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Chemical Earnings Growth Slows A Lot

Declines were confined to a few firms; Dow's plunge hurts

by William J. Storck
May 21, 2007 | A version of this story appeared in Volume 85, Issue 21

The U.S. chemical industry, as measured by a sampling of 25 major companies, slowed considerably in the first quarter of 2007. Combined sales for the firms rose 5.6% to $46.2 billion compared with first-quarter 2006 sales. Meanwhile, earnings increased 0.7% to a total of $3.68 billion. This compares with 23.7% year-to-year earnings growth in the fourth quarter of 2006 and a 23.0% increase in the third quarter of last year. Earnings are from continuing operations, excluding significant one-time items. The aggregate profit margin for the group was 8.0%, down from 8.4% for the same period last year.

Dow Chemical was a major contributor to the much slower earnings growth. It posted a 19.9% earnings decline to $973.0 million on sales growth of 3.4% to $12.4 billion. Excluding Dow, total sales for the remaining 24 companies increased 6.5% to $33.8 billion, and earnings were up 10.9% to $2.71 billion. A big factor in Dow's earnings decline was a drop in licensing revenues from extremely high levels last year, according to the company. Other than that, the industry leader notes solid demand across most businesses and in every geographic region outside North America.

Even if Dow may be blamed for much of the slower growth among the surveyed companies, evidence coming from government sources suggests the U.S. chemical industry is slowing.

Production of all chemicals in the first quarter, when compared with the same period one year ago, rose just 0.6%, according to Federal Reserve Board data. This compares with a 4.1% year-to-year increase in the fourth quarter and a 4.6% increase in the third quarter of 2006.

Criteria For C&EN Earnings Analysis

C&EN's quarterly report on financial performance of the U.S. chemical industry contains data from 25 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.

Price increases for all chemicals likewise slipped. The producer price index from the Labor Department rose 2.3%, down from 2.6% in fourth-quarter 2006 and from 9.2% in the third quarter last year.

Demand for chemicals also slipped. According to the Commerce Department, U.S. shipments of all chemicals in the first quarter were valued at $140.1 billion, a decline of 1.5% from year-earlier levels. And more reflective of the chemical companies in the survey, shipments of chemicals excluding pharmaceuticals fell 3.0% to $102.2 billion.

Perhaps more indicative of a possible slowdown within the U.S. chemical industry is the decline in domestic demand, calculated as shipments minus exports plus imports. For all chemicals, this figure dropped 5.7% from the same quarter last year to $127.2 billion. Excluding pharmaceuticals, domestic demand for the rest of the chemical industry fell an even greater 6.8% to $97.2 billion.

The slowdown in domestic demand was at least partially overcome by exports of chemicals, which have been made more attractive by the lower value of the dollar against foreign currencies. Exports of all chemicals in the first quarter soared 17.3% to $37.9 billion. And exports of chemicals excluding pharmaceuticals rose 15.0% to $29.4 billion.

At the same time, the dollar's decline made imports more expensive for U.S. buyers. The value of imports of all chemicals rose 7.5% to $38.2 billion. The increase appears to be due largely to imports of pharmaceuticals, because imports excluding drugs increased just 0.4% to $24.9 billion.

The slow growth of imports shrank the trade deficit for the chemical sector to $304.0 million, compared with $3.22 billion one year earlier. When drugs are excluded, the remainder of the chemical industry showed a surplus of $4.51 billion, up from a $569.0 million surplus the year before.

At least partly because of growing exports, U.S. chemical company results generally improved in the first quarter. Of the 25 companies in C&EN's survey, all but four had greater sales, and 17 companies had higher earnings in the first quarter than in the same period last year. These companies include fertilizer producer Terra Industries, which went from a $25.3 million loss in first-quarter 2006 to a gain of $30.3 million this year. And 13 of these 17 firms had earnings growth in the double-digits.

Nalco Holding posted the largest percentage increase in earnings: 77.4% to $24.3 million on a 7.1% sales increase to $909.3 million. Chief Executive Officer William H. Joyce, however, is not resting. "Although generally pleased with the direction of the company, we have our share of improvement opportunities," he says. "Some of our businesses trail expectations. However, growth in Latin America, Eastern Europe, and other emerging markets ran well ahead of our expectations to keep us on track."

Nalco's growth was followed by that at Albemarle, where earnings rose 68.9% to $58.1 million on a 3.0% sales decline to $589.2 million. Albemarle CEO Mark C. Rohr says in spite of lower volumes and a more than $9 million net increase in raw material and energy costs compared with the previous year, the company's businesses produced strong results with increased profitability in every segment.

At Celanese, where earnings rose 57.4% to $159.0 million on an 8.9% sales gain to $1.63 billion, CEO David N. Weidman says, "The excellent results in the first quarter reflect the successful execution of our business strategy and the benefits of our balanced geographic and end-market presence."

On the flip side were the few companies with declining earnings. Chief among these was Georgia Gulf. The firm's loss deepened to $26.6 million from $3.7 million in the first quarter last year. Sales at the company were up 25.7%, though, to $713.7 million from the 2006 period. The big increase in sales was a result of Georgia Gulf acquiring Royal Group in October 2006.

Huntsman Corp.'s earnings dropped 39.7% to $56.2 million, as sales edged downward 0.4% to $2.65 billion. Despite the more than one-third drop in earnings, CEO Peter R. Huntsman says, "I am pleased with our adjusted earnings per share of 24 cents, which was achieved in spite of the negative impact of unplanned production outages at facilities in Caojing, China; Greatham, U.K.; and Port Arthur, Texas."

Other companies with lower earnings were Chemtura, down 25.0% to $20.1 million; Ferro, down 24.5% to $6.2 million; Rohm and Haas, off 8.2% to $190.0 million; and PPG Industries, down 6.6% to $199.0 million.

Although industry leader Dow had the highest sales total for the quarter, number two DuPont had the largest earnings, $997.0 million, a 15.0% increase from the prior year's quarter on 6.1% sales growth to $7.85 billion. The company says strong seed sales and growth outside the U.S. more than offset lower volumes in the U.S. housing and automotive markets.

The Chemical companies surveyed are generally optimistic about the rest of 2007. Even Dow, with its large drop in first-quarter earnings, seems sanguine about the economy and the company's outlook. Dow Chief Financial Officer Geoffrey Merszei told a group of security analysts, "We continue to expect global gross domestic product to be healthy in 2007, above 3%." But growth in North America will be slower this year than last year, "principally because of the weakness in residential construction and the auto industry and some weakening in consumer spending." Merszei says Europe should be strong in 2007, especially in the emerging Eastern European countries. Japan should continue its steady growth, and growth in China is expected to be very strong once again. Thus, he says, "We will likely see higher demand for our products, particularly in China and other emerging regions of the world."

DuPont says it continues to expect modest volume gains as growth outside the U.S. and strong agricultural seed markets outweigh lower demand from the U.S. housing and automotive markets. CEO Charles O. Holliday Jr. says, "We are well-positioned in global industrial and agricultural markets and have an exciting pipeline of new products that customers value."

Among the medium-sized firms, Nalco expects better than 5% organic sales growth; 10% improvement in adjusted earnings before interest, taxes, depreciation, and amortization; 30% improvement in free cash flow; and 50% improvement in reported earnings per share, according to Joyce. He says, however, an important assumption in its forecasts is that costs of raw material and freight remain at or below existing levels. "We are already seeing higher year-on-year costs from freight and some other items as a result of the recent run-ups in crude oil and refined product prices," he says. But from what he now sees, Joyce says, "We remain confident in our ability to meet our forecasts."

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