Defaults to persist until 2010

C&I Issue 20, 2009

The chemical industry is showing signs of recovery, after suffering badly at the hands of the recession, but analysts warn that bankruptcies and defaults could continue well into 2010 as businesses struggle to refinance and pay down large debts. Questions also remain over how long it will take the industry to recover and whether there will ever be a return to the growth rates seen in the global chemical industry in 2007.

‘We clearly expect the third quarter to show an improvement, compared to the second quarter,’ says Tobias Mock, director corporate ratings at Standard & Poor’s. ‘Now the question, however, is: “How long does it take to come back to the production levels we once had in 2007?”. And there we would clearly say: “This can take several years”.’

Some tentative signs of ‘green shoots’ were visible as Bayer MaterialScience announced that it would be ending short time working at German plants on 1 November 2009. ‘The reason for lifting this special arrangement is the improvement in orders,’ says Tony Van Osselaer, labour director at Bayer MaterialScience. Of Bayer’s sub-groups, MaterialScience was worst hit by the recession.

BASF also reported positive news with its Q3 2009 figures. Sales were 19% down on the same period in 2008 at €12.8bn, but up 2.4% on its Q2 2009 figures. Earnings before interest and tax (EBIT) were €1.25bn, which, although 20% down on the same time last year, were nonetheless 9.5% higher than Q2 2009.

European chemical sales have also shown some signs of improvement recently, albeit relatively minor, according to a report by Standard & Poor’s. Q2 2009 sales volumes were down 19.5%, compared with the low point in Q2 2008, which was an improvement on Q1 2009 when sales were down 24.7%, compared with Q1 2008. Nevertheless, Standard & Poor’s expects sales amongst the major European players to be down 15% in 2009, compared with last year. The report paints a grim picture of the Eurozone, with a contraction of 4.2% expected in 2009, before it returns to slow growth of 0.6% in 2010.

Constantine Biller, senior analyst at Clearwater Corporate Finance, expects to see a spate of bankruptcies in the early part of next year. He adds that while many banks, some of which are principally publically owned, have not wanted to be seen bankrupting companies, they are likely to become more ‘ruthless’ next year. He adds that the casualties are likely to be small to medium sized companies. ‘If [the big players] were going to go, they would have gone by now.’

Mock says that 2010 will be a challenging year as the huge working capital inflow, due to lower activity, that companies benefitted from will not be available and also raw material prices, which have been depressed this year, are starting to recover. ‘We would still expect defaults and bankruptcies to be a key topic over the next 12 months, even if we are already starting to see an improving recovery,’ he adds.

A key question for struggling companies will be whether or not they will be able to refinance, Mock says. ‘In 2013-2014, will the market refinance these companies with five, six or seven times leverage?’ he asks. ‘Or is the market at this time expecting some other alternatives? Then maybe again we will see more M&A activity, some of these companies going back to strategic buyers.’

There does, however, appear to be more movement on the M&A side, Biller points out, although ‘the banks have not necessarily loosened the purse strings’. He predicts that many of the larger multinational groups will be looking to get rid of non-core assets to help pay down debt.

This could be an excellent opportunity for cash-rich groups, such as industrial investors – former chemical industry executives and ceos backed by private funds – who could be the big benefactors. ‘Anyone with the cash to spend is probably seeing 2010 as a vintage year for deal activity; just in terms of transactions we’re seeing quite a lot of these industrial investors come to the market,’ he says.

A number of deals involving industrial investors have taken place recently, including Albermarle’s sale of its fine chemicals business in Thann, France, to industrial investors ICIG. Dow offloaded its sealer and damper business to Katzberg Invest and Clearwater recently advised Yule Catto on the sale of PFW Aroma Chemicals to Indian investors.

The recession has given a lot of companies time to consider their business model, Mock says. Petrochemicals and, to a lesser extent, speciality chemicals have been characterised by overcapacity and the automotive, electronics and construction industries that supported these businesses may take years to return to their former strength, he adds.

The result of all this will be a change in companies’ focus, Biller says. ‘The next big thing that’s got to happen is a lot of the western groups have got to look east and, if they don’t look east, those eastern players will come and snaffle them up… If people are going to grow they’ll be fundamentally looking at the Asian markets.’

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