Chemical Industry Begins To Feel Wall Street Woes

THE CHEMICAL INDUSTRY will likely not be spared by the credit crunch gripping financial markets.

With the urging of corporate America, Congress passed a landmark $700 billion financial rescue package that gives the government the authority to buy troubled mortgage-backed securities and other devalued assets that are freezing credit markets.

The House easily approved the package on Friday and sent it to President George W. Bush, who immediately signed it into law. The 263–171 vote marked a sharp reversal from Monday, when an earlier version of the legislation was stunningly rejected by the lower chamber.

Senate leaders quickly revived the measure, adding an extension of numerous tax breaks for renewable energy, reinstating a tax credit for R&D investments, and raising federal insurance coverage for bank deposits. The revised bill won Senate approval Wednesday night, 74–25.

Chemical and pharmaceutical companies rely on the credit markets to finance day-to-day operations and larger business expansions. On Oct. 1, the American Chemistry Council joined other trade groups to advocate for congressional action. "Without reliable access to credit, the ability of ACC member companies to pay their bills, purchase inventory, meet payroll, and make critical investments in new technologies would be severely compromised," ACC CEO Cal Dooley wrote.

Companies use credit to pay their bills because it is usually more convenient and cheaper to access short-term loans than to convert company earnings to cash. Moreover, firms that have significant overseas earnings prefer not to move the money to the U.S. because of the income tax and currency exchange hit they would take.

Still, most chemical companies have strong free cash flow and relatively low debt and can ride out a short-term credit crunch, according to Dmitry Silverstyn, a chemical stock analyst at Longbow Research. "For normal maintenance capital expenditures, and even new plants or geographic expansion, usually the money has been earmarked early in the year," he says.

Chemical firms may feel the pinch more if their customers encounter credit problems. "They may have customers with liquidity problems who will carry less inventory or default on purchases," Silverstyn suggests. Worried consumers may cut back on purchases of cars, electronics, and other goods, dampening demand for chemical raw materials.

And companies with big plans that cannot be 100% self-financed, Silverstyn says, may find their deals in jeopardy. "There will be concerns with longer term impact if the economy seizes up for lack of credit," he adds. Silverstyn anticipates the climate for mergers and acquisitions will cool and sees a growing chance that already announced deals will not be completed.

These days, only firms with strong credit ratings will be able to borrow money at favorable terms, says Kyle Loughlin, team leader for chemicals at the credit rating agency Standard & Poor's. He says S&P ranks 26 chemical companies as investment-grade. "Their prudent, long-standing financial policies will hold up very well," he says.

Other chemical firms aren't in such a good position. Loughlin reports that 34 highly leveraged companies have seen their ratings downgraded. And those in the speculative-grade CCC category, such as Georgia Gulf and Tronox, he says, will have great difficulty getting financing.

Another S&P analyst, Arthur Wong, follows pharmaceutical companies. He reports that the industry "hasn't been affected as much from the credit crunch or the slowing economy. The big, investment-grade companies like Merck & Co., Eli Lilly & Co., and Pfizer have some of the strongest credit ratings out there."

Most biotech firms, Wong says, were able to secure financing during the boom years before the credit crunch. "Anyone who missed that era might be in trouble, but biotech is still hot and big pharmaceutical firms would have to pay good prices" if they want to acquire a biotech pipeline, Wong says.

Yet venture-backed start-ups are finding the economic climate too harsh for initial public offerings (IPOs) of stock. According to the National Venture Capital Association, only six U.S. IPOs have been issued so far this year, compared with 86 for all of last year.