INSIGHT: Niche commodities may hold up well in uncertain market

30 August 2011 16:34  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS)--Gauging the impact of slower economic growth and weaker market sentiment on volumes and prices is hardly easy. Commodities tend to react immediately when times turn bad. The turndown in specialties is likely to materialise a few months later, depending on feedstocks, the length of the process chain and end-use market fundamentals.

But there are so-called “niche” commodities that look as though they might hold up well in the midst of global market uncertainty. Take the polyurethanes precursor methyl di-p-phenylene isocyanate (MDI) and polycarbonate.

In an investor note on Monday, Bernstein research said: “We remain mildly positive about [Bayer] MaterialScience (because of high margins for ‘niche’ commodities – commodities with pricing power thanks to a highly concentrated supplier base – such as MDI and polycarbonate), but earnings growth will slow.”

The brokerage, which is part of Hong Kong-registered AllianceBernstein, put a target price of €50 ($72) on Bayer shares but said it did not “see much in the way of near-term events that will make it appear to be batter value than its peers”. Bayer was trading at just above €44 in Frankfurt on Tuesday afternoon.

Germany-based Bayer holds materials, crop-protection and pharmaceuticals businesses. Its shares have fallen by 21% in value since the start of July, while Germany’s DAX stock market index has dropped by 25%.

Bayer MaterialScience volumes are expected to fall but margins less so because of the niche nature of its major products. “We expect volume growth to weaken slightly to 3% in 2H [the second half of] 2011 and 3% in 2012 due to the weakening economic environment,” Bernstein chemicals analysts Jeremy Redenius and his colleagues say.

Bayer MaterialsScience earnings growth is expected to slow to 2% year-on-year in the second half of 2011 and be 5% in 2012 but earnings before interest, tax, depreciation and amortisation (EBITDA) margins to hold up reasonably well.

A 1% volume decline in the second quarter is seen as being related to one-off factors, such as destocking by customers because of falling oil prices and the anticipation of the start-up of the company’s toluene diisocycanate (TDI) plant in China, as well as new polycarbonate capacity coming on-stream in Saudi Arabia.

EBITDA margins for the Bayer sub-group in the second quarter fell by 50 basis points year on year after a good performance in 2010.

“We expect BMS margins to remain at current levels (still below the highs seen in 2005) as prices in most products are maintained due to the oligopoly structure [where a particular market is controlled by a small group of firms] . Industry sources show prices for MDI remaining flat in Q3/August, despite falling raw material costs (eg benzene prices are down 5% quarter on quarter in August in Europe, Asia and North America),” Bernstein research says.

“Polycarbonate margins also appear stable. However, TDI prices in WE [western Europe] have fallen and toluene costs have increased so we expect to see TDI margins contract,” it adds.

August MDI prices in Europe were reported flat by ICIS at the start of the month. Softening demand was helping to push benzene prices down at the month's end. The extent of the weakness, however, remains to be seen.

At the time of the second-quarter report, Bayer MaterialScience guidance was to “grow EBITDA before special items at a higher rate than sales”, although the company admitted that the target was increasingly ambitious.

Bernstein has repeated an earlier scenario analysis for the sub-group that shows how Bayer MaterialScience volatility could hurt or help the parent company’s earnings this year and next. In a slowdown where volume might fall by 1.5% in the second half of 2011 and be flat in 2012, group earnings per share in 2012 would decrease by 3% and the target share price by €2.

A more optimistic scenario of 5% volume growth in both periods suggests 2% higher 2102 earnings per share and a target share price up by €1.

The chemicals markets are not yet signalling demand destruction but if volume growth crashed at it did in the second half of 2008, Bayer’s 2012 EPS would fall by 19% and its share price by €7.

Volatile chemicals provide Bayer with volume growth and the opportunity to tap into wider geographic markets. Profit margins have been improving, making the business even more attractive.

But if times get hard, then chemicals can demonstrate their ability to disappoint. The concept of “niche” commodities can be tested to the full.

($1 = €0.69)

For more on Bayer visit ICIS company intelligence
For more on MDI, TDI and polycarbonate see ICIS chemical intelligence

By: Nigel Davis
+44 20 8652 3214

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