INSIGHT: Omicron hits labour, logistics amid higher raws, darkens Q1 outlook

Joseph Chang

24-Jan-2022

NEW YORK (ICIS)–The Omicron wave is pressuring supply chains with staffing shortages. Along with higher raw material costs, this is leading to downward earnings revisions among US chemicals companies for Q4 and Q1 2022 as well.

Late last week, US-based coatings producer PPG reported Q4 earnings and guidance for Q1 that both fell short of Wall Street expectations – the latest in a string of disappointing announcements from coatings companies.

“Omicron-related staffing shortages at chemical firms, their suppliers and customers have created expected, but hard to quantify, reductions to near-term earnings,” said UBS analyst John Roberts in a research note.

“Before Omicron, there were already reports of improving supply chains. Reports indicate that Covid will likely continue to mutate, so this may not be the last supply chain disruption firms face. But reports also indicate the rapid spread of Omicron may also lead to a rapid recovery, so that supply chain issues could begin to ease again shortly,” he added.

The uncertainty around Omicron, plus more vocal warnings in the scientific community about the potential for another mutation, is roiling financial markets worldwide. Shares of chemicals companies, which had held up relatively well amid rising interest rates ahead of expected rate hikes by the US Federal Reserve, have lately been selling off along with the broader market.

Q4 2021 EBITDA shortfall
$m
Company Consensus Actual/pre-announce % Miss
Axalta $220 $186 -15%
Ashland $124 $106 -15%
Ecolab $760 $720 -5%
PPG $499 $452 -9%
Sherwin-Williams $733 $601 -18%
RPM* $197 $195 -1%
Q1 2022 EBITDA shortfall
$m
Company Consensus Guidance % Miss
PPG $629 $486 -23%
RPM $117 $110 -6%
Source: UBS, company reports, FactSet

*RPM’s fiscal Q2 ends on 30 November, roughly corresponding to a calendar Q4, which ends on 31 December.

PLANT MANAGER THE ‘TOUGEST JOB’
For now, companies are grappling with the immediate impacts of Omicron, as vividly described by PPG CEO Michael McGarry on the company’s Q4 earnings conference call.

“The toughest job at PPG right now is a plant manager. They wake up in the morning, check their phone to see how many people called off sick. And then they get to work… and go to the dock area and see how many trucks didn’t get picked up, and then they go to the receiving area and find out what didn’t come in that was supposed to,” said McGarry.

“And then they move into the plant, and the supply chain people are telling them that they’re going to have to make smaller batches because of a lack of raw materials. And then the sales team is telling them that if we don’t get paint out the door, here’s how many customers we’re going to impact,” he continued.

Wells Fargo analyst Michael Sison cited lingering labour cost inflation and availability issues as headwinds in Q1 for PPG, and downgraded his rating on the company to “equal weight” from “overweight”.

Such challenges, along with raw material cost inflation on the order of 25-30% year on year, will dent Q1 earnings for PPG, and likely those of other coatings and specialty chemicals companies.

Raw materials for coatings include titanium dioxide (TiO2), acrylates, isocyanates and epoxy resins, along with a wide range of solvents.

“Raw material availability remains a headwind, specifically for key materials such as emulsions and isocyanates. Availability issues impacted Q4 2021 sales by $150m, and PPG anticipates sales volumes in Q1 seeing further impact from raw material availability issues, especially in Performance Coatings,” said Sison.

While higher raw materials costs are generally good for chemicals companies, that’s only when they are relatively stable at high levels, or rising steadily, giving producers a chance to raise their own prices. In contrast, spiking raw material costs typically lead to a quarter or two of lower margins as price hikes lag.

“There is always a lag between cost changes and prices, and the transient penalty to earnings is a function of the rate of change of raws – not just the amount of change,” Roberts at UBS pointed out.

“Recent raw material cost increases have been among the most rapid in the history of the chemical industry. Volatile oil prices globally, gas prices in Europe and coal prices in China have made it challenging to forecast chemical raw material costs,” he added.

PPG, along with other coatings companies, is aggressively raising prices to pass along not only higher raw materials but logistics costs.

SPECIALTIES, COATINGS MOST VULNERABLE
Specialty chemicals and coatings producers are more vulnerable to labour disruptions and raw material shortages, and this has been evidenced by the earnings shortfalls thus far.

“These are all specialty chemical firms who purchase many chemical ingredients, create formulated products in small batch operations and have significant technical service and sales organisations that interact closely with customers,” said Roberts.

“When one raw material is missing due to a supply chain issue, the formulation can’t be completed. The plants and customer interactions are much more people intensive. And pricing lags raw material cost increases by longer than for basic chemicals,” he added.

US-based coatings producer Sherwin-Williams recently noted the Omicron variant’s spread among the company’s store managers, field sales representatives and drivers in December. At some locations, the company cut store hours and reduced staff.

Many of Sherwin-Williams’ suppliers and customers suffered similar problems from Omicron, the company said.

PROSPECTS FOR IMPROVEMENT IN H2
While Q1 is set to be a challenging time for many chemicals producers, business could start to improve in Q2 and through the rest of the year if Omicron peaks and wanes as expected in many regions, and semiconductor shortages and other supply constraints ease.

“I see automotive OEM definitely improving. The chip shortage is going to continue to get marginally better,” said McGarry.

ICIS projects 2022 US light vehicle sales to rebound to 16.0m from 15.0m in 2021 as chip constraints ease later in the year. However, this would still be below the pre-pandemic 2019 level of 17.0m, according to ICIS senior economist Kevin Swift.

The PPG CEO also sees higher auto refinish paint demand from a harsher winter in the US, greater aerospace coatings demand from recovering air travel and China eventually approving the Boeing 737 MAX aircraft, and more demand from new metal packaging plants opening up to replace plastics packaging.

“Every quarter from this point out we should start to see improvement in margins,” said McGarry.

Raw material costs should flatten out, price increases will be implemented, manufacturing issues resolved, and cost savings and acquisition synergies realised. Plus, volumes should bounce back, led by auto and aerospace, he noted.

CHINA ZERO-COVID POLICY AND POTENTIAL FOR MORE DISRUPTIONS
However, China’s zero-Covid policy, where it shuts down cities and large sections of the country in the event of even limited COVID-19 infections, could prove to be severely disruptive if such a policy is maintained amid higher infections from Omicron.

“What we are really worried about is, if Omicron gets to China,” said McGarry, noting China’s zero-Covid policy.

PPG’s largest plant in China is in Tianjin, where a recent small COVID-19 outbreak prompted authorities to test 14m people within two days, he said.

“So, if Omicron were to get to China, and they continue with their zero-Covid policy, that could have a pretty disruptive effect” on PPG’s business in China, McGarry noted.

A major Omicron spread in China met with stringent lockdowns and restrictions would obviously have a disruptive impact not just on coatings, but the entire global manufacturing and chemicals chain.

Additional reporting by Stefan Baumgarten and Al Greenwood

Insight article by Joseph Chang

Thumbnail shows paint. Image by imageBROKER/Shutterstock

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