Crisis, but without the catastrophe?

26 April 1993 00:00  [Source: ICB]

As the three German majors are painfully aware, German companies have lost their competitive edge and, compounded by adverse currency fluctuations, are losing valuable export trade. Drastic measures are needed to ensure survival.

THAT GERMANY'S chemicals multinationals face a rather uncertain future - particularly in their domestic market - is becoming a widely held view within the industry, and not only by those who could be accused of indulging in a little schadenfreude. German managements are recognising that their domestic operations are losing their competitive edge, while their culture stands accused of being unwieldy and cumbersome and unable to adapt to the industry's rapidly changing circumstances.

In strategic terms the contrast with the two multinationals nearest to the German triumvirate is noticeable: ICI is demerging Zeneca in an effort to refine tactics and focus its human and capital resources more effectively, while Ciba is undergoing a self-examination of such fundamental proportions it could be described as a 'cultural revolution'.

The German companies have of course whittled away at costs and taken many decisions to restructuring their portfolios. But managements at BASF, Bayer and Hoechst dismiss the type of operational benefits ICI believes are available from a demerger, and show little inclination to follow Ciba's lead in to reinventing themselves. Ciba, for example, believes that only by creating a 'highly dynamic' organisation - delaying hierarchies and empowering employees - can it survive and prosper in the future.

While the German majors agonise over the apparent loss of their competitiveness, their exports were suddenly hit by appreciation of the deutschmark, particularly as many of their European competitors are based in countries whose parities were devalued last year.

Furthermore, the high corporate taxation in Germany, high requirements for environmentally-related capital expenditure and high direct and indirect (social) costs of labour, also add to costs and depress profits.

Moreover, the German system is such that many of these problems are not easily controllable. Labour cost growth is locked in by the long-term wage settlement with the chemicals workers union, while the recent Solidarity Pact will escalate wage and cost levels in eastern Germany. The price of unification will be a continuation of Federal budget deficit and therefore high interest rates and a resultant strong currency.

Of particular concern, judging from recent statements, is the emergence of new 'non-traditional competitors'. Bayer, for example, says Asian competitors are able to supply organic intermediates and textile dyestuffs at prices which it cannot match because of the German levels of costs. Dr Manfred Schneider, Bayer chairman, believes it is doubtful that dyestuffs - the historic basis of the chemicals industry - can be produced in Germany profitably in the long term.

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On a separate front, the chemical producers of eastern Europe, operating with 'unassailable' cost advantages, are desperately pushing into the hard currency markets of western Europe, according to Schneider.

German groups are acutely aware of their unfavourable cost structure, suggests one leading industry figure, because much of their original domestic plant infrastructure was rebuilt after 1945 and is nearing the end of its useful life. As reinvestment decisions arise, managements are left with the option of moving production to more competitive locations. This, at least, explains why the Swiss companies - which operate in a similar high-cost environment - appear less concerned. The age-profile of their plant infrastructure is more evenly distributed.

The financial results for BASF, Bayer and Hoechst for 1992 show a continuation of the pattern established since the downturn in chemicals was compounded by the recession. BASF suffered the greatest decline in operating profit of the three companies, followed by Hoechst, while Bayer's results were the most resilient. This mirrors their relative exposure on one hand, to the depressed sectors of petrochemicals and polymers, and on the other, the more recession-resistant sector of healthcare. BASF's operating profit fell nearly 40% to DM1.31bn ($815m), that of Hoechst dropped 22% to DM2.15bn and Bayer fell 13% to DM2.76bn.

The costs of restructuring depressed profits at Bayer and Hoechst, as these are not recorded separately, but BASF introduced an extraordinary income/charge element to its profit and loss account for the first time. The stronger deutschmark also depresses the relative contribution from foreign subsidiaries.

Dividend cuts were forced on all three companies. BASF reduced its payment to shareholders by DM2 to DM10/share, Hoechst by DM3 to DM9/share and Bayer by DM2 to DM11/share. This followed smaller reductions of DM1/share from DM13/share at BASF and Hoechst in 1991. Fortunately, German-style capitalism does not make the same short-term financial demands on companies as in the UK or the US, and the companies have kept dividend cover ratios at prudent levels.

Although the recovery in the US provides some room for optimism, it is unlikely to offset much of the economic malaise in Europe this year. Hoechst has the highest relative exposure to the US (and indeed the North American) economy via its subsidiary Hoechst Celanese. BASF, however, traded at a loss in the US last year.

1992's results also highlighted a substantial decline in volumes which has occurred in Germany since the first quarter. Consequently, results in Germany came under pressure from a third effect for the first time - loss of volume. Previously, the profits of German operations were depressed by rising fixed costs and falling price levels.

Since the start of the year, the picture has markedly worsened. Typical of the declines recorded in first two months this year were that of BASF, which reported sales down by 10% and profits almost certainly falling by a greater proportion. Sales for the parent company, which represents most of BASF's German operations together with their direct exports, fell by 17% in January and February.

Although the downward trend has been exaggerated by extended holidays taken over Christmas in German manufacturing industry, and the introduction of short-time working in the automotive industry, the figures do reflect a considerable slump in a number of markets. In particular, agrochemicals in Europe have continued to decline, prompted by the EC-led reform to the CAP. German pharmaceuticals sales have also slumped as a result of the introduction of reforms to the healthcare reimbursement system while the increase in VAT in Germany has further put pressure on demand in consumer-orientated sectors.

The slump in domestic drug sales - down 20-30% by the end of February - is of particular concern, although most observers believe equilibrium will be found with a more modest decline. Bayer's chairman Dr Schneider warns that 'if Germany becomes a country of generics and cut-price medicines then there is no future for research-based companies here'.

Financial results this year are likely to show a continuation of the declining profits. Although the response has been to cut costs, German companies have been late in acting in relation to many of their counterparts. So far, employment levels have been reduced through early retirement and short-time working but only recently has there been the regrettable prospect of compulsory lay-offs. Hoechst's chairman professor Wolfgang Hilger says the company is now putting all its efforts into restructuring and cost cutting.

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Within the parent company, Hilger sees 'virtually no scope for manoeuvre on the profit side'. 'Apart from strict limitation of expenditure, the most urgent measure is the shutdown of plants which are making a loss and which have no hope of returning to profitability.' Hoechst has 3900 employees on short-time working, with 500 more joining this month. Bayer also has introduced short-time working at a number of units.

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In the long term, Bayer's chairman believes competition for the German companies will remain tough, even when the economic situation improves. Schneider says Bayer will only be able to hold its own by rationalisation, continuing to reduce costs and developing new technologies. The group places a particular emphasis on stepping up capital expenditure in Asia in the coming years. Schenider says he is convinced that a significant presence in Asia is essential for a company wishing to be among the world leaders in the year 2000.

BASF's chairman Dr Jürgen Strube describes 1992 as a year of 'critical analysis' for the company, in which important decisions were implemented to shape the strategy in the future. Strube says BASF, as a widely diversified company, is well equipped to handle extreme fluctuations ordinarily in the economic cycle. And adds that he has no intention of restricting BASF's portfolio by placing undue emphasis on 'economically insensitive' sectors.

BASF has taken a 'more critical look' at the marginal areas in which it cannot - with reasonable levels of investment - build up major world market positions in the long term or whose synergy or earnings potential is not adequate.

BASF took a strategic decision two years ago to enter the natural gas business with the joint venture between Wintershall and the Russian company Gazprom. After huge investment, the project to build the Stegal and Midal pipelines is moving ahead and the first gas has been supplied from Stegal since October last year.

Strube says capital expenditure will be brought back in line with 'normal levels' following an exceptionally high period. He says, the pattern of expenditure in recent years was shaped by: the objective of securing a raw materials base; the policy of logical backward integration - the reconstruction of the ethylene oxide plant and the cracker and ammonia plants at Antwerp; by targeted regional diversification - the acquisition of Schwarzheide, expansion of Yokkaichi in Japan and Altamira in Mexico; and the need to build large central environmental protection facilities, especially at Ludwigshafen - stack gas desulphurisation, denox plant, residue incineration and safety tanks and treatment plant.

Strube's strategy for BASF - which he admits will always bear a relatively heavy burden of costs - is twofold: differentiation through innovation, and continuous reduction in unit labour costs. To ensure production remains in Germany, he says, 'we need a favourable climate of innovation'.

Bayer's chairman Dr Manfred Schneider quotes Max Frisch when characterising his approach to the tasks ahead: 'Crisis is a productive state; we just have to remove the sense of catastrophe that goes with it'.

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