Strong Demand Buoys Chemicals

The chemical industry’s financial results in the second quarter were a triumph, especially when compared with the lousy second quarter of 2009. Many chief executive officers, although happy to point to strong quarterly profits, warned that the rest of 2010 will not be as dramatically positive.

Overall, the 22 companies tracked by C&EN saw sales shoot up by 21.1% and earnings rise a stunning 89.6% in the second quarter. In earnings reports, chemical executives emphasized that for most product families, the majority of the revenue increase came from higher sales volumes, as opposed to higher prices, a signal that manufacturer demand for chemical raw materials is rebounding.

The increased demand carried over from the first quarter, when the economy was regaining traction after the recession. Celanese CEO David Weidman summarized the quarter’s results when he said, “Product demand across all regions and industries remained strong and reflected an ongoing, modest global economic recovery.”

The phrase “global economic recovery” got top billing in most of the firms’ earnings reports. Demand for electronic materials led the demand rebound, with automotive and construction-related materials following at a slower pace.

The strength of the recovery emboldened a number of firms to increase their 2010 full-year earnings estimates, including Arch Chemicals, Celanese, Cytec Industries, DuPont, Eastman Chemical, FMC Corp., Ferro, Lubrizol, and Nalco. Still, seasonal slowdowns and higher input costs mean that firms are unlikely to pile on the same profits in the second half of the year as in the first.

In addition, experts point out that the recovery in demand comes from purchases made by end-product manufacturers needing raw materials for factories that have just begun to increase production. Neither economic data nor the chemical firms’ own earnings reports provide evidence that demand from consumers is returning to prerecession levels.

But chemical firms made the most of what could be a temporary spike in demand. In addition to earnings, profit margins also increased significantly, to 9.2%. During last year’s second quarter, chemical makers, having cut costs to the bone, were able to achieve a respectable 5.9% margin despite very low sales. Most have held on to those cost cuts, allowing company leaders to extol their firms’ so-called operating leverage—factories’ ability to run on the fewest resources possible.

At DuPont, those facilities were busy supplying electronics makers. CEO Ellen J. Kullman told analysts in a conference call that “sales and earnings results from our electronics and communications business surpassed prerecession peaks.” She reported that sales in the photovoltaics market grew more than 150%. Other electronics markets expanded by at least 25%, she said, with “the recovery broad-based across markets including cell phones, PCs, and displays.”

Boosted in part by its sales of chemicals and materials for electronics, DuPont reported earnings of about $1.1 billion, almost double last year’s second-quarter figure. Sales, which reached approximately $8.6 billion, were back to the levels of 2008’s second quarter.

DuPont’s coatings and performance polymer sales benefited from a recovery in the global automotive market, Kullman added. The company’s performance materials segment, which includes packaging polymers and engineering plastics, had a 35% increase in sales volume compared with the second quarter of 2009.

Automobiles were also the major driver of Cabot’s vastly improved earnings. A maker of carbon black, used largely in tires, Cabot reported earnings of $61 million, compared with a paltry $4 million in last year’s second quarter. The firm reported that sales in China were up 32% compared with the same time last year.

At Dow Chemical, sales were up about 20% compared with last year’s second quarter. In a conference call with analysts, CEO Andrew N. Liveris focused on profit margins, saying that certain performance materials segments, including electronic and specialty materials, had returned to prerecession levels.

Liveris also updated analysts on Dow’s progress in transforming itself into a manufacturer of performance, rather than basic, chemicals. “The best proof point that our strategic agenda is the right one is the continued strength in our performance businesses, which delivered more than 70% of the earnings before interest, taxes, depreciation, and amortization for the quarter,” he said.

But basic chemicals continue to be a cash cow for the firm, which needs the money to pay the towering debt it took on with its purchase of Rohm and Haas. Charles Neivert, chemicals analyst at equity research firm Dahlman Rose & Co., said in a report to investors that the basic chemicals segment will be a challenging one for earnings in 2010 and 2011. In addition, Neivert does not anticipate that the firm will sell off its basic chemicals holdings in the near term. Still, he gave the company credit for “moving the needle with its shift to higher margin business.”

Eastman took full advantage of demand in the second quarter, reporting record earnings per share of $2.05, compared with 86 cents in the year-ago quarter. It saw much higher customer demand for performance chemicals and intermediates, particularly olefin derivatives and the plasticizers it got when it acquired Genovique Specialties in May.

At Cytec, new demand turned a quarterly loss last year of $1 million into earnings of $65 million. Its largest business, coating resins, enjoyed a sales volume rise of 27%. A ramp-up in manufacturing in the aerospace industry helped Cytec sell 11% more of its engineered materials. Meanwhile, the firm had to raise prices of building-block chemicals such as acrylonitrile by 75% to make up for significantly higher propylene costs.

Likewise, Huntsman Corp.’s second-quarter earnings of $69 million were in considerable contrast with its $64 million loss in 2009. The company benefited from increased demand for performance products and advanced materials and from growth in the North American and European markets, which make up about two-thirds of its sales.

Overall, the second quarter was “very impressive” for the chemical industry, said Tim Hanley, global chemical group leader at business consultancy Deloitte. Customer restocking and new orders, plus lower cost structures and the ability to pass along price increases, made the quarter very profitable, he added.

At the same time, Hanley pointed out that “it’s hard to get empirical data on demand for finished goods. Customer inventory levels are getting somewhat back to normal now, and chemical firms won’t get that boost next quarter.”

Chemical companies that sell to China increased their sales thanks to the country’s strong economy. China’s National Bureau of Statistics reported that the nation’s gross domestic product (GDP) rose 10.3% in the second quarter, a bit slower than the 11.9% growth of the first quarter. Much of the second-quarter increase was related to government investments in infrastructure, which rose 25.0% in the first half of the year. Meanwhile, Chinese retail sales grew 18.2%.

But U.S. economic growth was slow in the second quarter. The Bureau of Economic Analysis reported U.S. GDP growth of only 2.4% compared with 3.7% in the first quarter. Consumer spending rose just 1.6% in the second quarter. Spending increased 7.5% on durable goods but only 1.6% on nondurable goods. Consumers were holding on to their money. Although real incomes increased by less than 0.1% in the quarter, workers have held to a savings rate of more than 6% since last summer.

The chemical industry has been telling investors that it will likewise avoid significant spending. Although capacity utilization and production are up from last year, Hanley reported that investments in infrastructure will resume slowly.

“There were a lot of deferred costs in the past two years,” Hanley said. “Capital expenditures were cut to the level that kept the lights on, but now firms are starting to increase spending carefully.” Firms are looking at their supply chains, he said, and they might find that increasing wages in China suggest the need to bring some manufacturing closer to home.

Hiring will also rebound slowly, Hanley said. “Companies are still careful about adding back headcount,” he said. “Instead, they are looking at using overtime and contract workers.” Chemical firms aren’t the only ones slow to hire. The unemployment rate has stayed near 10% since the beginning of the year. According to the Labor Department, private employers added a mere 31,000 jobs to the economy in June.

The lack of jobs caused consumer confidence to drop sharply in June and again in July, according to the Conference Board, a business research organization. “Concerns about business conditions and the labor market are casting a dark cloud over consumers,” the group reported.

Even though chemical firms have joined other industries in the hiring standoff, the jobs numbers are bad news for the industry. “To sustain growth for the next two to three years, we need more people with more jobs that support a higher standard of living,” Hanley said. “Growth would require unemployment to fall to 8% from 10%, and that may take a long time.”