INSIGHT: Discounting the volume dip

30 September 2011 17:41  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS)--Cefic’s revised EU chemicals growth forecast for 2011 takes us back to where – late last year – we were expected to be. And the question remains: where do we go from here?

JP Morgan Cazenove’s European chemicals analysts revised down their earnings estimates for sector companies in a report released on Wednesday, based clearly on increasing risks to economic growth in forecasts for Europe and the US.

Cefic reverted to forecasting a 2.5% output growth for EU chemicals in 2011 – it raised the forecast to 4.5% in June, following a strong first five months of the year.

The JP Morgan team ratcheted down their earnings estimates significantly for some players, but on average dropped them by 6% for 2011 and 16% for 2012.

The bank’s current investment case is based on a “mild economic contraction” in the US and the eurozone. It translates into a 1.5% cut in the volume growth forecasts for chemicals, and softer pricing.

Europe-based chemical companies currently, almost without exception, continue to operate with a firm order book. They can’t see far into the future, but they are not picking up any signs of a sharp slowdown.

“Growth is expected to fall markedly in third quarter 2011, but this is considered a temporary pause – no 'double-dip' is expected,” Cefic said on Friday.

Data for the first seven months of 2011 show chemicals production was 3.2% below the 2007 peak, but the European trade group forecasts that it will reach the pre-crisis threshold toward mid-2013.

The JP Morgan chemicals team in Europe, notes that there are further downside risks to its forecasts.

Most financial analysts’ earnings estimates for European companies in the sector are as much as 23% above the median of the long-term earnings trend. In other words, 2011 earnings estimates have been set high, following the continued bounce back in the first half.

And companies have given themselves some leeway for making downward adjustments to earnings guidance.

Profits targets for 2011 have been set in broad terms, and are dependent on conditions remaining as they were in July and August.

“Akzo is at the forefront of expectations of a lowering in guidance since the previous profit warning in June, while we believe Wacker, Symrise, and Kemira are all at risk of guiding down before the year end,” JP Morgan said of the quoted European chemical producers it follows.

Not all the companies it tracks are equally exposed to a slowdown in demand. Some firms, such as the UK’s Johnson Matthey, Croda and Victrex have a lower fixed costs base than others.

Companies such as Switzerland’s Clariant, AkzoNobel of the Netherlands and Finland’s Kemira have less cost flexibility, and might be expected to be harder hit by a volume contraction in 2012.

The volume of chemicals sold in emerging markets also needs to be taken into account.

Emerging market sales growth is likely to continue to benefit many firms in 2012, although they will still be exposed to the impact of lower levels of demand overall. Chemical producers will suffer greatly should emerging market growth stall.

The bank’s current 2012 earnings forecasts, although revised down sharply for some European chemical companies, are still significantly higher than earnings achieved in 2009.

“On average, we forecast 2012e EBITDA [estimated 2012 earnings before interest, tax, depreciation and amortisation] to be 78% above [adjusted] trough EBITDA,” the analysts say.

“We see inventory levels as lower than was the case in mid-2008, and hence the risk of aggressive destocking remains lower. Furthermore, company balance sheets have typically strengthened over the past two years, and this should support multiples above the prior trough levels.”

The 2009 earnings low point is seen as a good reference point – estimated comparisons with currently forecast 2012 earnings are shown in the chart below.

“Earnings-based valuation multiples suggest the sector is now attractively valued, but relies on the significant caveat that our revised earnings estimates turn out to be reasonably accurate,” the JP Morgan European chemicals team says.

“Given the uncertainties surrounding the pace of global economic growth, earnings-based valuations are likely to remain peripheral in driving share price performance until visibility over global growth improves.”

2012 compared to the trough

By: Nigel Davis
+44 20 8652 3214

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