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CHEMICAL EARNINGS CLIMB ONCE AGAIN

Improved pricing, demand, and output spark big quarterly and annual increases

by WILLIAM J. STORCK, C&EN NORTHEAST NEWS BUREAU
February 28, 2005 | APPEARED IN VOLUME 83, ISSUE 9

The fourth quarter put the cap on 2004 for the U.S. chemical industry. Or perhaps it should be called the winner's wreath, as the 24 chemical companies sampled by C&EN finished their fifth straight quarter of above-40% earnings increases. It was also the first year since 1995 that total earnings for the sample increased in every quarter when compared with the comparable year-earlier quarter.

For the fourth quarter, total earnings at the 24 companies, excluding significant extraordinary and nonrecurring items, increased 45.2% from the same quarter of 2003 to $2.76 billion as sales rose 16.4% to $35.3 billion. This drove the aggregate profit margin for the full group of companies to 6.4% from 5.2% the year before.

For the full year, earnings were up 52.0% when compared with 2003 to $9.58 billion on a 15.1% sales increase to $139.7 billion. Aggregate profitability rose to 6.9% from 5.2% in 2003.

The reason for the growth is simple--it lies in the industry fundamentals of pricing, demand, and the output needed to fill that demand. Of these fundamentals, pricing is paramount, as recognized by Rohm and Haas Chief Executive Officer Raj L. Gupta, who says of the quarter: "Of particular note was the solid increase in selling prices, which have been essential to temper the continuing rising raw material and energy costs. However, selling price increases still lag those continually rising raw material costs, and as a result, our gross profit remains depressed."

Rohm and Haas's quarterly earnings increased 16.5% to $127.0 million, at the lower end of the double-digit rises among the companies surveyed, and sales rose 13.2% to $1.86 billion.

Government price data give a picture of what companies were seeing during the fourth quarter and, indeed, the full year. The Labor Department's producer price index for all chemicals in the fourth quarter rose 12.1% from the comparable quarter in 2003 and was up 7.7% for the year.

This figure, however, includes pharmaceuticals. More relative to the products made by many of the companies in the C&EN survey, the index for basic chemicals increased a whopping 25.0%. For the full year, the index was up 14.7% for these products. It must be remembered, however, that many of these basic chemicals are raw materials for downstream specialty makers such as Rohm and Haas. And that is why their costs are rising.

Plastic resins also scored big price gains, rising 22.8% for the quarter and 11.2% for the year, according to government data.

As with pricing, basic chemical production vastly outperformed the total chemical industry for the quarter and the year. The Federal Reserve Board's chemical production index for all chemicals increased 3.8% in the fourth quarter over the comparable period the year before, and for the full year it was up just 2.7% over 2003. Basic chemical output, in contrast, grew 6.6% in the fourth quarter and 4.7% for all of 2004.

The increases in prices and production were, of course, driven by demand. According to Commerce Department data, the value of all chemical shipments in the fourth quarter was $131.4 billion, a 10.8% increase over the same period in 2003. And for the full year, total chemical shipments were up 9.9% to $504.3 billion.

Excluding pharmaceuticals, chemical shipments rose 13.2% for the quarter to $101.9 billion and 13.7% for the year to $388.0 billion.

Besides an improving U.S. economy, another important factor in shipments growth was a big increase in export demand. Government data show total chemical exports rising 23.0% in the quarter to $29.1 billion and 19.5% for the year to $109.4 billion. Exports excluding pharmaceuticals increased 22.3% in the quarter to $23.1 billion and 18.3% for the year to $86.1 billion.

As a result, exports as a percentage of shipments for all chemicals increased to 21.9% and 21.7% for the quarter and full year, respectively. Excluding pharmaceuticals, the percentages were 22.6% for the quarter and 18.3% for all of 2004. This is a far cry from 10 years ago when exports of all chemicals accounted for just 12.8% of annual shipments and 14.1%, excluding pharmaceuticals.

Export growth, by far, outpaced import growth in the two periods. Import growth for all chemicals was 11.4% in the quarter to $28.8 billion and 11.8% for the year. Excluding drugs, quarterly import growth was 11.8% to $19.7 billion, with an 11.9% increase for the full year to $77.8 billion.

Total chemicals for the quarter actually showed a surplus of $370.0 million, up from a deficit of $2.13 billion in the same period a year earlier. The total chemical deficit for 2004 was cut to $3.51 billion from $9.51 billion in 2003.

Pharmaceuticals have been a major factor in the trade deficit in chemicals since the monthly balance began to go almost consistently negative toward the end of 2001. Thus, when drugs are excluded, the resulting trade surplus for the rest of the industry rose 177% for the quarter to $3.30 billion and 152% for the year to $8.26 billion.

WHILE EXPORTS were soaring, demand growth for chemicals in the U.S. was also impressive. Domestic demand--shipments minus exports plus imports--rose 9.1% for the quarter to $131.0 billion and 8.4% for the year to $507.8 billion. Without counting pharmaceuticals, domestic demand for the quarter was up 8.7% to $96.6 billion and 12.4% for the year to $379.8 billion.

With economic fundamentals like these, it's no wonder U.S. chemical companies performed well in the fourth quarter and had their first really good full year in quite some time.

Only one company, Arch Chemicals, showed a deficit in the fourth quarter and none did for the full year. Arch had a loss of $8.6 million, despite a 31.8% increase in sales to $241.8 million. The company's HTH water treatment unit was the main culprit, posting a $16.1 million operating loss for the quarter.

Of the remaining 23 companies, 19 had higher earnings in fourth-quarter 2004 than in 2003. These include Great Lakes Chemical, PolyOne, and Stepan, which had losses in fourth-quarter 2003 but posted positive results in the 2004 fourth quarter.

Three companies had triple-digit increases for the quarter--Eastman Chemical, Georgia Gulf, and Monsanto. Eastman had the most impressive gain, with earnings rising 440.0% to $54.0 million on a 31.2% increase in sales to $1.66 billion. Eastman attributed the improvement primarily to "continued focus on more profitable businesses and product lines, cost reduction efforts, higher selling prices, and higher sales volume." It also noted that fourth-quarter raw material and energy costs increased by approximately $250 million when compared with the 2003 quarter. Eastman's earnings for the full year rose 165.1% to $220.0 million as sales increased 20.8% to $6.14 billion.

Georgia Gulf saw earnings rise 265.2% to $24.1 million in the quarter on a 58.6% sales increase to $590.9 million. For the full year, the company's earnings were up 401.9% to $105.9 million, and sales increased 52.7% to $2.21 billion. CEO Ed Schmitt concisely explains: "Strong demand and very limited capacity additions allowed us to produce at nearly full capacity and increase sales prices."

Monsanto's quarterly earnings rose 236.5% to $35.0 million as sales increased 6.8% to $1.10 billion. The company credits its seed performance, not only in the U.S., but also in Brazil, Europe, and Australia.

These companies were not the only ones that had stellar growth in the quarter. Cytec Industries' earnings almost doubled, rising 91.8% to $28.0 million on a 24.5% increase in sales to $450.6 million. "Sales volumes were up 16%, selling prices were up 7%, and exchange rate changes added 2%," CEO David Lilley notes. However, he also says that "raw material and energy costs, continuing their upward trend, were significantly higher and were well above the prior-year period."

In the area of growth, it was not just the medium-sized and small companies that racked up good earnings gains. Industry leader Dow Chemical saw quarterly earnings grow 73.3% to $823.0 million. Sales were up 31.3% to $10.9 billion. The sales increase came from 6% better volume and a 28% price rise. The company says strong industry demand drove high operating rates and allowed it to expand margins across most businesses, despite an unprecedented $1.5 billion increase in feedstock and energy costs compared with the same period in 2003.

Dow also notes that, for the full year, feedstock and energy costs climbed more than $3.4 billion compared to 2003. Despite this, the company's earnings doubled for the year, rising 100.5% to $2.58 billion on a 23.1% sales increase to $40.2 billion. Volume for the year increased 6% and prices were up 17%.

Number two DuPont did not fare so well, with earnings increasing 25.3% to $371.0 million in the quarter and sales declining 7.4% to $6.0 billion. However, DuPont's reported fourth-quarter 2003 sales figure of $6.48 billion included its divested textiles and interiors unit.

DuPont says higher raw material costs reduced earnings for the fourth quarter by about $230 million. CEO Charles O. Holliday Jr. says, "The fourth quarter caps a year of improved operating performance by our company, delivering broad-based revenue growth, cost productivity, and margin improvement." For all of 2004, DuPont's earnings improved by 43.4% to $2.39 billion on a 1.3% increase in sales to $27.3 billion.

With 2004 behind them, chemical industry executives expect continued growth in 2005, but they are also seeing continued problems with feedstock and energy costs. Holliday says, "With the structural transformation of our company now complete, our number one priority is delivering on our business, which we are confident will create superior value for our customers and our shareholders." The company expects 2005 earnings to be between $2.65 and $2.85 per share--an increase of 11 to 20%.

IN GENERAL, DuPont sees worldwide industrial economic growth at historic trend line rates, with strong growth in Eastern Europe, China, and Latin America. It sees growth at slightly below trend line in the U.S. and Western Europe.

At Dow, CEO Andrew Liveris says: "We expect worldwide demand for our products to continue to grow and supply to tighten further. We find that our customers are becoming more concerned about the availability of our products, as opposed to their price." However, he says the company is not looking for much relief from high feedstock and energy costs. "We now consider them to be a permanent part of the industry landscape, and we have prepared ourselves accordingly." He adds, "We will control the things we can control and take 2005 one quarter at a time."

At Praxair, CEO Dennis H. Reilly says: "We expect continued strong growth in 2005, bolstered by our growing hydrogen business, the consolidation and integration of the acquired business in Germany, a record pipeline of new contracts and projects under construction, and increased price realization. We believe that economic activity in North America, South America, and Asia will be strong, while growth in Europe is likely to slow somewhat from 2004." The company expects earnings per share in the $2.33 to $2.45 range. Praxair earned $2.10 per share in 2004.

FMC CEO William G. Walter says: "Our financial performance should further improve in 2005. We expect continued double-digit growth in earnings per share, before restructuring and other income and charges, to result in full-year earnings of between $3.70 and $3.90 per diluted share, driven by a significant recovery in selling prices in industrial chemicals, lower interest expense, and continued growth in specialty chemicals, partially offset by higher input costs." FMC's 2004 earnings per share were $3.20.

At Rohm and Haas, which had a 16.5% earnings increase for the quarter and a 72.2% rise for the year, the economic assumptions include global gross domestic product growth of 3.5%, compared with 4.0% in 2004; an expectation that the dollar will remain at current levels compared with the euro and the yen; and expectation that raw materials and energy costs will likely continue to increase throughout 2005, driven by high oil and natural gas prices, as well as a tight supply-and-demand balance for most commodities.

"Given these assumptions," Gupta says, "sales growth should be in the 9 to 11% range, yielding annual sales of approximately $8 billion. This would represent the third consecutive year of double-digit sales growth. Our 2005 earnings should be in the $2.50- to $2.75-per-share range, a substantial improvement over our 2004 performance," when the company's earnings per share from continuing operations were $2.21.

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