Commentary: Bumpy ride for chemical profits

It’s going to be a bumpy ride for chemical profitability for the rest of 2015 and into 2016. Companies will be facing major headwinds from lower crude oil prices and the commodities collapse. Throw in China’s manufacturing contraction and stronger Western currencies, and you have a recipe for dis…ruption.

Not disaster yet, but the macro trends are certainly trending towards the negative. The commodities collapse has not been confined to crude oil, but spreads across the spectrum from copper to iron ore to aluminum and petrochemicals.

And it should not be surprising, given the persistent weakness in China, the big consumer of commodities. China’s manufacturing PMI (Purchasing Managers Index), measured by the Caixin/Markit index, has been in contraction for seven straight months.

The widespread carnage in commodity-related stock prices is spreading to the chemical sector. Shares of US-based Huntsman lost 29% of their value in one day on 28 September, following a warning on third-quarter earnings, followed by another 6% drop on 29 September, to $9.33 – a level not seen since late 2011.

Virtually all the trends cited in the announcement were running against the company – from lower titanium dioxide (TiO2) prices, particularly in North America, to soft demand in Asia including for polyurethanes, and headwinds from the strong US dollar.

Huntsman said delayed benefits from raw material prices will help adjusted Q4 earnings before interest, tax, depreciation and amortisation (EBITDA) to be relatively flat both versus Q3 and year on year, at around $300m.

But the shock to investors was the projected decline in Q3 EBITDA to around $300m. In last year’s Q3, Huntsman earned $356m in adjusted EBITDA, a figure that took a $30m hit from a disruption in PO/MTBE (propylene oxide/methyl tertiary butyl ether) operations.

TIO2 A SORE SPOT

The weakness in TiO2 is clearly a big concern for investors, evidenced by the 23% drubbing of fellow producer Tronox on the day of Huntsman’s warning.

“Persistent oversupply across the globe and depreciated currencies (particularly the euro) are impacting the North American [TiO2] market, with the price gap narrowing,” said Wells Fargo analyst Frank Mitsch.

“Also, market sources have quoted global TiO2 operating rates close to 80%, which does not bode well for any price increases,” he added. “While there is some positive news on the supply side with Huntsman and Tronox shuttering capacity, demand remains muted and mixed China trends add another layer of risk. Directionally, pricing continues to go down without a near-term catalyst to turn the market.”

Mitsch cut his 2015 earnings per share (EPS) estimate on Huntsman by $0.37, to $1.83, and his 2016 forecast by $0.25, to $2.30. Even based on those reduced estimates, Huntsman trades at shockingly low multiples of 5.1x 2015 EPS, and 4.1x 2016 EPS – and that is assuming trough earnings, if in fact they are near the bottom.

Huntsman is also relatively leveraged, with net debt of $4.45bn and last 12 months adjusted EBITDA of $1.32bn, for a net debt/EBITDA ratio of 3.37x. Leveraged commodity plays are particularly out of favour with investors these days.

BASF TAKES DOWN ASSUMPTIONS

China and other emerging market headwinds were also cited by Germany-based BASF at its investor days on 28 and 29 September. The BRICs (Brazil, Russia, India and China) are running on only one cylinder, noted BASF CEO Kurt Bock.

“Major markets did not grow as fast as anticipated,” he said. “The oil price has been unpredictable and has decreased substantially. Geopolitics have contributed to higher volatility.”

BASF took down global GDP growth expectations for 2015-2020 to a compounded annual growth rate of 3.0% from its view of 3.2% in 2011. It also lowered its global industrial production forecast over the period to 3.5%, compared to a previous 3.7%. For global chemical production, growth of 3.9% is expected, down from 4.0%.

BASF plans to reduce capital spending from a peak of €5.4bn in 2014 to a level slightly above depreciation, which is running at less than €4bn as of 2015, based on figures (including imprecise bar charts) in its investor presentation.

Expect rough sledding for the cyclical global chemical sector in the coming quarters on unfavourable macros. While many chemical companies are already engaged in cost cutting measures and divestitures, expect more in the near future.