New US tariff threat, Q2 earnings reports dash hopes for H2 recovery

Author: Joseph Chang

2019/08/02

NEW YORK (ICIS)--After the bulk of Q2 earnings reports and management guidance, hopes for a second half recovery have been dashed. And US President Donald Trump’s threat to slap 10% tariffs on an additional $300bn in imports from China starting on 1 September only dampen the outlook.

End market headwinds in automotive, housing, consumer electronics and durable goods, and geographically in China and Europe will persist while the US-China trade war is about to escalate even further.

Chemical stock prices took a beating on 1 August following Trump’s tariff threat. While the broader US market as measured by the S&P 500 fell 0.9%, the S&P 500 Commodity Chemicals Index plunged 3.0%.

Bellwether Dow fell 3.3% to its lowest level since its spinoff from DowDuPont in March. Other notable decliners included Trinseo (-5.9%), Westlake (-4.1%), Eastman (-3.8%) and Huntsman (-3.5%).

VOLUMES DOWN ACROSS THE BOARD

For Q2 earnings season, volumes were down across nearly across the board in chemicals while pricing was mixed – down for the more commodity names and higher for specialties.

This reflects a struggling industrial sector and a still relatively healthy consumer – but a consumer that’s just not spending on big ticket items like cars, housing and high-end electronics.

But US President Trump is about to hit arguably the strongest sector of the global economy – the US consumer – with the new tariffs.

An important aspect of the latest US tariff threat of 10% on an additional $300bn in imports from China, on top of the existing three rounds of 25% tariffs on $250bn of Chinese imports is that Round 4 targets primarily consumer goods such as apparel, electronics, toys and footwear.

For bulk chemicals directly, the US fourth round of tariffs target vinyl chloride monomer (VCM) along with fatty alcohols, fatty acids and glycerine. However, US imports of these materials from China are minimal.

The bigger impact will be on finished plastics and other products that will have an indirect impact on demand for US chemicals and polymers, along with the shock to global confidence of a protracted and more costly trade war between the world’s two largest economies.

Even if the US enacts the fourth round of tariffs at 10%, the threat of bringing these to 25% or higher still looms. Global supply chains have already been shifting away from China and this will only accelerate.

HUNTSMAN TRADE HEADWINDS

On 30 July, US-based Huntsman posted a 38% decline in Q2 earnings per share, citing the US-China trade dispute as playing a key role.

Following the US announcing potential tariffs on an additional $300bn in China imports in mid-May, Huntsman saw customer order patterns slow significantly in late May and June in its key methylene diphenyl diisocyanate (MDI)/polyurethanes business.

It’s now once again worth watching closely the impact on buying patterns in the global chemicals sector following the latest US tariff threat.

Huntsman CEO Peter Huntsman said 2019 earnings before interest, tax, depreciation and amortisation (EBITDA) could fall by 20% year on year, and perhaps 15% or less if conditions become more positive in the second half.

Jefferies analyst Laurence Alexander slashed his 2019 earnings per share estimate on Huntsman by $0.40, to $2.25, representing a 32% decline year on year.

“Auto OEM demand, Asia MDI margins, EU industrial activity and US destocking will likely all act as incremental headwinds in H2 2019,” said Alexander.

Frank Mitsch, analyst at Fermium Research, points out that Huntsman’s EBITDA guidance for 2019 has fallen through the year, from down 5-7% on 13 February, to down 7-10% on 30 April, to down 20% on 30 July.

“We don’t recall a single conversation with the buy side over the past six weeks where the lowering of H2 [estimates] wasn’t expected, though suspect the 20% was at the upper limit of the whisper number,” said Mitsch.

DUPONT BEATS EXPECTATIONS

US-based DuPont on 1 August beat Wall Street expectations with a 9% gain in earnings per share. It raised 2019 profit guidance slightly to a range of $3.75-$3.85 per share versus prior guidance of $3.70-$3.85 but noted organic sales would fall slightly. The revised guidance remains below 2018 adjusted earnings per share of $4.07.

“The Street expected lower guidance so this is a surprising and positive result,” said Bernstein analyst Jonas Oxgaard.

DuPont’s overall volumes fell 5% while pricing was up 2% year on year. Transportation & industrial segment sales fell 10% year on year as volumes plunged 12%, and the electronics and imaging segment saw 7% lower sales on a 5% decline in volumes.

LYONDELLBASELL SEES CONSUMER RESILIENCE

LyondellBasell on 2 August posted a 36% decline in Q2 earnings per share with volumes ex-refining down 5% and overall sales down 11%.

Resilient consumer-driven demand is driving a healthy polyethylene (PE) market, said CEO Bob Patel.

“We’ve continued to see the consumer driving demand for our products. Where we see a little bit more tepid buying is on the industrial side,” said Patel.

“There’s a lot of concern about trade, tariffs and Brexit and the direction of interest rates. Our view is that it’s all causing industrial buyers to be cautious,” he added.

LyondellBasell’s Olefins & Polyolefins business improved both in the US and Europe sequentially in the second quarter but were down year over year.

In LyondellBasell’s Olefins & Polyolefins – Americas segment, the PE spread to ethylene increased by about $65/tonne in the second quarter versus the first quarter, helped by “abundant and affordable” natural gas liquids (NGLs).

Notably, O&P – Americas EBITDA margin was a robust 30.0% in thesecond quarter versus 26.4% in the year-ago quarter and 24.4% in Q1 2019, aided by sharp decline in US NGL feedstocks.

DOW, BASF POST BIG DECLINES

Earlier in earnings season, Dow and BASF posted sizeable declines in adjusted Q2 earnings per share (Dow -39%, BASF -54%) on both weak volumes and prices, and guidance for the rest of 2019 was uninspiring at best.

US-based Dow didn’t give specific guidance for 2019 but was clear that the macro environment remains cautious with little visibility along supply chains. In response to the more challenging macros, the company is slashing 2019 capital spending (capex) by $500m, to $2.0bn.

Bernstein’s Oxgaard on 26 July pointed out that each of the major commodity chains to which Dow is exposed - polyethylene (PE), polyurethanes, silicones, and monoethylene glycol (MEG) - are all expected to remain under pressure into the third quarter.

“We also see room for US PE benchmarks to fall, as the premium of domestic contract price to the export spot price is at a multi-year high,” said Oxgaard.

“We see no fundamental reason this should continue and believe domestic prices will fall to export parity,” he added.

It was a prescient statement on PE, as the US contract fell 3 cents/lb on 31 July.

Germany-based BASF shocked the entire chemicals sector on 25 July with a huge cut in guidance as it reported Q2 results. It now expects earnings before interest and tax (EBIT) for 2019 to fall by as much as 30% versus its previous forecast of a slight gain.

GLOBAL PMI WEAKNESS PERSISTS

The challenging full-year outlooks should come as no surprise to those tracking the key global manufacturing purchasing managers’ indexes (PMIs). China and European manufacturing activity have been in contraction territory (below 50) while the US has been losing momentum fast.

Earlier in the year, even as managements were still optimistic about a second half recovery in 2019, the PMIs were telling a different story.

On 1 August, the ISM US Manufacturing PMI for July came in at 51.2, below expectations and down from 51.7 in June. The leading indicator remains above the key 50 level denoting expansion or contraction but has quickly been losing momentum, down for the fourth consecutive month.

Meanwhile, Eurozone and China manufacturing PMIs for July continued to languish in contraction territory with exceptional weakness in Europe.

US PE CONTRACT PRICES DECLINE

It’s hard enough getting pricing power amid challenging macros. Mix in major capacity additions to the formula and you get persistent declines in pricing.

On 31 July, ICIS assessed US polyethylene (PE) contracts for July down 3 cents/lb ($66/tonne), tracking sufficient supply and declining feedstock costs. US PE contract prices are down 12 cents from a year ago. For linear low density PE (LLDPE), contract prices are down 19% year on year.

PE supplies are lengthening. ExxonMobil in late July started up a new 650,000 tonne/year high density PE (HDPE) line at its Beaumont, Texas, facility.

On tap is Sasol’s 420,000 tonne/year low density PE (LDPE) plant in Lake Charles, Louisiana, which had been slated to start up in August but will be delayed by four-to-six weeks. Sasol started up its new 470,000 tonne/year LLDPE unit in in May.

And the US is ramping up PE exports as well. The US exported over 50% of its LLDPE production in 2018, according to the ICIS Supply and Demand Database.

With China tariffs on US HDPE and LLDPE, much more volume is going to Southeast Asia among other regions.

From a year ago, Southeast Asia LLDPE prices are down 19% to $955/tonne on a spot cost and freight (CFR) basis.

DON’T HOLD YOUR BREATH ON TRADE DEAL

Before Trump’s latest tariff threat, a number of CEOs, including those from Dow, PPG and Huntsman, alluded to the potential of a resolution to the US-China trade dispute sparking a big snapback in demand in many important end markets as confidence is restored.

The industry really needs this shot in the arm on the trade front to revitalise growth. US-China trade talks are ongoing but do not hold your breath for a positive outcome.

ICIS senior consultant John Richardson argues against a grand US-China deal anytime soon as the US presidential election season kicks off – even as the election is far off in November 2020.

“President Trump has nothing to gain and everything to lose on softening his China approach, given that the US economy is on the surface doing fine despite the trade war,” said Richardson in the ICIS Asian Chemical Connections Blog.

Trade disputes emanating from the US continue to weigh on global growth prospects. The IMF recently trimmed its 2019 global GDP growth estimate from 3.3%, to 3.2%, citing US tariffs as well as prospects for a no-deal Brexit.

While hardly a terrifying revision, the trend is moving in the wrong direction.

POSITIVES – INVENTORIES, CENTRAL BANKS

So with weak Q2 earnings and a sluggish outlook amid a pending escalation in the US-China trade war, what could go right?

While the negatives clearly outweigh the positives, as Peter Huntsman noted on the company’s Q2 earnings call, one positive is lower customer inventories, especially in Asia – an emerging theme and not surprising given two quarters of destocking following the late 2018 collapse in demand, and short-term buying patterns amid lack of confidence.

Another and more important positive is central bank support. Central banks around the world are cutting interest rates, or signaling that rate cuts are coming – importantly the US Federal Reserve, the European Central Bank and the People’s Bank of China are all on the same loosening page.

This makes borrowing costs cheaper and spurs economic activity.

The US Fed cut rates by 25 basis points on 31 July – its first cut since December 2008.

However, Fed chairman Jerome Powell botched the messaging, leaving the markets confused about whether this is a one-off, “midcycle” cut, or whether further cuts may be needed to offset economic weakness.

When so much of the macroeconomic weakness has to do with confidence – the lack thereof – introducing this kind of uncertainty could be viewed as suboptimal.

The US dollar, which normally would fall in the face of rate cuts, actually surged to its highest level in over two years against a basket of international currencies as measured by the US dollar index. This essentially signals scepticism about further rate cuts.

For the US chemical sector and the overall economy, a higher dollar is a headwind as it makes exports less competitive.

However, Trump’s latest tariff threat, if actually implemented, could further strain global and US economies, forcing the hand of the US Fed to act by cutting rates more aggressively to stave off a more serious downturn.

Additional reporting by Zachary Moore and Stefan Baumgarten

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Insight article by Joseph Chang