INSIGHT: Cutting costs further in a low-growth world

21 October 2011 16:44  [Source: ICIS news]

By Nigel Davis           

LONDON (ICIS)--AkzoNobel makes you think about coatings and decorative paints and to a lesser extent, ‘speciality’ chemicals. But is there much to read across for the chemicals sector generally from the latest set of financial results?

The world’s largest coatings producer is being forced to implement a €500m ($685m) cost savings programme to maintain profits in the face of much higher raw material costs - principally titanium dioxide (TiO2) -  lacklustre demand growth and a margin shift in its product mix.

Group earnings before interest, tax, depreciation and amortisation (EBITDA) were down 12% in the third quarter at €507m.

The sharp rise in raw material prices hit the company’s decorative paints and specialties business segments hard although these costs are likely to moderate in future.

And AkzoNobel did well to raise product prices strongly over the period. But it suffered from poor volume growth, a harbinger, perhaps, of much tougher times ahead.

“We believe management appear to be 'right sizing' the business for an extended period of depressed demand,” Credit Suisse said in a note to clients on Friday.

“The deteriorating economic conditions clause has kicked in,” Bernstein Research said is a similar publication on Thursday.

Its analysts were referring to the company’s statement that its full year 2011 EBITDA guidance remains unchanged “at least in line year on year assuming no further deterioration in economic conditions”.

Bernstein is assuming that AkzoNobel’s full year EBITDA will fall by 5% to €1.86bn in 2011.

AkzoNobel benefits from having broadly spread decorative and coatings businesses which reached down to the consumer and to important industrial sectors but is clearly feeling the pressure in the large mature markets in western Europe and North America.

One take on the results is that the market environment in chemicals has turned to the extent that developing world business is no longer capable of compensating for weakness in Europe and the US.

The latter face a miserable few quarters. Few can expect the macroeconomic situation to improve quickly. Decorative paints sales and those for many industrial coatings will not rise until it does so.

Remember it was the AkzoNobel CEO, Hans Wijers, a former economics minister in the Netherlands, who in July said: “This is a very volatile world, with very little visibility, and there are scenarios which are of course very scary”.

The third quarter of 2011 is likely to represent a tipping point for most chemical producers who currently are operating against the backdrop of weaker, or “softer”, demand growth and downward price pressure.

Even industry giant SABIC at the start of this week was able only to report flat sequential sales and net profits for the third quarter.

The company is riding high on significantly increased production capability compared with a year ago. The year-on-year increase in its third quarter net profits was an impressive 54% but sequentially profits were up 1% on a 0.3% sales increase.

“The increase in net income for the quarter ended 30 September 2011 compared to the second quarter of 2011 is contributed [to] by improvement in plant reliability positively impacting the revenues, and lower financing and operating costs,” the company said in a statement.

In the fourth quarter of 2011, and running into 2012, chemicals becomes again (it always is?) very much a costs game. The demand growth spurt following the 2008/2009 slump appears to be well and truly over.

This raises important questions about the future and about just what will sustain chemical company fortunes. Times look as though they are about to become hard again and a tough operating environment will expose companies again to industry fundamentals and long-term trends.

“Since 2000, the industry growth rate declined by half, significant reductions in selling, general and administrative expenses (SG&A) and research and development (R&D) resulted to offset declines in gross profits,” consultants Deloitte said in a report published this week.

“As the already stretched laws of diminishing returns are pressed further, the industry may not be able to rely on SG&A and R&D reductions alone and needs to examine the role of those investments in enabling or limiting growth,” it added.

Based on more than 60 industry interviews and questionnaires, the report suggests that companies need to capture more value from end-market growth than they do currently - a far from easy task.

It also suggests that the answer to growth might lie in “an updated market-focused growth model” which “could position the role for chemical companies, beyond purveyors of liquids and solids, into problem solvers and solution providers”.

Chemical producers are not going to become “solution providers” overnight. They are also not likely to catch up or gain much from the end-consumer marketing game if their cash flows are squeezed. And moving into a period of expected low growth they will hard-pressed to find more ways to cut costs and streamline in difficult times.

($1 = €0.73)

Read Paul Hodges’ Chemicals and the Economy Blog
Read John Richardson and Malini Hariharan’s blog – Asian Chemical Connections


By: Nigel Davis
+44 20 8652 3214



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