As price increases hold, and production and demand improve, chemical industry executives are becoming more and more convinced that the economic recovery is for real. Evidence of this recovery is in sales and earnings, which in the second quarter turned in their third straight quarter of solid growth.
Total second-quarter earnings from 28 companies surveyed by C&EN jumped 51.5% from the same period last year to $2.98 billion. Earnings are from continuing operations, excluding significant one-time items. Meanwhile, sales rose 13.6% to $39.1 billion. Profitability also improved, with the aggregate profit margin for the group rising to 7.6% from 5.7% in second-quarter 2003.
As an added bonus, not one company among the 28 posted a loss for the 2004 period.
For the first half of 2004, the companies chalked up a 69.5% increase in earnings to $5.56 billion on a 14.1% sales increase to $76.8 billion. Profitability rose to 7.2% from 4.9% in the first six months of last year.
During the second quarter, the industry was spurred by both prices and production. According to government data, the average price index for all chemicals in the second quarter rose 5.2% over the same period in 2003 to 170.5 (1982 = 100), while the production index increased 6.0% to an average 110.8 (1997 = 100). This gain is much better on both counts than in the first quarter, when prices were up 3.6% and output increased just 3.2%.
The large basic chemicals sector did not perform as well as the overall category, however. Output of basic chemicals increased 3.9% over second-quarter 2003 to an index of 97.2. But this increase is still much better than in the first quarter, when production of basic chemicals rose just 1.1% over the same period the year before.
The increase in prices combined with greater physical demand to bolster the value of chemical shipments in the quarter. The shipments value for all chemicals in the second quarter totaled $125.0 billion, according to Commerce Department data, up 12.9% from the year-earlier period. In the first quarter, when price and production growth was slower, the increase was just 7.1% when compared with first-quarter 2003.
Excluding pharmaceuticals to better reflect the companies in C&EN's sample, the increase in shipments for the rest of the chemical industry was even more dramatic. Here, the value of shipments jumped 16.3% to $95.6 billion, again much better than the 11.5% rise seen in the first quarter.
One factor related to shipments that is supporting price increases in chemicals is the relatively low inventories that chemical producers have on hand. The shipments-to-inventories ratio for all chemicals except pharmaceuticals in the second quarter was 1.00, indicating just one month's supply on hand. This is down from a still tight 1.04 in the first quarter and from 1.17 in the second quarter of 2003. Not only are chemical inventories tight at the producer level, but economists suspect that they are also slim at the customer level, giving buyers of chemicals little room to negotiate prices.
That price increases are holding is a very good thing in the current economic climate because raw material and energy costs to chemical producers are still rising at breakneck speed, a point illustrated by J. Pedro Reinhard, Dow Chemical's chief financial officer. Dow's "margins in the second quarter," he says, "have been under severe pressure from the increased and volatile feedstock and energy costs. In fact, Dow spent more than $3.5 billion on feedstock and energy. That's a rise of over $600 million compared with the same quarter in 2003 and more than $200 million higher than the first quarter of this year alone."
Industry leader Dow's second-quarter earnings grew 74.3% to $685.0 million on sales of $9.84 billion, up 19.4% from last year's second quarter. Profitability at the company increased to 7.0% from 4.8%.
Eastman Chemical Chief Executive Officer J. Brian Ferguson sees improvement despite rising costs. "We are gaining momentum in improving financial performance, as our second-quarter results indicate," he says. "While we are benefiting from a strengthening economy and actions to improve our profitability, we are also confronted by historically high raw material and energy costs and, therefore, will continue our efforts to raise selling prices to offset those costs."
Eastman's earnings increased 36.2% for the quarter to $64.0 million on a 13.2% sales rise. But profitability remains low at 3.8% compared with 3.2% in the second quarter of last year.
Five of the companies in the C&EN survey moved from losses in last year's second quarter to gains this year: Crompton, IMC Global, Lyondell Chemical, PolyOne, and Terra Industries. Crompton went from a loss of $19.4 million last year to earnings of $1.1 million as sales rose 21.4% to $646.7 million. IMC Global made $42.7 million, compared with a loss of $25.9 million last year; Lyondell made $3.0 million against a $68.0 million loss; PolyOne moved from a $4.5 million loss to a $22.0 million gain; and Terra had $17.9 million in earnings compared with a $4.1 million loss.
Two of these companies-fertilizer producers IMC and Terra-took advantage of the improving farm economy, and they weren't the only ones. FMC and Monsanto also benefited.
"Nitrogen products demand and selling prices in key Terra market areas were strong this quarter," says Michael L. Bennett, Terra's CEO. "The same factors continue to look strong as we start the 2004-05 fertilizer year. We attribute the current environment to very low industry-wide nitrogen inventories and low global grain inventories. Nonetheless, nitrogen markets and profits have been unpredictable," he warns. "Nitrogen margins will continue to be pressured if natural gas costs remain at current high levels."
At IMC, CEO Douglas A. Pertz says: "Our second-quarter performance exceeded expectations and demonstrates the very strong leverage we have in our low-cost potash and phosphate businesses from improving prices and volumes. The impressive double-digit price and volume increases in both crop nutrient segments reinforces previous optimism we have expressed about improving worldwide agricultural and fertilizer fundamentals, including tighter supply and demand and low producer inventory levels."
At FMC, which saw 96.3% earnings growth to $42.6 million on a 4.8% sales increase to $534.3 million, pretax earnings from its agricultural chemicals segment rose 76.5% to $48.0 million. "We have again exceeded the expectation we set earlier due to continued strong performance in our agricultural products segment and on-target performance across the balance of our portfolio," CEO William G. Walter says.
At Monsanto, earnings rose 34.5% to $234.0 million as sales increased 14.4% to $1.68 billion. A large part of the sales increase came from the company's agricultural chemicals segment. For the quarter, sales of Roundup and other glyphosate herbicides increased 27% to $588.0 million, the firm says, with increased sales in most of the world. Thanks to the increased Roundup sales, quarterly sales for the segment as a whole increased 17% to $998.0 million.
DuPont, where earnings were up 29.2% to $805.0 million on a 2.1% rise in sales to $7.53 billion, also participated in the improving agricultural economy. In agriculture and nutrition, its largest business segment, pretax operating income excluding one-time items rose 9.8% to $482.0 million. Sales in the segment increased 6.4% to $2.08 billion.
AMONG THE companies surveyed, Georgia Gulf had the highest percentage earnings increase for the quarter: 253.6% to $29.7 million. Sales improved 45.4% to $522.3 million. The company notes that operating income, before interest expense and taxes, in its chlorovinyls unit almost doubled, rising 82.0% to $53.0 million. And in its aromatics unit, operating income was $5.0 million, compared with an operating loss of $900,000 in last year's second quarter.
"Looking forward, demand for our products continues to be good," Georgia Gulf CEO Edward A. Schmitt says, "and it will be interesting to see if demand for the third quarter continues at second-quarter levels."
Like Schmitt, executives at other chemical companies are optimistic about the near-term future. When Dow released its earnings report, Reinhard spoke to security analysts and the press, and what he said about Dow's outlook pertains very well to most of the U.S. chemical industry: "The global economy maintains its pace, with global gross domestic product growth between 3.5% and 4.0% anticipated for 2004. This is expected to translate into higher industrial production and good levels of demand, benefiting Dow segments broadly.
"With no additional capacity expected in the near term," Reinhard continued, "Dow expects the supply/demand balances to tighten further, providing impetus to pricing momentum. On the other hand, the ongoing volatility and high level of oil and gas prices, which has become a new reality for the chemical industry, will continue to exert pressure on margins. However, price increases during the third quarter are expected to keep pace with these rising costs for most of Dow's major products, maintaining margins at or around the levels seen in the second quarter."