INSIGHT: Lower costs, stronger growth make US chems attractive

30 January 2012 16:57  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS)--The US chemical industry is attractive to potential investors in more ways than one.

Sector firms are undervalued, players believe, and by the look of it there is no real bias towards specialities or commodities.

The two deals made public most recently – the opposed bid by Westlake for vinyls producer Georgia Gulf and the proposed friendly takeover of Solutia by Eastman Chemical – illustrate that.

Indeed, there are two underlying aspects to the industry that support ongoing deal-making activity: costs and growth.

The shale gas revolution potentially lowers feedstock costs for the sector across the board – although financial analysts such as Hassan Ahmed of Alembic Global Advisors believe that the impact of low-cost ethane is diluted as you move down the various petrochemical value chains.

Indeed, the shale gas story – and the potential – runs on and on.

Some are predicting that the Henry Hub gas price could drop below $2/MMBtu by March – it was $2.59/MMBtu on Friday 27 January, which equates in energy equivalent terms to an oil price of about $13/bbl. The Mont Belvieu ethane price that day was around 58.59 cents/gal.

The low natural gas (largely methane) price puts huge pressure on the margins of the companies fracking shale. So much so that the second-largest natural gas producer in the US, Chesapeake Energy, has decided to cut its dry gas drilling activity this year by as much as 50%; cut gas production, and redirect capital savings towards “liquids-rich plays”. The company’s liquids production has increased from 30,000 bbl/day in 2009 to almost 110,000 bbl/day currently.

More readily available natural gas liquids (NGLs – ethane, propane and butane) suit the chemical industry fine. These hydrocarbons accounted for 66% of US petrochemical feedstocks in 2010 according to the American Chemistry Council (ACC), and 50% of fuel and power consumption by US petrochemical producers, says veteran industry consultant and active blogger Peter Spitz in one of his Chemengineering posts.

Increased volumes of lower-cost feedstock and lower-cost energy work to the advantage of producers of ethylene and propylene derivatives, methanol, ammonia and chlor-alkali, notes Spitz.

The feedstock and energy cost advantaged US is a draw to foreign as well as domestic producers. At the Gulf Petrochemicals and Chemicals Association (GPCA) meeting in Dubai in December, for instance, both Saudi Arabia's SABIC and Kuwait’s Equate expressed an interest in US projects.

“We expect consolidation to continue in the sector, with US and European firms looking for scarcity value and market-leading positions, Asian firms looking for technology and Middle Eastern firms looking for vertical integration,” Laurence Alexander, an analyst at US-based investment bank Jefferies & Co said last week.

Couple the US feedstock and cost situation with the prospects for near-term market growth, and you have a winning combination.

This may not be the best of times for the US chemical industry but is hardly the worst. The US economy is growing at a subdued rate but much more strongly than economies in Europe. Chemicals demand in the US has recovered from the 2008–2009 slump, driven by manufacturing, although construction (an important consuming sector of a wide range of chemicals) remains in the doldrums.

“The manufacturing sector is the largest consumer of chemical products, and 96% of manufactured goods are touched by chemistry,” says the ACC.

Chemicals demand trended down towards the end of last year, in contrast to the more buoyant first half. But the sector has been reflecting the international mood.

The 6.1% gain in volume output of the industry in the US, excluding pharmaceuticals, in 2010 is likely to have slowed to 3.8% in 2011 and be 1.6% in 2012 before recovering to 2.1% in 2013, the ACC forecast in December last year.

“Strong growth is expected in synthetic rubber and later (to a more limited extent) in petrochemicals and organic derivatives and plastic resins as export markets revive. Production of specialty chemicals will be driven by demand from end-use markets,” it added.

The trade group believes that longer-term output growth will exceed the growth of US GDP.

US merger and acquisition (M&A) activity currently is reflecting the start-stop nature of the operating environment last year – from a sector as well as a financial point of view. But consolidation is a continuing trend, with investors keen to capture markets, technologies and cost-advantaged growth.

“Valuations are depressed and cheap US natural gas is making both sub-sectors of the US industry – specialty and commodity – attractive and making a whole host of US chemical names interesting M&A targets,” said Ahmed.

Jefferies & Co’s Alexander said Albemarle, Celanese, Cytec Industries, Huntsman, OMNOVA Solutions and WR Grace were the targets usually talked about.

Eastman, Solutia and Westlake believe the time is right for consolidation – Eastman’s offers is about 7.8 times Solutia’s estimated earnings before interest, tax, depreciation and amortisation (EBITDA), says Alexander.

Westlake’s $1bn, $30/share bid for Georgia Gulf, which has been firmly rejected by Georgia Gulf management, is seen as inadequate by Charles Neivert, an analyst with US investment bank Dahlman Rose & Co. He has valued the vinyls producers at $45/share, based on a 6-times multiple on normalised, rather than projected 2012, EBITDA of $350m (€266m).

Transaction multiples have increased but are nowhere near the highs agreed before the slump, given the still-subdued chemicals markets and the difficult global financial situation. Potentially, however, there are some good deals to be had that will allow the participants to capture value and growth.

($1 = €0.76)

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By: Nigel Davis
+44 20 8652 3214

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