Chemicals are generally used to make a wide variety of consumer goods and are also used in agriculture, manufacturing, construction, and service industries. The chemical industry itself consumes 26% of its own output. Major industrial customers include rubber and plastic products, textiles, apparel, petroleum refining, pulp and paper, and primary metals.
The chemical industry has shown rapid growth for more than fifty years. The fastest-growing areas have involved the manufacture of synthetic organic polymers used as plastics, fibers and elastomers. Globally, the chemical industry is mainly concentrated in three areas of the world: Western Europe, North America and Japan. The European community is the largest producer, followed by the U.S. and Japan.
Chemicals are a nearly $3 trillion global business, and the European Union (EU) and U.S. chemical companies are the world’s largest producers.
The US chemical industry produces 19% of the world’s chemicals output, amounting to $689 billion. The industry directly employs over 800,000 people nationwide. A total of nearly 5.5 million additional jobs are supported by the purchasing activity of the chemical industry and by the subsequent expenditure-induced activity. In addition, the US chemical industry is responsible for 10% of US merchandise exports, totaling $145 billion annually, as well as 11% of all US patents.
The recession had hit the chemical industry hard. As a result of lack of demand, chemical companies shelved their growth plans. With plants idled or running at historically low rates, the companies looked for avenues to streamline operations and increase productivity. Accordingly, they resorted to restructurings, plant closures and layoffs. Cost-cutting initiatives at industry majors, like, The Dow Chemical Company (DOW) and EI DuPont de Nemours & Co (DD) helped them save billions of dollars.
With the economic turnaround, the global chemical industry is recovering from the recession-hit lows. Domestically, chemical production volumes increased across all regions of the country in 2010, reversing the steep declines experienced in 2008 and 2009. The largest gains occurred in the Gulf Coast and Ohio Valley regions, boosted by export demand for basic chemicals and plastics. Output is expected to grow moderately in all regions in 2011 and continue to improve through 2012.
The growth outlook for the U.S. economy remains favorable, despite the anemic pace in the first quarter. Current expectations are for a real GDP growth rate in excess of 3% for 2011.
End-markets for chemical products are showing strong growth. This growth has been reflected in the earnings releases of most chemical companies for first quarter 2011. Eastman Chemical Company (EMN), for example, reported a 28% increase in sales revenues, primarily due to improved customer demand in packaging, transportation and other markets and the positive impact of growth initiatives.
Combined with the restructuring and cost saving programs that many chemical companies implemented last year, output growth is driving high earnings across the sector, to the extent that many companies are confident of out-performing full year forecasts.
Based on the strong first quarter results, Eastman Chemical Company expects second quarter 2011 earnings per share to be slightly higher than first quarter 2011 and full year 2011 earnings per share to be slightly higher than $9.
Celanese Corp. (CE) revenue also grew 14% year over year to $1.6 billion in first quarter 2011 driven by higher volumes across all business segments. Encouraged by the first quarter strength, the company raised its outlook for full-year 2011.
The company now expects 2011 operating EBITDA to be at least $200 million higher than 2010’s $1,122 million and adjusted earnings per share to be at least $0.85 higher than 2010’s $3.37, based on a tax rate and diluted share count of 17% and 158.7 million shares, respectively.
The Dow Chemical Company (DOW) revenue grew 20% year over year to $14.7 billion by volume (8%) and pricing (12%) gains across all business segments and geographical regions, particularly North America and Europe.
Growth in export markets has been driven by several factors. These include favorable energy costs (natural gas) due to the abundance of newly found shale natural gas; and demand from emerging markets, where recovery and expansion have been the strongest. As per the American Chemistry Council (ACC), U.S. exports would grow by 9.7% in 2011, outpacing the expected 7.8% growth in imports.
Further, the cost-containment measures implemented by chemical companies, such as plant shutdowns, aggressive cost cutting and production improvements, should continue to bolster industry-wide margins. The resultant large cash flows could then be leveraged for growth opportunities.
Dow Chemical, Celanese and Eastman Chemical have long-term strong Buy recommendations, while DuPont has a long term Buy recommendation.
In the U.S. there are 170 major chemical companies, operating internationally with more than 2,800 facilities outside the U.S. and 1,700 foreign subsidiaries or affiliates operating.
In Europe, especially Germany, the chemical, plastics and rubber sectors are among the largest industries. Together they generate about 3.2 million jobs in more than 60,000 companies.
According to the ACC, the Chemical Production Regional Index (CPRI) rose 0.5% in March 2011, following a revised 0.8% gain in February 2011, as chemical production increased in all regions, with the largest gains in the Northeast, Mid-Atlantic, Southeast, and West Coast regions.
U.S manufacturing sector output was up 0.7% in March, following a 0.6% gain during February. Output grew in many key end-use markets for chemistry products, including construction supplies, motor vehicles, electrical equipment, furniture, paper and plastic and rubber products.
The U.S. home building sector is a major consumer market for the chemicals industry accounting for about 10% of chemical demand.
Nationwide housing starts declined 4.3% to a seasonally adjusted annual rate of 529,000 units in December 2010, according to the U.S. Commerce Department. While this was the slowest pace of starts activity since October 2009, further downside risks from current levels are limited. Nevertheless, the continued softness in the U.S. housing industry makes this the weakest end-market for the Chemicals industry.
Trends in Raw Material Markets
The chemical industry is a large consumer of oil, naphtha and natural gas, which are widely used as energy and feedstock inputs.
Oil prices trended upward throughout 2009, and in April 2011, crude oil prices averaged around $111 per barrel, though they have since come down to the under-$100 level. With current economic conditions improving worldwide, global demand for oil is rising, leading to higher prices. Naphtha prices are also expected to remain elevated relative to last year’s levels, though they have given ground lately as well along with crude oil prices.
Over the past five years, the U.S. natural gas markets have seen a dynamic shift due to the emergence of a new source of energy shale gas which exists in large quantities with sources close to many big energy-intensive cities. The abundant availability of shale gas is not only desirable on environmental considerations, given its lower carbon footprint relative to coal or oil. But it is also cost effective, essentially removing a key source of disadvantage for U.S. based chemicals producers.
As per the ACC, favorable dollar exchange rates, growth in emerging markets and abundant shale gas will drive US chemical exports up and China will overtake the US as the largest market for chemical.
The chemical companies are looking at mergers and acquisitions as an option to grow in the current economic environment. The companies are focused on exploring growth opportunities in emerging markets with strong performance in the fast-growing regions of Asia-Pacific and Latin America, particularly China and Brazil. The United States expects growth to continue, albeit at a slower rate than last year. Business conditions are improving, with corporate profits and investments rising and industrial production showing solid gains compared with the year before.
One of the largest operators in this space, DuPont (DD), recently entered into a definitive agreement to acquire Denmark’s Danisco for $5.8 billion in cash and the assumption of $500 million of Danisco’s net debt. This marks the company’s largest acquisition since its $7.7 billion buy of Pioneer Hi-Bred International in 1999. The deal will enable DuPont to expand the company’s offerings in more specialized areas like biofuels and food enzymes.
DuPont is focused on capturing $1 billion in working capital productivity gains during the 2011−2013 timeframe. The company is also on track to achieve a cumulative $600 million in benefits from fixed cost productivity and restructuring actions in 2011. It is executing strategies for further development and growth of new products, particularly for agriculture, photo-voltaics, alternative energy and materials.
Dow is delivering cost synergies from the Rohm & Haas acquisition and is targeting synergy capture of $2 billion by the end of 2012.
The global nature of the industry puts competitive issues into sharp focus. U.S. producers have responded to competitive pressures by streamlining operations, relocating manufacturing facilities to low-cost regions closer to end-markets, and being overall more nimble and flexible in responding to market opportunities. And it is not always easy to pull this off.
The recent surge in commodity prices, though subsiding in the last few days, is adding to the feedstock costs for many of these producers. Their ability to pass these costs on to end consumers is not always easy given competitive pressures. As a result, margins for a number of producers will be under pressure in the coming quarters.
Additionally, given the industry’s sensitivity to the global economy, a diminution of growth outlook will be a materially negative development. The recent turmoil in Europe and its impact on global growth remain sources of near-term uncertainty.
German chemical company BASF announced plans to lay off at least 2,000 workers as it reported a 68% decrease in its first-quarter 2011 net profit compared with the same period a year ago. The company said it expects earnings before interest and taxes (EBIT) to decrease even further as its sales suffer amid weakening demand.
Calgon Carbon Corporation (CCC), a leader in the activated carbon sector, faces weak demand for carbon products. The company had weak volumes in 2010 and, though activated carbon sales recovered to some extent in the last reported quarter, we are skeptical about its sustainability. We expect sales volumes in the segment to remain challenging as the end-markets have yet to recover fully.
There are other possible hurdles that chemical makers may have to face such as pending rule changes within US regulatory agencies. The U.S. EPA has proposed a sweeping new rule that could impose stricter hazardous air pollutant emissions limitation and other requirement on operators of new and existing boilers and process heaters.
According to EPA’s calculations, compliance with these rules would cost boiler owners $12.2 billion to implement and annualized cost of $4.1 billion after accounting for savings and also result in mill closures.
The largest corporate producers worldwide with plants in numerous countries include BASF, Bayer, Braskem S.A. (BAK), Celanese Corp., Degussa, The Dow Chemical Co., EI DuPont de Nemours & Co., Eastman Chemical Company, ExxonMobil, INEOS, Mitsubishi UFJ Financial Group, Inc. (MTU), PPG Industries Inc. (PPG), SABIC and Shell, along with thousands of smaller firms.