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Do third quarter earnings really matter? As we move into the thick of the earnings season, all eyes will be on how the fourth quarter is shaping up and how analysts will handicap fourth-quarter 2011 and full-year 2012 projections.
Leading up to results, pre-announcement warnings have been scarce in the chemical group, boding well for overall third quarter numbers in relation to analyst expectations. The impact of the global economic slowdown will be evident, but likely to be more pronounced in the fourth quarter.
For the petrochemical sector, there is particular risk to the fourth quarter outlook. One key question, says Laurence Alexander, analyst at US-based investment bank Jefferies & Company, is: What will be the timing of volumes and margins in the fourth quarter? US ethylene margins have contracted sharply in the past two months, while volumes have been lackluster.
"Anecdotally, volumes in October are weak as downstream buyers wait for derivative pricing to come down," says the analyst. "Fourth-quarter earnings prospects for polyolefin producers hinge largely on if volumes recover in November, ahead of the winter shutdowns, and if such an uptick in volumes coincides with margin recovery."
Alexander sees downside risk to Wall Street's fourth-quarter consensus estimates for US-based Dow Chemical and Netherlands-based LyondellBasell. His earnings-per-share forecasts for Dow and LyondellBasell are $0.37 (versus consensus of $0.50) and $0.77 (versus consensus of $0.92), respectively. His 2012 earnings-per-share estimates on Dow and LyondellBasell for 2012 are also significantly below consensus.
On the flip side, Hassan Ahmed, analyst at US-based investment research firm Alembic Global Advisors, sees positive signs that global chemical volumes are not as weak as many believe. At Dow's investor day meeting on October 4, the company indicated that it continued to see significant demand growth across almost all end markets in China - "negating the cycle bear arguments in our view," says Ahmed.
More recently, he points out that strong third-quarter results from Saudi Arabia-based SABIC bode well for commodity chemical sector results in the quarter.
Yet on the outlook, most analysts have taken down 2011 and 2012 earnings-per-share estimates in the past several weeks, with more cuts likely to come following third-quarter earnings season.
The global economic recovery since we climbed out of the depths of the financial and economic crisis since 2009 has been described by many as a V-shaped recovery, refleting the strong rebound off the lows. But this recovery has also been characterized by volatility - volatility in crude oil prices, metals prices, commodity prices, and currency and interest rate movements.
When viewing long-term market trends, watch for extreme volatility to signal major turning points, especially following a long-lasting trend in one direction. Casting an eye on crude oil, the magnitude of daily price movements over the past few weeks has been off the charts.
Daily price swings of 4-5% are becoming more common - Wednesday saw a nearly 5% drop in crude oil prices on the NYMEX to under $100/bbl.
In the US, gasoline consumption fell as consumers protested $4/gal prices - a pittance compared to European prices, but a shocker for the US consumer nonetheless. Demand fell 2.4% in the week ended May 6 - the largest decline in seven consecutive weeks of demand drops.
In the UK on May 8, drivers manning about 150 vehicles staged a day-long protest against high fuel prices, driving at a deliberate pace across main highways to the Shell's Stanlow oil depot and refinery, where they continued to protest.
The best cure for high prices is high prices. Now consumers are pushing back, as their bills grow from higher gasoline prices, higher food prices, and the price inflation in commodities flowing through to everything from paints to packaged goods.
In the chemical markets, there has been increasing buyer push-back on the relentless rise in major commodities across the board.
In China, prices of low density polyethylene (LDPE) and nylon have been falling, while monoethylene glycol (MEG) has been stuck in neutral after coming off its highs earlier in the year. Europe LDPE and polypropylene (PP) spot prices took a hit last week on the back of plunging crude. In the US, one acrylonitrile (ACN) producer has cut operating rates on record feedstock propylene prices.
Buyers and sellers of chemicals look towards the crude oil price as a gauge, even if oil is not the main feedstock. A major medium-term reversal in trend resulting in declining crude oil prices would give some much-needed relief for beleaguered buyers.
After unimpeded optimism over several months fueled by the continuing global economic recovery, some serious concerns are coming out of the woodwork.
Expectations for an interest rate hike in China to tame growing inflation threw cold water on world stock markets last Monday. Meanwhile, fears about Ireland's debt crisis and an impending bailout by the EU and the International Monetary Fund (IMF) continued to build.
The crisis in Ireland is also fueling fears about credit problems in other European countries such as Portugal and Spain - a stark reminder that the credit problems in the Eurozone are far from over.
And in the US, the Federal Reserve is facing a growing backlash over its $600bn (€444bn) quantitative easing policy, known as QE2 - both home and abroad. The program is meant to pump money into the economy and lower interest rates further.
But in the early going, the bond market is just not cooperating. US government debt prices are falling, pushing up yields, rather than the other way around.
While the US Federal Reserve is buying Treasuries, investors are selling. It could just be a case of "selling on the news" as prices had already run up substantially in anticipation of the QE2 announcement, but if yields keep rising unchecked for a prolonged period, the Fed will lose credibility.
Critics complain that QE2 could lead to rampant inflation, while other nations also slammed the easy money policy, pointing out that the US is unfairly devaluing the dollar to boost exports. That makes US goods more competitive at the expense of its neighbors.
But thus far, inflation remains contained in the US. The core Consumer Price Index (CPI), which excludes the volatile food and energy components, was unchanged in October for the third month in a row. Price increases in basic materials have not yet translated into higher consumer prices in the US.
In the global chemical markets, producers are riding the wave of rising prices - from the Americas to Europe to Asia.
Voracious Chinese demand and the US QE2 program are boosting petrochemical and polymer prices in Asia, reports Felicia Loo, one of our ICIS pricing editors in Singapore.
"It is a bullish market. The feel is bullish and everything is bullish," said one Chinese polymers trader.
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After a blip down in world stock markets on Tuesday, October 19, sparked by China's quarter-point hike of a key interest rate as well as continuing fears in the US about the consequences of an ongoing investigation into improper foreclosures, bourses were back in the black on Wednesday.
Industrial stocks, including chemicals of course, were pounded on Tuesday but led the rally on Wednesday.
The widespread rally in the chemical sector was bolstered by the announcement by Germany's BASF, the world's largest chemical company, that it expects strong third-quarter earnings and record overall 2010 results.
And looking to the fourth quarter, the company expects the favorable business conditions to continue. For all of 2010, it anticipates sales of €63bn ($88bn) and underlying earnings before interest and tax (EBIT) of over €8bn.
Hassan Ahmed, analyst at US-based investment advisory firm Alembic Global Advisors, found it "particularly noteworthy" that BASF's underlying Q3 earnings EBIT guidance of €2.2bn is ahead of its reported Q2 EBIT of €2.1bn, signaling sequential earnings improvement.
This bodes well for US-based Dow Chemical and Westlake Chemical, as well as Netherlands-based LyondellBasell, said the analyst.
"Current consensus estimates for all three companies are looking for sequential earnings declines in Q3, contrary to BASF's guidance. We are above consensus on all three names for Q3 as well as 2010." said Hassan.
Indeed, Wall Street consensus estimates indicate a significant decline in sequential earnings per share (EPS) for Dow (-24%) and Westlake (-26%). The Street also sees sequential EPS declines for Hunstman (-9%), Celanese (-35%), Methanex (-23%) and Georgia Gulf (-10%).
DuPont's sequential numbers are skewed by seasonality in its ag business, while newly-listed LyondellBasell has no comparable consensus Q3 to Q2 EPS figures available.
But all signs point to an overall strong Q3 for the chemical industry. Analysts will likely boost profit estimates, or companies will surprise to the upside, or both.
Many commodity chemical and polymer markets have remained tight or have tightened further during Q3 - a trend that remains in effect today. During the financial and economic crisis of 2008-2009, companies cut back on capital expenditures and shut down marginal production facilities, leading to some of the tight markets we see today.
And for all US Treasury Secretary Tim Geithner's talk of not devaluing the US dollar, it is not this office that controls monetary policy. That's the domain of the US Federal Reserve, whose chief Ben Bernanke is poised to unleash an estimated $1 trillion of funds into the economy with purchases of debt securities - otherwise known as quantitative easing (QE).
This will hand US chemical producers two gifts - greater pricing power as money creation puts upward pressure on commodity prices, and a weaker US dollar, providing an earnings tailwind for those with significant exports and foreign operations.
While the threat of a potential slowdown in the Chinese economic expansion, another potential US mortgage crisis and European austerity measures are not to be dismissed, the overall balance of forces tilts towards a continuing global economic recovery.
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QE2 has arrived in the US! - not the famed cruise ship, but the second round of quantiative easing by the US Federal Reserve.
The pace of economic recovery in the US has been painfully slow, and momentum is waning with persistent high unemployment, weak housing and construction markets and tight credit availability.
And abroad, there are still the minefields of the European debt crisis, which is already resulting in austerity measures by governments, and a potential economic slowdown in China.
So what is quantitative easing and more importantly, how could it help the economy and the chemical markets? In this action, the Fed will essentially buy up US Treasuries with cash, resulting in a two-pronged impact.
First it injects cash into the economy, boosting overall money supply and liquidity. Secondly, buying up Treasuries puts upward pressure on Treasury prices, driving down the yield and ultimately interest rates.
So money becomes more plentiful and borrowing costs go down. This will give a boost to the overall economy, and hopefully juice-up important end markets for chemicals such as automotive, housing and construction, and consumer durables (white goods).
Plus, an added benefit will come in the form of even lower rates at which companies can refinance their debt. Right now, chemical companies are already lining up to raise funds on attractive terms.
On August 5, US specialty chemical company Ferro sold $250m in 7.875% senior notes due 2018. US specialties firm Chemtura is looking to sell $450m in senior unsecured notes due 2018 to finance its exit from bankruptcy. And Brazilian chemical giant Braskem is issuing an additional $350m in 6.875% senior unsecured notes due 2020 after selling $400m in notes in April at 7%.
Normal monetary measures by the Fed would involve simply taking down the discount and Fed Funds rates, but these are already at record lows after unprecedented "easing" steps through the global financial and economic crisis of 2008-2009. With a targeted Fed Funds rate of 0-0.25%, there is basically no more room to maneuver.
But the QE2 measures the Fed is taking will be somewhat limited in scope - at least for now. Right now, the plan is to use funds from maturing mortgages in its $2 trillion securities portfolio to buy up Treasuries. This will amount to around $10-$20bn every month. Observers are hopeful that this could be the first step towards more robust easing actions ahead.
Upon the initial news of QE2 on August 10, which was widely expected, the US stock market reversed much of its losses by the end of the day. But on August 11, the Dow Jones Industrial Average plunged 265 points, or 2.5%, to 10,378, on weaker-than-expected manufacturing data from China and renewed concerns about a global economic slowdown.
China's industrial production in July grew 13.4% year on year - hardly a weak showing, but it was the smallest gain since August 2009.
Economically-sensitive chemical stocks fell harder on the day, including Dow Chemical (-3.1%), DuPont (-3.0%), Hunstman (-5.8%), Eastman Chemical (-3.6%), Celanese (-5.5%) and Georgia Gulf (-10.6%).
It will take more than just baby steps to revive the fading recovery. With inflation currently low, and a greater risk for deflationary conditions ahead, it's time for the Fed to crank up the printing press.
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Fears of a double-dip global recession abound, driven by the European debt crisis and the resulting austerity measures by governments to balance their budgets. And concerns about a sharp slowdown in China's economy linger as that government aims to cool rampant speculation in its property market.
"Austerity" has made a big push into the financial lexicon these days, as noted by Paul Hodges, chairman of UK-based consultancy International eChem in the ICIS Chemicals & the Economy Blog.
Mentions of the dour term in the Financial Times shot up dramatically in May and rose further in June. Hodges sees the odds rising of entering the next phase of the downturn - a protracted affair.
But second quarter profits will almost assuredly come in strong, based on senior executive chatter at the American Chemistry Council (ACC) annual meeting in June, as well as positive guidance from European majors BASF and Arkema. CEOs of major chemical firms at the ACC meeting indicated that Q2 results were looking robust, and expressed optimism that the European debt crisis could be contained,
France-based specialty chemicals company Arkema expects record second quarter profits, while BASF indicated a better-than-expected Q2. Wall Street consensus estimates show US major Dow Chemical posting earnings per share of $0.58 in Q2 - up sharply from the $0.05 it earned a year-ago. And DuPont is expected to boost Q2 profits by 52% year on year to $0.93/share.
Purer-play US commodity chemical and polymers firm Westlake Chemical is expected to nearly double profits year on year to $0.50/share.
But going forward, the earnings comps will get much tougher. On the upcoming Q2 conference calls, analysts will be looking for any signs of a slowdown in momentum or trouble ahead. The impacts from Europe and China will feature prominently on the calls.
And in the US last week, the Federal Reserve indicated that the economic outlook has deteriorated a bit with a downwardly revised GDP growth forecast of 3-3.5% for 2010 versus its estimate of 3.2-2.7% in April, based on "economic developments abroad."
Most signs point to rough sledding ahead, but look for more clarity after Q2 results.
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The BP oil spill in the US Gulf will have major implications for the US chemical market. Yes, the chemical industry is not the oil industry, but they are inextricably linked - not just in terms of feedstocks, but also how they are perceived in the minds of the general public.
The direct impact of the spill on the chemical industry will be the restriction of oil and natural gas feedstock and energy supplies stemming from the moratorium on new offshore drilling and other potential policies.
But the indirect impact has far more potential for damage. As one astute executive at the American Chemistry Council (ACC) annual meeting in Colorado Springs in mid-June pointed out, the BP disaster highlights the inherent risks of all operations and puts into play the precautionary principle - where the burden of proof that something is not harmful is put on the producer/operator.
This could impact US chemicals management policy, and the ACC is rightly concerned (see story on page 17).
"A global, high-profile industry has lost the trust of key stakeholders, and I suspect that many industries have been tarnished in the process," said Brian Ferguson, executive chairman of US-based Eastman Chemical and chairman of the ACC. "American institutions face a crisis of trust, and the chemical industry and our products remain at the front, or near the front of the line."
On a positive note, the buzz from CEOs and other senior executives at the meeting was that sales and earnings are holding up well so far, even in the face of the European debt crisis and worries over a potential slowdown in China.
Coming off a robust first quarter, where profits of many global chemical companies swung ever closer to prerecession levels, there was no talk of a loss in momentum. Sales in Europe are holding steady, while strong growth continues in Asia and Latin America. There are also pockets of strength in the US, such as in the automotive and electronics markets.
While the unemployment rate remains stubbornly high in the US at 9.7%, those that have jobs are feeling more confident that they will continue to be employed, and are loosening up the purse strings, according to some executives.
Although the world is more connected than ever and the decoupling argument was smashed in the global recession of 2008-2009, the CEO of one of the largest global chemical companies expressed optimism that this time, it truly is different - that the European crisis will ultimately be contained.
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No doubt there will be bumps along the way - and some of them big ones. The Asian economic crisis of 1997-1998 put the brakes on growth in the region and the impact reverberated around the globe.
And today the European debt crisis featuring a $1 trillion bailout of Greece and other fiscally troubled nations is threatening the nascent global economic recovery following the worldwide financial and economic crisis of 2008-2009.
But the long-term trend for Asia is clearly up, led by China and India. The mood at the Asia Petrochemical Industry Conference (APIC) in Mumbai, India, in mid-May was widely optimistic. While some expressed caution about the large amounts of new petrochemical and polymers capacity coming on in the Middle East and China, the overall sentiment was that rapidly growing demand from China and India would absorb that capacity.
There has already been huge growth in these countries over the past decade. But in the words of 1970s rock band Bachman-Turner Overdrive - you ain't seen nothing yet!
"This century belongs to Asia. Increasing per capita income among the 2.5bn people in China and India will generate huge demand for goods and services for an extended period of time," said Reliance Industries chairman Mukesh Ambani in his keynote address at APIC. "Billions of people are impatient to realize unrealized aspirations. And this will result in a jump in demand for petrochemicals and chemicals."
The head of India's largest refining, petrochemical and polymers company pointed out that even basic polymers are growing at double-digit percentage rates in the country. For example, consumption of polyvinyl chloride (PVC) grew by 25% in the country in 2009, he said.
It doesn't hurt that construction in India is booming, as evidenced by the massive amount of projects underway in Mumbai and Delhi. India's cities are buzzing with new construction activity - from condominiums to commuter railways. Amid the scorching heat, you can feel the vibrancy of economic activity.
Ambani sees India emerging as a major manufacturing hub for chemicals and polymers. And growing demand from Asia will create the need for "super-sized" projects in the range of $5-10bn (€4-8bn), he noted.
But the global chemical industry will also face challenges from unprecedented financial volatility. Deviating from historical patterns, the epicenters of the latest earthquakes have been in the Western world rather than in emerging countries.
"We grew up thinking the US and Europe were the most stable economies. But in the last five years, we've seen the US housing crisis and European sovereign debt crisis impact global markets," Ambani noted.
The European debt crisis and the resulting austerity measures by governments in the eurozone has created major anxiety and negative sentiment worldwide, evidenced by tumbling bourses from Europe to the US to Latin America and Asia.
The world being more deeply interconnected than ever before, we will feel more shocks to the system and more often. Volatility is something the industry will have to get even used to. But through the panic, it's critical not to lose sight of the long-term picture.
The opportunities are huge, and will require investments of similar magnitude for those with the vision, wherewithal and courage.
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DOW CHEMICAL CEO and Australia native Andrew Liveris coined the term Lazy-V in describing the global economic recovery on the US-based company's fourth quarter earnings conference call. Now we've all heard of a V-shaped recovery, but what's a Lazy-V? "Aussie for moderate growth," or slow, steady progress, translates BB&T Capital Markets analyst Frank Mitsch. Looking at Q4 2009 earnings for Dow and other major chemical companies, most reversed losses from a devastating Q4 2008 when demand collapsed. Volumes were up 10% year-over-year for Dow and US major DuPont. Taking a closer look, the gains were driven by Asia. DuPont's and Dow's volumes were both up 34% in Asia Pacific, while relatively flat in North America and Europe. The global market shift to Asia is becoming more apparent, reflected in Swiss specialty chemical firm Clariant, which announced further plant shutdowns, the largest of which will take place in Switzerland in the textile dyes and chemicals operations. "We are often faced with the strange situation that we purchase raw materials in China, ship them to Europe, manufacture at significantly higher costs and then ship them back to Asia, where our customers are," said CEO Hariolf Kottmann. "Hence, there is no value-creating alternative... but to transfer production to Asia." This trend, and many others, were part of my presentation on the Chemical Market Outlook for 2010 given to the joint meeting of the Societe de Chimie Industrielle and Racemics Group on February 17 in New York. Please let me know if you'd like the entire presentation, including text. Email email@example.com
DOW CHEMICAL CEO and Australia native Andrew Liveris coined the term Lazy-V in describing the global economic recovery on the US-based company's fourth quarter earnings conference call. Now we've all heard of a V-shaped recovery, but what's a Lazy-V? "Aussie for moderate growth," or slow, steady progress, translates BB&T Capital Markets analyst Frank Mitsch.
Looking at Q4 2009 earnings for Dow and other major chemical companies, most reversed losses from a devastating Q4 2008 when demand collapsed. Volumes were up 10% year-over-year for Dow and US major DuPont.
Taking a closer look, the gains were driven by Asia. DuPont's and Dow's volumes were both up 34% in Asia Pacific, while relatively flat in North America and Europe. The global market shift to Asia is becoming more apparent, reflected in Swiss specialty chemical firm Clariant, which announced further plant shutdowns, the largest of which will take place in Switzerland in the textile dyes and chemicals operations.
"We are often faced with the strange situation that we purchase raw materials in China, ship them to Europe, manufacture at significantly higher costs and then ship them back to Asia, where our customers are," said CEO Hariolf Kottmann. "Hence, there is no value-creating alternative... but to transfer production to Asia."
This trend, and many others, were part of my presentation on the Chemical Market Outlook for 2010 given to the joint meeting of the Societe de Chimie Industrielle and Racemics Group on February 17 in New York. Please let me know if you'd like the entire presentation, including text. Email firstname.lastname@example.org