16 December 2011 15:51 [Source: ICIS news]
By Nigel Davis
LONDON (ICIS)--At least chemical producers have run into this deeply worrying, global downturn in better financial shape than when the 2008–2009 crash hit.
A period of frenzied activity in mergers and acquisitions (M&A) had exposed companies as the depth of the “Great Depression” became apparent. The most highly leveraged faced a tough ride.
This time, things are different, even though the nature and the extent of downturn cannot yet be appreciated. Debt has been re-financed and balance sheets fixed. A period of strong cash flows – certainly up to the end of the second quarter of this year – has given firms the confidence to invest in new plant and equipment and M&A.
Since mid-year, however, the mood has changed markedly. Recent memories loom large, and no-one feels flush with cash.
Profitability has been squeezed on lower demand and reduced operating rates. The situation is likely to get worse – in Europe, particularly, but elsewhere as well, should the eurozone crisis deepen.
On the positive side, chemical companies are a lot less reliant on the banks – a point made by Fitch Ratings in a Europe, Middle East and Africa (EMEA) chemical sector note on Friday.
“Liquidity is generally strong across the board, boosted by robust cash flow generation in 2011, cautiously funded expansion and M&A activity, and manageable repayment obligations,” the ratings agency’s analysts said.
“Chemical companies had extensive recourse to the bond markets in 2009, resulting in reduced reliance on bank funding.”
Fitch is not alone in expecting lacklustre growth in chemical markets in Europe and the US in 2012. Costs will be a problem for sector companies, it suggests; as “visibility” is poor.
It depends which markets you are in, but those closer to the consumer – indeed, many specialty markets – are likely to prove to be tough as customers rein in spending. The prices of raw materials for these businesses have fallen, but are more closely linked to the price of oil, which remains above $100/bbl (€77/bbl), and are buoyed by tight supply.
That situation is expected to persist into 2012 – and the relief produced by falling prices of chemicals such as butadiene and titanium dioxide, just two examples, could be short-lived.
“Absent a severe recession, prices are likely to recover to mid-cycle levels, supported in part by emerging market demand,” Fitch suggests.
It is growth in emerging markets that holds out the most hope for chemical producers – at least in the first half of 2012. And after the Lunar New Year, in January, the picture in these markets may be a lot clearer.
So the level of capital spending by European players in 2012 could be similar to that in 2011, if the market deterioration is not worse than expected.
Spending on property, plant and equipment is likely to feature most strongly in 2012. And Fitch says it expects capital spending to be funded primarily from “internal cash-flow generation with positive free cash flow for most issuers [of debt across the agency’s rated European chemical players] in 2012”.
Companies will be considering their discretionary spending carefully in 2012, but will still be keen to expand market shares in emerging market economies.
They might be expected to spend more on research and development, too, as they attempt to secure a stronger competitive advantage, even though the operating environment might be a lot tougher.
Senior executives with industry giant BASF indicated earlier this month that they would like to have the option, at least, of launching a share buyback programme to use in 2012 if capital spending or M&A opportunities are not forthcoming. But with visibility deteriorating, Fitch does not believe that chemical companies generally will actively pursue this option or additional dividend payments to investors.
($1 = €0.77)
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