19 March 2012 00:00 [Source: ICB]
The chemical financing market is showing signs of improvement in 2012 after a major downturn in the second half of 2011. Volatility in the high-yield debt market will likely persist, but the investment-grade debt market will remain strong. On the equity side, initial public offerings (IPOs) continue to be challenging.
Last year was positive for the chemical industry in terms of earnings and cash flows. With the exception of the IPO market, the chemical sector stock market performance and debt and equity financing markets were positive in the first half of 2011.
© Rex Features
There was a noticeable slowdown in chemical industry debt financing in 2011
Chemical stock market performance was strong in the first half of 2011, both on an absolute and a relative basis, compared to the general market.
The industry traded at a premium to the market, but events in August brought on a severe retreat in chemical stock prices.
Jolted by the escalating economic and financial crisis in Europe, the US debt ceiling debacle and subsequent credit downgrade by US ratings agency Standard & Poor's, and an alarming slowdown in Western economic growth, the stock market suffered constant volatility and a significant drop in valuations. This was particularly true for the chemical industry as its cyclical industry halo became a curse.
As a result, chemical stock prices and valuations went from a modest premium in mid-year 2011 to valuations by the end of the year that were generally equal to or less than the overall market. This was driven by market fears that cyclical industries, such as chemicals, would suffer the most.
NON-BANK DEBT ISSUANCE FALLS
There was a noticeable slowdown in chemical industry debt financings in 2011. Global non-bank debt issuance dropped nearly in half to $13.9bn (€10.3bn) in 2011 versus $26.7bn in 2010. Investment grade debt totaled $10.8bn in 2011 compared to $12.6 billion for all of 2010 - a very moderate drop.
The vast majority of the overall decline, therefore, came from the high-yield market. High-yield debt issuance was only $3.0bn in 2011 compared to $14.1bn for all of 2010. Although there was some activity in the first half, high-yield debt issuance in the second half of 2011 was at a virtual standstill.
Why the slowdown? Although investor demand continued to be strong, there was a dramatic reduction in issuer demand for debt capital and some flight from risk and European high-yield debt.
The dramatic and negative economic and financial events starting in August 2011 caused the debt markets to deteriorate. The most notable change was the near shutdown of the high-yield issuance market (particularly in Europe) with major high-yield mutual fund cash outflows and a flight to safety by investors. There was a modest recovery later in autumn, but it was not enough to avoid a dismal 2011 overall.
The beginning of 2012 is showing some recovery, but the unfolding events in Europe will have a heavy influence on the high-yield market for the rest of 2012.
Global chemical equity issuance has historically been very modest each year due to low chemical company valuations and the limited equity financing needs of chemical companies.
With strong cash flows, excess cash, access to low-cost debt financing and no large M&A deals requiring subsequent balance sheet adjustments through the issuance of equity, the chemical industry's need for public equity has been limited.
In 2011, $11.6bn of equity was issued as a result of 19 offerings by the chemical industry. This was a record for any one year. However, this dollar volume record was primarily due to the sale of US fertilizer firm Mosaic shares by US agribusiness Cargill and other shareholders.
On the IPO front, three chemical company IPOs - CVR Partners, Rentech Nitrogen Partners and China First Chemical Holding - were completed in 2011. It is noteworthy that the three companies fall into two specialized themes - fertilizers and emerging markets.
The recent U.S. Silica IPO is the first chemical IPO that was not in one of just a few niche areas. So a number of privately-owned chemical companies are watching closely to see if the market door will open up a little to more mainstream chemical companies.
WHAT WILL THE FUTURE BRING?
The significant economic and financial uncertainty since the middle of last year has led to increased volatility in the equity markets and concerns about another downturn. As expected, basic industries (which includes chemicals) have suffered more than the broader market and lost their valuation premium. This will continue as long as uncertainty, particularly focused on Europe and China, persists.
Should global economic growth revive, we would expect the chemical stocks to outperform the market again. However, in an era of sluggish or zero growth, the industry is likely to trade at a discount to the market.
Numerous chemical companies have filed IPO registrations to either sell equity or to use as negotiating leverage in an M&A sale process. But the stalled IPO market has made these plans difficult.
Except for situations concerning unique fertilizers and emerging markets, chemical equity issuance has been, and will continue to be modest, when the poor condition of the equity markets and the market's view of chemicals are taken into account.
However, we are seeing some improvement in conditions and a slight opening of the market to less specialized chemical IPOs. Whether this will continue or not is heavily dependent on how the global economic and financial picture evolves.
Source: Young & Partners
Investment-grade debt volume will be driven by issuer demand as opposed to investor demand. M&A related financing will drive volume. High-yield debt issuance plunged in 2011 as investors shied away from risk, but there are signs of a modest revival. Debt financing volume will be driven heavily by issuer demand as opposed to investor demand.
That has been the reason for the lower volumes more recently. However, there have been serious disruptions of the high-yield debt financing markets and flight from risk since early August that will likely continue for some time.
It is our hope that market demand for chemical company debt will recover after this recent period of weakness and volatility, but much depends on how a number of major economic and financial factors develop.
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