Chemical Firms See Good Quarter

Four quarters of solid earnings growth for chemical companies: A year-and-a-half ago, who would have thought it? And it has not been just solid growth; it has been close to spectacular. In C&EN's sample of major U.S. firms with at least half of their sales in chemicals, overall year-over-year earnings growth each quarter has been 50% or higher than the previous one.

Granted, the companies' earnings are being compared to a low base--the quarters in the tail end of the economic slowdown. But the results have been impressive nonetheless, considering the huge and still continuing run-up in energy and raw material costs over the past few years.

In the third quarter of this year, the 26 chemical companies surveyed had total earnings of $1.98 billion, a 63.6% increase over the same quarter in 2003. Sales at the firms rose 15.0% to $36.1 billion. The aggregate profit margin for the group improved to 5.5% from 3.9% in the comparable period last year.

For the first nine months, the companies had earnings growth of 65.0%, to $7.41 billion, as sales increased 14.4% to $110.4 billion. The aggregate profit margin for the first three quarters increased to 6.7% from 4.7% in the same period a year ago.

The quarterly increase by the 26 companies was based on some pretty good economics, which, at most firms, overcame the effects of higher costs. Chief among these was that chemical companies were able to increase their own prices, in many cases at a greater pace than the rate of cost increases. The higher prices are indicated by the Labor Department's Producer Price Index, which for all chemicals in the third quarter rose 9.1% from the same period in 2003 to 175.8 (1982 = 100). This is the greatest increase in the chemical index since the first quarter of 2003, when it was up 9.4%.

Basic chemicals, which are more indicative of the companies surveyed, saw a Producer Price Index increase of a whopping 19.2% in the quarter, to 166.6. Again, this is the highest rate of increase for this sector of the industry since the first quarter of last year, when the index rose 19.7% over the year-before period.

Chemical production also was up in the third quarter. The average production index for all chemicals increased 6.6% to 112.3 (1997 = 100), the largest increase since the second quarter of 1997. However, the rise in the basic chemical production index--99.2 in the quarter--slipped slightly from the 5.4% increase seen in the second quarter to 4.1%. This still was the second highest growth rate since the index moved up 6.9% in second-quarter 2002.

The combination of rising prices and increased demand in the quarter sparked the value of shipments. Chemical shipments in the third quarter, when compared with the same period in 2003, grew 8.8% to $127.9 billion. This was down from the 13.2% growth seen in the second quarter.

Although the government does not report shipments for basic chemicals, it is possible to derive a third-quarter shipments figure for chemicals, excluding pharmaceuticals, of $98.1 billion, which was up 13.6% from the same period a year ago. Like the growth rate for all chemicals, the percentage increase for chemicals, excluding drugs, was down from 16.6% in the second quarter of this year.

J. Pedro Reinhard, chief financial officer of industry leader Dow Chemical, summed up the quarter well in a teleconference with analysts and media: "Looking at the quarter overall, this can once again be characterized as a period in which price increases, volume gains, and cost discipline allowed us to continue to expand margins--albeit modestly--against considerable raw materials headwind."

For the quarter, Dow had an 85.8% increase in earnings to $617 million, as sales rose 26.3% to $10.1 billion. The company's profit margin improved to 6.1% in the quarter from 4.2% in the same period a year ago.

"Economic growth continued solidly throughout the quarter, stimulating a further positive shift in chemical industry fundamentals," Reinhard went on to say. "Supply/demand balances tightened across many of Dow's products and in all geographic areas, with operating rates increasing for the period. The company's operating rate for the third quarter reached 90%, compared with 84% a year ago--its highest rate since the second quarter of 2000."

On costs, Reinhard said: "Dow's feedstock and energy bill exceeded $4.0 billion for the quarter, an increase of more than 12% on the previous quarter and up more than 40% compared with the same period in 2003. That is the largest year-over-year increase Dow has ever seen. Year-to-date, because of higher prices, Dow's feedstock and energy costs are $1.9 billion higher than in 2003 and over $4.0 billion higher than the first nine months of 2002."

In the interdependent world of chemicals, where companies are both chemical buyers and sellers, one firm's price rise is another company's cost increase. That's the case for Rohm and Haas. Speaking of his own company's petrochemical raw materials, Chief Executive Officer Raj L. Gupta says: "The unprecedented escalation of raw material costs has required us to be quick and persistent in pursuing price increases to contain the erosion of gross profit margins. This quarter's results provide evidence that, while we have not yet been able to recover all these higher raw material and energy-related costs through pricing, we are making progress."

Earnings at Rohm and Haas rose 18.0% to $118 million, as sales increased 13.3% to $1.80 billion. Profitability increased to 6.5% from 6.3%.

Adhesives producer H.B. Fuller--which had a 19.5% decline in earnings to $9.5 million, despite an 8.5% increase in sales to $350 million--was in a similar boat. CEO Albert P. L. Stroucken says, "Our focus for the remainder of the year will be to deal effectively with the run-up in raw material costs by putting a strong effort behind improved operational efficiencies and working with our customers to raise our selling prices, while securing the positive trend of our top-line growth."

Other companies noting higher costs include Albemarle, W.R. Grace, PPG Industries, PolyOne, and Eastman Chemical.

Despite the higher costs, three companies, including Eastman, pulled off triple-digit earnings increases in the quarter, but these were generally from a very low earnings figure in the comparable 2003 quarter.

The largest increase was at Georgia Gulf, where earnings rose 333.8% to $33.4 million as sales improved 71.0% to $596 million. The company says the higher earnings were primarily the result of increased selling prices and volumes for aromatics, particularly cumene, which more than offset higher aromatics raw material costs. CEO Ed Schmitt says, "In the third quarter, the company returned to the level of earnings that we had in early 2000, prior to the economic downturn." But he warns that fourth-quarter earnings may be lower than those in the third quarter because of an anticipated seasonal slowdown and plant maintenance turnarounds.

Longer term, Schmitt says, "Industry fundamentals are expected to remain strong for our products as chemical industry analysts continue to forecast a period of strong performance and good returns."

Eastman's earnings rose 245.0% to $69.0 million on 14.2% sales growth to $1.65 billion. "Despite continued increases in raw material and energy costs, our earnings in the third quarter and first nine months of 2004 confirm the improvements we have made in the company that have strengthened our profitability," CEO J. Brian Ferguson says. "We are on track for full-year 2004 earnings to be our best since the year 2000."

At Arch Chemicals, earnings rose 176.2% to $5.8 million, while sales increased 23.6% to $317 million. Double-digit sales increases in personal care, industrial biocide, and wood protection products "helped offset a decline in pool chemical sales due to cool, wet weather and persistently high raw material costs that impacted several of our businesses," CEO Michael E. Campbell says.

DESPITE HIGH growth rates, company executives are expressing, at best, a cautious optimism about the future. Number two DuPont says, "Leading global economic indicators, especially those in industrial production, are showing signs of slowing growth rates in response to energy-related costs during the third quarter. DuPont anticipates that these conditions will continue for the remainder of the year." DuPont's third-quarter earnings were up 87.4% to $253 million, despite a 6.5% downturn in sales to $5.74 billion.

At PPG, CEO Raymond W. LeBoeuf says, "While the rates of growth may vary from market to market and country to country, we believe the odds favor continued growth in the global economy."

Reinhard says the chemical industry is in an environment of strengthening volumes and prices and that, with limited capacity additions in the near term, supply-and-demand balances are continuing to tighten across many product lines. "That said," he notes, "elevated and extremely volatile feedstock and energy costs continue to cause concern within Dow, both in relation to the immediate impact on margins and the long-term toll on consumer confidence."

And Gupta notes that the overall economic outlook remains reasonably strong. The company expects continued growth in demand across all regions, although there is an indication of a slowing in the overall electronic materials market. "The escalation of raw material and natural gas costs is occurring at rates faster than our price increases can fully recover," he says, "although we are beginning to see the benefits of the pricing initiatives we implemented earlier this year."