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Chemical Earnings In Fourth Quarter

Results were hard hit by effects of hurricanes; DuPont was a big factor in poor growth

by William J. Storck
February 27, 2006 | A version of this story appeared in Volume 84, Issue 9

The fourth quarter of 2005 was a three-month period that many in the U.S. chemical industry might like to forget. After posting double-digit earnings growth for eight consecutive reporting periods, the companies C&EN regularly surveys, on average, hit a wall.

A major factor was the lingering effects of the hurricanes that hit the Gulf Coast in late August and in September, causing plant closures, disrupting the transportation system, and driving down demand, especially for basic organic chemicals.

The aftereffects of Hurricanes Katrina and Rita were such a big factor during the quarter that 16 of the 23 companies surveyed by C&EN mentioned the storms in their earnings commentary, and they were cited a combined 50 times as a factor in the firms' results. DuPont alone mentioned them 11 times.

The result was that combined earnings from continuing operations, excluding special items, at the 23 companies increased just 0.9% compared with fourth-quarter 2004 to $2.31 billion, while sales rose 7.5% to $38.1 billion. This dropped the aggregate profit margin for the group to 6.1% in the 2005 quarter from 6.5% in the same period the year before.

The modest rise in sales and earnings put the brakes on what looked to be an extremely good year for the chemical industry. Cumulative results for the nine months ending in September showed sales up 12.5% and earnings increasing 48.0% over the first three quarters of 2004. When the fourth-quarter results were added in, the full year was not as outstanding as the first nine months, but still very strong: Earnings increased 28.6% from 2004 to $11.9 billion as sales rose 10.5% to $153.6 billion.

Naturally, with plants shut down, production was hit hard in the fourth quarter. Using the average of the Federal Reserve Board's industrial production index for the quarter, output of all chemicals, including pharmaceuticals, fell 3.3% when compared with the index for fourth-quarter 2004. This decline followed a 2.1% year-to-year drop in the third quarter. For the full year, total chemical production was down 0.2%.

Basic chemicals, with their large concentration along the Gulf Coast, were especially hard hit, with output falling 16.3% in the fourth quarter after a 12.9% decrease in the previous three months. For all of 2005, basic chemical output was 6.8% below that of 2004.

Meanwhile, prices continued to rise. The Labor Department's producer price index for chemicals jumped 8.8% for the quarter, after an 8.2% increase in the July through September period. For all of 2005, the index for total chemicals was up 9.6%.

But this was nothing compared with the increases for industrial chemicals, which rose 10.0% in the fourth quarter following an 11.0% increase in the third period and 14.1% for the full year.

Analysts at Merrill Lynch noted this trend, especially in ethylene. "Earnings fell below expectations for the ethylene producers in Q4," they wrote. "Volumes were weaker than expected due to lingering hurricane-related outages and weak demand in December as converters reduced purchases in anticipation of lower prices in Q1 2006."

Despite lower production, the increase in prices was enough to raise the value of chemical shipments for the quarter. Shipments of all chemicals, according to the Commerce Department, totaled $140.3 billion, up 3.7% from the same period 12 months earlier. Excluding pharmaceuticals, the shipments value for all other chemical industry segments combined was $105.7 billion, an increase of 6.7% over the prior-year period.

For the full year, shipments of all chemicals totaled $549.0 billion, a 5.5% increase over 2004. Excluding pharmaceuticals, shipments of the remainder of the chemical industry rose 9.8% to $411.3 billion.

Considering these rather impressive growth rates, the chemical industry should have done better in the fourth quarter. And it would have were it not for DuPont.

DuPont suffered greatly in the quarter with a 2.9% decline in sales to $5.83 billion and a 66.3% plunge in earnings to $125.0 million. Without DuPont, combined sales for the other 22 companies increased 9.6% to $32.3 billion, and earnings improved 13.9% for the remaining firms to $2.19 billion.

DuPont's problems were largely hurricane related. The company says the current quarter net income reflects the impact of prolonged disruptions to power, logistics, and production and sales resulting from Hurricanes Katrina and Rita, in addition to unplanned production outages at three of the company's plants that are located in Brazil, the Netherlands, and the U.S. Quarterly income also reflects lower sales of crop production chemicals and higher costs.

Another major chemical company that reported a decline in earnings was PPG Industries, whose earnings fell 24.3% to $143.0 million on a 3.9% increase in sales to $2.51 billion. The company estimates that the hurricanes knocked about $17 million off after-tax earnings because of lower sales volumes.

Chief Executive Officer Charles E. Bunch says, "We faced notable headwinds this quarter and during the entire year, including the economic fallout from the hurricanes, historical peaks in energy costs, and demanding conditions in some of the markets we serve. Despite these challenges, we achieved record annual and fourth-quarter sales, which were supported by all-time-high chlor-alkali pricing."

Bunch also took the opportunity while discussing earnings to announce a restructuring plan. "In addition to the annual cost reductions that we consistently deliver," he said, "we are finalizing plans to take severance and restructuring actions to further streamline our operations that would result in first-quarter [2006] charges in the range of $50 [million] to $70 million."

Fertilizer producer Terra Industries had the largest earnings decline in terms of percentage for the quarter, down 86.2% to just $3.3 million, despite a 44.8% increase in sales to $513.4 million. The company noted higher North American and U.K. natural gas costs and effects of the two hurricanes. These were partially offset by higher selling prices for nitrogen products and the contributions from the acquired Mississippi Chemical operations.

Besides DuPont, PPG, and Terra, six other companies saw earnings decline for the quarter: PolyOne fell 40.8% to $12.5 million; Cabot was down 37.1% to $22.0 million; Georgia Gulf, 22.4% to $18.7 million; Cytec Industries, 9.3% to $26.4 million; Hercules, 6.4% to $18.9 million; and Stepan, which had a loss of $100,000 compared with positive earnings of $600,000 in the fourth quarter of 2004.

One other company had a loss for the quarter. Arch Chemicals posted a deficit of $3.2 million, but this was an improvement over the $13.9 million loss it suffered in the final quarter a year earlier. Sales at Arch were up 15.1% to $278.3 million.

It was not all earnings declines and losses for the chemical companies. Industry leader Dow Chemical had a 20.7% gain in earnings to $993.0 million as sales increased 9.0% to $11.9 billion, increasing its profit margin to 8.3%, the fifth highest among the 23 firms, from 7.5% a year earlier.

Dow CEO Andrew N. Liveris says, "This was a tremendous quarter at the end of an outstanding year for Dow. In 2005, we achieved record earnings; we reduced net debt by more than $2.4 billion; and for the third year in a row, with institutionalized financial discipline and operational excellence, we recovered lost margin. The fact that we did this in the face of high and volatile feedstock and energy costs bears testimony to the quality of our people and the strength and consistency of our strategy."

In the quarter, pretax earnings excluding unusual items increased 39% for Dow's performance plastics to $364 million, 4% for performance chemicals to $191 million, 102% for agricultural products to $83 million, and 5% for plastics to $622 million; but they fell 34% for its chemicals segment to $272 million.

Industrial gas companies performed above average in the quarter. Praxair posted $220.0 million in earnings for the quarter, up 21.5% from fourth-quarter 2004. Sales at the company increased 13.1% to $2.02 billion. CEO Dennis H. Reilley says, "We delivered record results in all of our markets through successful implementation of new growth initiatives while continuing to supply the highest level of service to our customers."

Praxair saw sales grow 11% in North America, 12% in Europe, 33% in South America, and 10% in Asia.

Fellow gas producer Air Products & Chemicals had slower, but still good growth in the quarter as earnings increased 13.0% to $180.7 million on sales growth of 5.0% to $2.09 billion. Sales of gases were up 8% to $1.56 billion on higher volumes in Asia, stronger pricing in North America, as well as higher natural gas cost contractual pass-throughs to customers.

Down the road from Air Products, Philadelphia-based Rohm and Haas had $176.0 million in earnings, up 27.5% from the year-earlier quarter on a 7.9% sales increase to $2.01 billion. CEO Raj L. Gupta says the fourth quarter "demonstrates that the pricing strategies we have adopted continue to enable us to recover unusually high raw material and energy costs. We have been successful in executing portfolio management strategies to shed underperforming businesses and move toward more technically advanced, higher growth and margin products."

While most people in the U.S. were complaining about the high price of oil, the refinery business helped Albemarle, which scored a 73.5% increase in earnings to $34.0 million as sales rose 30.4% to $588.2 million. The increase in sales, according to the company, was primarily the result of strong sales in its catalysts segment due to higher sales in refinery catalysts. Continued pricing improvements in some businesses in polymer additives and fine chemicals also helped.

CEO Mark C. Rohr says: "We faced many challenges in 2005, and our team met them very successfully. We implemented pricing initiatives as well as specific cost reduction measures to meet the increasing pressure of inflated raw material and energy costs."

Rohr also says, "We believe we have positioned ourselves for growth and financial stability, and we are poised to accomplish a very positive and rewarding 2006."

Other chemical executives are also optimistic about this year, apparently viewing the hurricane-influenced third- and fourth-quarter results as an aberration that they hope will not happen again.

Eastman Chemical's CEO, J. Brian Ferguson, says the company is off to a good start in the quarter, led by a strong base of earnings, which consists of the fibers; coatings, adhesives, specialty polymers, and inks; and specialty plastics segments. He warns, however, that Asian imports of polyethylene terephthalate polymers into North America and challenging market conditions in certain propylene derivatives "are expected to be headwinds." In addition, Ferguson says, "we anticipate continued high and volatile raw material and energy costs."

Dow's Liveris says: "Our outlook for 2006 is positive, both for the chemical industry and our company, despite the uncertainty and volatility in feedstock and energy costs. We expect that worldwide demand for chemical and plastic products will continue to grow, led by Asia-Pacific, Latin America, and other emerging geographies, with solid contributions from North America and Europe. As we have been saying for some time, we believe 2006 will be an even better year than 2005."

DuPont is not so sure, at least about the first quarter. The company says that results for the agriculture and nutrition segment are forecast to be below last year's first quarter, based on an expectation of lower volumes in crop protection chemicals, competitive pressures, and a shift in seasonal revenues between the first and second quarters.


Criteria For C&EN Earnings Analysis

C&EN's quarterly report on financial performance of the U.S. chemical industry contains data from 23 major U.S. basic chemical companies and from five petroleum companies, each of which has more than $1 billion in annual chemical sales.

To be included in the table of basic chemical companies, a company must have at least 50% of its sales in chemicals.

In referring to chemical sales, C&EN means sales of chemicals for which the molecular composition has been changed during manufacture. Hence, these include traditional categories of basic petrochemicals and inorganics, organic intermediates and inorganic compounds, polymers such as plastics and fibers, and agricultural chemicals and specialty derivatives.

In listing earnings, the report gives after-tax income for continuing operations, excluding significant nonrecurring and extraordinary items.


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