StreetSmart Strategies believe that in the next several quarters, the industry will be confronted with some of the greatest commercial and financial challenges in its history. If these are not addressed, or if business and investor relations strategies are misaligned, the impact on a company's performance and valuations will be severe. However, investors will bid up the stock price of chemical companies they believe will not only survive 2009 but also thrive in the future.

A competent and well-articulated strategic plan, seamlessly integrated with a proactive investor relations campaign, will dictate the chemical stock "winners" by this time next year.

Jonathan Goldhill is a senior vice president of Kline & Company. Responsible for Kline's management consulting activities, he focuses on strategy and innovation. Contact:

Jonathan Goldhill or +1 215 887 4257.

Tim Gerdeman, president of StreetSmart Strategies, has helped many corporations develop their financial messages and investment themes. Contact:

Tim Gerdeman or +1 312 320 3393.

Eric Vogelsberg is a senior vice president of Kline & Company, responsible for Kline's global chemicals and materials practice. Contact:

Eric Vogelsberg or +1 973 435 3466.

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