Market outlook: Chemical company CEOs to put cash to work

26 October 2012 08:46  [Source: ICB]

Senior executives in the global chemical sector prioritise investments and acquisitions as they seek growth in an uncertain world

Following a return to growth in 2010 and 2011, the global chemical and performance technologies industry in 2012 is once again having to battle hard in the face of strong economic headwinds.

The crisis in the eurozone, doubts about the sustainability of the US economic recovery and the cooling of emerging market growth rates all continue to keep senior executives across the industry awake at night. Other concerns include escalating input costs and ever-stiffening competition within the sector.

Against this uncertain backdrop, global consultancy KPMG has sought to gauge a view on the outlook for the chemicals industry as we look ahead to 2013 and beyond.

We interviewed 156 senior executives across the global chemical and performance technologies industry during the third quarter of 2012, with participants asked about business conditions in their sectors, drivers of revenue growth, investment trends and factors that may impede or support their sector's recovery.

RECOVERY HOPES DIM
The results were certainly a bit of a mixed bag. At a macro level, executives appeared to be much more pessimistic than they were 12 months ago - something which, given renewed economic volatility across the globe, doesn't come as much of a surprise.

In 2011, 26% felt that the economy would recover by the end of 2012, whereas only 10% of this year's respondents expect recovery by 2013. In the same way, predictions of a substantial recovery within two years also have declined, from 42% in 2011 to only 18% in 2012.

However, despite the general sense of pessimism about the global economic outlook, the majority of chemical executives have spent the last two years with a keen focus on cost and cash discipline, such that many companies now have significant cash reserves.

CASH BUILD UP
Indeed, 72% of respondents indicated that their companies currently have significant cash on the balance sheet - up from 70% in KPMG's 2011 survey - and more than one-half (51%) say their cash positions have improved from last year.

As a result, the survey suggests that almost all companies very much intend to put this cash to work over the next 12 months, either by undertaking or planning significant changes in business models; making improvements in operational process and technology; making investments in organic growth from new product development; as well as implementing growth strategies focused on geographic expansion.

INVESTING IN GROWTH
Looking at the results in more detail, a total of 63% of all executives say they plan to increase capital spending over the next year.

Indeed, almost 40% of US respondents reported that investment is already significantly underway, almost doubling the results reported from this region in 2011. Thirty-one percent of Asia-Pacific respondents believe investment will heat up in the fourth quarter of this year.

Meanwhile, more than one-half (52%) of European respondents said they anticipate investments to occur during the fourth quarter of 2012 or first quarter of 2013.

Worldwide, the highest priority investment areas are new products or services (35%), and the acquisition of a business (33%). However, US executives indicated that they plan to be much more aggressive investing in these two areas than their Asia-Pacific and European counterparts.

M&A TRAIL
While general enthusiasm for mergers and acquisitions (M&A) activity around the world seems to be faltering in the face of economic volatility, the prospect of chemicals businesses getting back on the acquisitions trail is certainly an intriguing one.

Ninety percent of executives indicated that their companies are likely to be involved in a merger or acquisition in the next two years - up from 83% in KPMG's 2011 survey.

And once again, it seems that respondents in the US are the most bullish, with 48% saying they are actively on the hunt for potential acquisition targets, while European respondents look to be the most likely sellers (52%).

This recognition from chemical executives that organic growth will continue to be a challenge, particularly as input prices continue to impact production costs, certainly sets the stage for a wave of aggressive M&A activity over the coming months.

Dealmakers broadly fit into two groups of equal size. Large chemical companies in Europe and the US are on the lookout for opportunities to reorganise their portfolios of companies to better suit these challenging times.

Meanwhile, Middle Eastern and Chinese players are keen to pick up mature chemical assets in order to tap into their more advanced intellectual property.

With this in mind, the top trump assets for chemical investors are without doubt those specialty businesses which have high intellectual property value and which operate at high margins.

Intrinsically, high technology businesses also have the magic ingredient of high barriers to entry, which makes them particularly attractive for those with cash to spend.

HUNT FOR HIGH-TECH
The pursuit for high-tech assets is borne out by another of the survey's key findings which suggest that technology (29%) and geographic expansion (27%) will also prove to be significant areas of investment for global chemical companies.

Respondents in Asia-Pacific had the highest expectations for investment in technology (42%), while European executives (36%) plan to increase investment in geographic expansion the most.

As for where they intend to deploy that capital over the next two years, it appears that US and European executives are demonstrating a much stronger preference for domestic investment.

Unsurprisingly, China remains a favored investment location for executives in all three regions.

REVENUE AND HIRING
Despite the positive noises being made around investment and M&A, ongoing business challenges such as the prolonged economic crisis, volatile input prices and increased pricing pressures do seem to have dampened executives' expectations around revenue.

Only 68% of chemical executives expect revenue to increase next year - down from 85% in the 2011 survey. And while executives in the US were the most bullish in their revenue projections - 73% expecting revenue to increase next year, down slightly from 77% in 2011 - expectations for increased revenue among the Asia-Pacific and European executives decreased substantially in the 2012 survey (Asia-Pacific: 69% versus 96% in 2011; Europe 60% versus 82% in 2011).

Executives also appear less optimistic on hiring, with only 64% saying headcount will increase next year - down from 71% in 2011. Indeed, in the US, 21% of executives actually expect to decrease headcount in the next year, up from 14% in 2011.

THE ROAD AHEAD
In spite of the prevailing economic uncertainty, the survey results are certainly a lot more encouraging than we may have initially anticipated.

Indeed, it's evident that there is nothing like a lack of economic buoyancy to focus the mind on priorities, from addressing the make-or-break issues for individual organisations to considering what the wider chemical and performance technologies industry really needs in order to prosper in the longer term.

Here, balancing the potential economic risks with the need to expand into new products and markets to capture growth will be undoubtedly the key to success for firms across the globe.

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Paul Harnick is global COO for KPMG's chemicals and performance technologies practice. The KPMG Chemical Industry Outlook Survey was conducted in July 2012 and reflects the responses of 156 senior executives in the Chemical industry - 53 in the US, 50 in Europe and 53 in Asia-Pacific. Based on revenue in the most recent fiscal year, 22% of respondents work for institutions with annual revenues exceeding $10bn, 35% with annual revenues in the $1bn-$10bn range, and 44% with revenues in the $100m to $1bn range. For a copy of the survey, please visit: www.kpmg.com/reaction.

Author: Paul Harnick

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