Germany's LANXESS faces headwinds in key markets despite ARLANXEO sale

Author: Tom Brown

2019/03/13

LONDON (ICIS)--LANXESS has gone through a series of dramatic transformations over the last half decade improving its resilience as a business, but exposure to weak end markets is likely to weigh on the company this year after a difficult 2018.

- Extensive repositioning of the company in recent years

- Significant remaining exposure to weak end markets in 2019

- Healthy capital reserves following ARLANXEO stake sale

Since rejoining the company, CEO Matthias Zachert has taken significant steps in diversifying its portfolio and reducing reliance on the automotive and rubber sectors, which saw a slump earlier in the decade as well as in the second half of 2018, and a sales footprint overwhelmingly dependent on Europe.

At the time of the 2012-13 automotive downturn, LANXESS was the European chemicals producer most exposed to any change in fortunes, and despite substantial cost-cutting measures the company was forced to issue a profit warning for 2013.

With limited capacity for asset sales without cutting profit margins and a focus on high-value tyres that failed to offset the extent of the decline, the company seemed to be left with a business model that no longer functioned.

This led to the abrupt departure of former CEO Axel Heitmann in 2014, and the recruitment of former CFO Zachert, who had carried out a successful turnaround operation as CFO at Merck KGaA since his departure from LANXESS in 2011.

Zachert quickly embarked on a realignment programme, nudging the company away from rubber in favour of specialty chemicals through its acquisitions of Chemtura and Chemours’ cleaning and disinfectant product business.

The most ambitious part of the strategy was folding its synthetic rubber business into a 50/50 joint venture with Saudi Aramco, providing a €1.2bn cash injection, reducing LANXESS’ exposure to the space and providing it with a source of cheap feedstocks from the state giant.

The transformation continued with the sale of the remaining 50% stake in ARLANXEO to Saudi Aramco, completed in late 2018.

The €1.4bn price tag was better than the €1.2bn Aramco paid for its stake in the business in 2016, but analysts still expressed surprise at the timing and price of the deal, which had been projected to fetch up to €1.8bn-1.9bn.

At the time of the announcement, equity chemicals analyst Oliver Schwarz of Warburg Research noted that the timing of the deal came despite an agreement between both partners that there would be no sale before 2020, and an agreement between the partners for a supply of competitively-priced feedstock to the business this year.

The decision to move forward with the divestment despite the agreed terms and scheduled cheap raw materials pointed to some reason for LANXESS to pursue an expedited schedule. The motivation could be an acquisition target – although no news has surfaced yet – or simply to better represent itself to the market as a specialties player.

Chemicals companies are increasingly pushing back against the so-called conglomerate discount, where a wide range of up- and downstream operations across different value chains lead investors to undervalue businesses, in favour of a simpler and more compelling value proposition.

“The partners didn’t wait for that, either because LANXESS has another acquisition target on its mind and simply needed the cash to finance that, or because it wanted to become more visible as a pure-play specialty chemicals player," said the analyst.

A last reason may be that the company foresaw bearish conditions in the automotive sector that would have weighed on earnings over the next two years and led to an even lower valuation come 2020.

Whatever the reason for the schedule change, LANXESS divested the business at a relatively strong valuation, and bolsters company cash reserves at a time when acquisition valuations are starting to slip after some extremely multiple-heavy years.

“LANXESS sold the stake in ARLANXEO at the peak of the market, they got a very nice valuation, and if they’re lucky they might follow the mantra of sell high, buy low,” said Moody’s chemicals analyst Martin Kohlhase.

“We think that's why they're probably in no rush to redeploy their billion quickly, they might wait for equity valuations to go south along with the cycle,” he added.

This has been borne out in the short term, with the extent of automotive sector weakness resulting in Germany coming close to a recession in the second half of 2018.

Data from the European automobile trade group ACEA showed that EU's commercial auto registrations fell 4% in December, while passenger car demand fell 8% in November.

Whatever the reason for the schedule change, LANXESS divested the business at a relatively strong valuation.

CHALLENGES AHEAD
Indeed, despite the extent of the transformation Zachert has brought about, and moves this year to tighten the company’s capital structure with a €200m share buy-back, LANXESS still faces substantial challenges.

Analysts at Germany’s Baader Bank rated the company as one of the worst performers in the listed European chemicals sector last year, and with 40% exposure to challenging end markets in 2019, with automotive, electronics and construction markets all bearish for the year.

However, it upgraded its rating on LANXESS stock from hold to sell, claiming that the company’s valuation has reached a fair level after a 40% decline in its share price since mid-2018.

2019 is expected difficult for companies, with demand growth projected below the long-term average at around 2% globally, and weaker in Europe, and many basic and intermediate chemicals shifting into the lower part of the cycle as specialties start to feel the benefit of lower raw materials costs and moves to pass on price increases continue to bear fruit.

Nevertheless, the ARLANXEO divestment leaves the company with a good deal of financial flexibility after the ambitious buys of recent years pushed up debt levels, and the full-year earnings before interest, taxes, depreciation and amortisation increased at the upper range of its 5-10% guidance.

According to analyst consensus, earnings before interest, tax, depreciation and amortisation (EBITDA) pre-exceptionals is expected to be relatively stable this year compared to 2018, but net income is expected to fall.

Pictured: LANXESS' headquarters in Cologne, Germany
Source: REX/Shutterstock

Focus article by Tom Brown