LONDON (ICIS)--Market growth expectations for European chemical stocks are underpinned by unrealistic ideas of emerging market demand, according to the research unit of UK-headquartered banking group HSBC on Friday.
The majority of listed European chemicals producers have significantly increased their footprint in emerging market regions over the last decade in response to tepid growth at home. However, growth in those regions is slowing and is unlikely to meet current market expectations for sector performance, HSBC said.
The developing world share of European industry revenue rose by 10 percentage points between 2005 and 2015, to 39% of the total. But emerging market GDP growth is slowing, and growth multipliers for chemicals in those regions are slipping close to developing world levels, the bank said.
Expectations for the sector are likely to be revised down over the next 12-18 months as emerging markets fail to be the growth engine as expected, the bank added.
“Consensus expectations around revenue growth and margin improvement for the sector underpinned by emerging market exposure appear wholly unrealistic,” Sriharsha Pappu, HSBC's Emerging Markets chemicals equity analyst wrote in the report.
“It is also not just emerging market demand growth that has been declining. Returns on investment in emerging market chemicals have consistently trended downward as increased competition and overcapacity have driven prices lower,” he added.
The European industry has benefited from portfolio optimisation and cost-cutting, leaving it less cyclical and more efficient, HSBC said, but sector growth remains strongly tied to GDP growth.
With developed market growth projected by HSBC to be 1.5% in 2016 and 1.6% in 2017, the emerging markets would need to expand by 8% per year in 2016-18 for European chemical companies to reach annual 5% revenue expansion over the period, according to HSBC.
The sector has benefited from lower energy and capital costs, but these have been priced into performance expectations, and margin improvement or strong revenue growth necessary for a producer to outperform the sector, HSBC said.
Local growth by developing market firms has also reduced the amount of product those regions have been able to absorb from western producers.
“In some key markets, China for example, it is hard to think of a major downstream chemical product or product chain, which… is currently undersupplied,” Pappu said.
HSBC identified revenue visibility – the extent to which future earnings projections are probable – as desirable in a sector where general growth estimates are likely to be revised down, as well as additional sector consolidation.
Solvay is most likely to outperform the market on the basis of revenue growth visibility, attractive end markets and structural tailwinds, while AkzoNobel, Covestro and Clariant are most likely to underperform, the bank added.
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