Specialty, scarce M&A targets to drive Europe chems growth – Moody’s

LONDON (ICIS)–While the European economy’s positive momentum continued into the first quarter, chemical companies in the region will need to seek growth through mergers and acquisitions (M&A) and specialisation to remain competitive globally, according to a senior analyst at US-headquartered credit rating agency Moody’s.

Francois Lauras, senior credit officer for European chemicals, added however that M&A targets are becoming scarce and, as a consequence, companies will need to be prepared to pay high multiples for attractive targets.

Specialisation may prove the saviour of many diversified chemicals in years to come, said the analyst, on the back of new environmental regulations to be enforced following the 2015 Paris agreement to limit global warming, allowing chemical producers to “thrive” by innovating with more efficient materials.

The European economy’s recovery has evolved into full-steam economic activity in some core countries, with even France posting signs of a comeback.

Indicators for the first quarter showed manufacturing and services at six-year highs, with most chemical companies posting increasing sales volumes, revenue and selling prices, compared to the first quarter of 2016.

“Overall, there is a better economic backdrop, with many end-markets performing quite well like automotive and even construction. Also, let’s not forget that many European companies have invested a lot in new capacities which are coming to fruition – that could also explain why volumes are up,” said Lauras.

“Moreover, companies that are increasingly focused towards specialty chemicals are able to leverage current trends such as energy efficiency, climate change and rising living standards in emerging economies.

“For example, the trend in the automotive sector to substitute materials for lightweight, more efficient plastics, shows the potential of many companies to exceed GDP growth. Some companies have been claiming that for some time – and in a way recent performance seems to bring some credence to that claim.”

The European Central Bank’s (ECB) quantitative easing (QE) programme, started in 2015, fuelled the economic recovery as credit started to flow to corporates and households in the 19-country eurozone.

The purchases of public and private bonds also permitted, according to Lauras, more activity in the chemical M&A sector, as record-low interest rates in the eurozone made credit cheap and abundant. However, growth through M&A in Europe is starting to find its limits.

“We think cheap money has been supportive of the M&A activity we have seen in the last few years and it is obviously a driver of stronger economic growth. The large, diversified chemical companies which are shifting their portfolio towards downstream and specialty activities have benefited from stronger growth dynamics, but there is always a search for M&A targets,” he said.

“However, these are not that easy to identify and, on top of it, prices have gone up because there is a scarcity of attractive targets. But M&A is a key part in their strategy to move away from commodity, base chemical activities towards specialty chemicals.”

Crude oil prices have remained around the $50/bbl level since the OPEC and non-OPEC producers agreed at the end 2015 to cut or freeze production in order to prop up prices.

With the influence of OPEC, captained by Saudi Arabia, to set crude oil prices dwindling as other countries outside the cartel gained prominence in production, potential high crude prices which could increase input costs for chemical companies will not be a concern for some time to come.

The International Energy Agency (IEA) said in April that, in fact, non-OPEC producers would be the long-term beneficiaries from the output cuts.

Even more, if the economy continues to perform at its current rates, passing higher input costs onto selling prices to customers would not be too much of a challenge, said Lauras.

“We have a fairly cautious view about crude prices, which we expect to remain in the range of $40-60/bbl in the medium-term. Currently, there is a certain amount of reflation compared to last year and that’s where downstream producers will seek to pass on higher raw material costs to customers,” the Moody’s analyst said.

Reflation can be considered as a form of inflation, but economists use that term to refer to the ‘good inflation’ which identifies a recovery of the price level when it has fallen below the trend line.

“That [passing price increases on to customers] may be the challenge going forward, but chemical companies are managing that relatively well, as we can see from recent [first-quarter] results.”

Interview article by Jonathan Lopez