OUTLOOK ’15: Modest growth, volatility for European chemicals players

Tom Brown

06-Jan-2015

By Tom Brown

LONDON (ICIS)–Doing business in Europe over the last few years for many markets has been an exercise in searching for the bottom, with the followers of the worst-hit sectors such as the automotive rubber sector pronouncing that demand had hit the floor several times over the course of 2012 and 2013, only to see end markets such as the automotive sector slide further on the back of the eurozone’s faltering limp out of recession.

2014 saw a slight thawing of the market environment in Europe, but the region’s recovery remains as grinding and protracted as ever.

Purchasing managers’ index (PMI) data for eurozone bulwarks such as Germany and France has slid into contraction on multiple occasions over the course of year, despite the European Central Bank moving further into uncharted policy waters with its move to purchase asset-backed securities.

The eurozone is expected to continue to grow in 2015, but at rates that are unlikely to threaten the prevailing idea that Europe may be facing a decade of economic stagnation, according to estimates from the IMF and OECD.

This sluggishness is likely to be mirrored by the chemicals industry, with Cefic cutting its 2015 growth forecast from 1.5% to 1% in its latest sector outlook, released in early December, on data indicating continued anaemic economic condition.

The forecast is echoed by HSBC, which forecasts such lethargic volume growth for chemicals in Europe that without cost-cutting measures – which has been the watchword for many companies for several years now – margin expansion is likely to be next to nonexistent.

We expect the environment to remain tough with volumes expanding by a mere 2-3% in the mid-term.

Given ongoing fixed cost inflation and commoditisation, this means that in the absence of cost efficiency programmes, underlying margin expansion will be virtually non-existent,” the banking group said in its December chemicals industry report.

Despite the lack of scope for margin recovery for many producers, the bank is still predicting an average year-on-year growth in earnings before interest, tax, depreciation and amortisation (EBITDA) of 8%, based less on improving market conditions and more on the easing of some additional competitive headwinds.

“Three quarters of [predicted EBITDA growth] is coming from currency tailwinds, acquisitions and cost cutting,” HSBC said, cautioning that “we do not expect earnings momentum to return to the [chemicals] sector yet, which will make it difficult to outperform given the high multiples the sector is trading on.”

While the effects of the sharp drop in oil prices over the last few months are still rippling through the market, the weakening of the euro against other major currencies has reduced the impact of exchange effects on European producers.

BASF noted a 7.7% increase in EBITDA in its third-quarter earnings and a 3.3% increase in revenues, despite an overall fall in net profit on the back of a higher tax bill, while AkzoNobel posted a 32% year-on-year increase in third-quarter net profit on the back of lower costs, despite slightly reduced sales.

However, numerous companies noted prevailing challenges, placing  and full-year earnings forecasts in the lower end of projected ranges, despite the low expectations those initial predictions may have been made on

“Structural challenges in the emerging markets and the uncertainty stemming from ongoing political disputes and military conflicts are increasingly holding back growth expectations,” noted Evonik in late October.

The need to examine efficiencies and focus on strengths as a means of driving growth in a static market means that divestments driven by the casting off of non-core operations is likely to continue to be a driver of mergers and acquisitions activity in the sector for another year.

The continuing shift away from commodity chemicals toward higher-margin specialties is also like to be a factor in European chemical company divestments next year, according to Anton Ticktin, a partner at chemicals industry M&A advisory firm Valence Group.

“I
f you look at most European companies, they’ve actually moved out of large parts of the demand chain anyway. Look at Solvay, they’ll be exiting quite a few businesses soon, if they haven’t done so already,” Ticktin said.

“The businesses being sold are more on the commodity side, either related to energy costs or feedstocks… I think European companies will continue divesting upstream assets in favour of the downstream, and I think we’re going to continue that cycle over the next few years,” he added.

The impact of falling oil prices, and how long they will stay low, is difficult to predict at present. HSBC predicts the price fall will have little overall impact on the competitiveness of European chemicals producers, while the IEA predicts that the effect will be a more pronounced negative for producing countries than it will be a positive for importing countries.

Oil producers are expected to eventually tighten supply by reducing investment in exploration, but the IEA noted that fully-funded projects are likely to go forward, meaning that tightened supply on reduced investment is likely to be more deeply-felt in the medium to long-term.

However, for the time being reduced energy costs may serve to level the playing field to an extent between European and North American producers, Ticktin added.

“I think Europe has a big advantage because they’re no longer disadvantaged in the same way in terms of energy costs,” he noted.

Moody’s is predicting that European companies will continue to underperform North American firms at the lower end of the 5-7% average growth rate the ratings agency predicts for the industry in 2015, but a $40/bbl drop in the oil price serves to mitigate the extent of the competitive difference between the regions as price falls gradually get passed down by energy companies.

“It’s interesting when you look now at share prices, the prices of some [US] companies like LyondellBasell and Westlake have collapsed comparatively speaking, simply because the gas-oil price difference has basically disappeared, so their massive advantage has just gone now,” he added.

While Europe is unlikely to be able to compete on ethylene and derivative products, the move towards specialties in face of the US’ ramp-up of polyethylene capacity may pay dividends down the line, with falling prices and an anticipated wave of additional ethylene (C2).

“I think obviously in terms of C2 chemicals, Europe remains at a disadvantage against the Middle East and the US, I think that’s an area in which will Europe will be a very small area in the future,” he said.

For C3, C4 and aromatics, that whole commodity polymer chain, I think Europe will still hold its own, so I think there will still be some opportunities there for European companies, and I think that downstream they’re pretty well-positioned. I think going forward, it’s interesting what would happen in five years’ time, who is going to be the winner of what’s happening in shale gas,” he added.

Analysts have not removed another eurozone economic collapse from their bear cases for 2015, and the impact of sanctions and cheap oil on Russia’s stability has implications for the whole continent.

But assuming, as most analysts have, that the recovery will broadly continue its lumbering path upwards, then zero growth does not mean no growth.

Some of the key headwinds that have dogged results have faded and that, along with lower oil prices may add a slight fillip to European company competitiveness, meaning that 2015 could stand to be a modest improvement on the year that preceded it. That is probably the best producers could hope for from the current regional environment.

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