Taking the high-margin road Europe’s chemical

TAKING THE HIGHMARGIN ROAD

The European chemical industry is confronted with the prospect of a long wait before it returns to the growth rates in output it enjoyed before the 2008 financial crisis. Sean Milmo reports.

Europe’s production of chemicals was still in the second quarter of this year around 8 per cent below its peak in early 2008 and was looking unlikely to climb back above the level of 5–6 years ago for some while.

In late 2012 the European Chemical Industry Council (Cefic), the main trade association of chemical producers in Europe, was predicting a slight expansion of 0.5 per cent in output this year.

But by June its forecasting panel had changed its position with a prediction of a 1 per cent decrease in output in the year mainly because of weaker than expected demand. It will be a second successive year of decline after production fell in 2012 by 1.7 per cent.

Demand was particularly fragile in the first part of 2012 in the European Union’s construction and automobile sectors. Sales of new vehicles were being held back by high unemployment and low growth in incomes. The construction sector was still suffering from the effects of past speculative building keeping construction output at historically low levels.

“The EU chemical industry is still facing headwinds from the weak European economy,” says Kurt Bock, Cefic’s president and chairman of BASF, Europe’s and the world’s largest chemical company. “The chemical industry (also) continues to be exposed to strong international competition.”

In the first five months of 2013 EU chemicals production went down by 2.1 per cent compared with the same period in the previous year, according to Cefic.

However there were signs of a pick-up. In May the monthly output grew by 2.7 per cent compared to April. Confidence among EU chemical companies significantly improved in June, according to Cefic.

The association is expecting that a rise in demand in the second half of the year will continue into 2014 with a strengthening of industrial production in Europe after two years of weakness. As a result it is expecting growth in production of 1.5 per cent next year.

Among the main chemicals segments in Europe, fine and speciality chemicals are expected to expand by 2 per cent in volume terms and consumer chemicals by 1.5 per cent. Petrochemicals production will go up by 2 per cent and inorganic basic chemicals by 1 per cent.

High margin opportunities

The industry will be looking to the chemicals segments with higher added values to achieve stronger growth rates than over the last few years.

Currently – and in the medium and long term – Europe does not have the low production costs and plentiful supplies of relatively inexpensive energy to give it major competitive advantages in the production of commodity chemicals on a world scale.

On the other hand it does have the technological and scientific knowledge and innovation expertise to be a global leader in high margin speciality chemicals.

The competitive edge the European industry has in consumer and speciality chemicals is shown by the way they account for much – around 80 per cent currently – of the EU’s trade surplus in chemicals. This totalled €42 billion in 2011.

Over the past few years the higher margin speciality and consumer chemicals have made up around 40 per cent of the EU’s total chemical sales of about €550 billion. These include consumer chemicals like soaps, detergents, perfumes and cosmetics with the specialities covering auxiliaries for industry, coatings and inks, crop protection products, dyes and pigments.

Of the remaining 60 per cent of bulk chemicals, the biggest proportion is petrochemicals and the rest polymers and basic organics such as industrial gases and fertilisers.

Since 2007, however, the best performing sections of the chemical industry in terms of sales have been the bulk chemical producers. Sales of petrochemicals and basic inorganic chemicals went up by 27 per cent in 2007–2012 while total chemical sales increased by only 7 per cent.

Much of the improvement in petrochemicals sales has been due to consistently high oil prices, despite the recession in the developed world. Also there have been shortages in capacity for some petrochemicals due to plant closures in Europe during the economic downturn.

Petrochemical prices have risen at a much higher rate than in many other chemical sectors.

Sales of speciality and consumer chemicals have been more directly influenced by general economic trends. In the six years to 2012, EU sales of consumer chemicals decreased by 14 per cent and coatings and inks by 13 per cent while those of agrochemicals and colourants have been flat.

Normally the outlook for higher-margin chemicals looks more promising when chemicals are combined with pharmaceuticals. This gives a truer picture of the industry because the vast majority of pharmaceuticals are based on chemistry.

In 2012 pharmaceutical sales in the EU amounted to around 40 per cent of those for speciality and consumer chemicals. So when the three categories are brought together they account for close to 60 percent of the total with commodities making up the remainder.

Move to Asia

However the pharmaceuticals’ share of this much larger cake has been shrinking as the European pharmaceutical multinationals move production to the emerging economies, particularly in Asia, and as European state-funded health services switch to low priced generic medicines to cut costs. Also a growing proportion of pharmaceuticals are now biotech-derived biopharmaceuticals.

In the UK, which is one of Europe’s biggest producers of pharmaceuticals, the chemical industry has been hit by a slump in the output of finished medicines which predominantly consist of chemicals. In 2012/13 UK production of pharmaceuticals, led by its two major international players GlaxoSmithKline (GSK) and AstraZeneca, was languishing at 15 per cent below the level of 2007.

“The latest figures – for May this year— show output of UK chemicals going up by 2.5 per cent but pharmaceuticals production down by 6 per cent,” says Alan Eastwood, chief economist at the UK Chemicals Industries Association (CIA). “A lot of the final stages of pharmaceuticals production is being moved to Asia –to places like Singapore and Shanghai—so that it is closer to the final market. This is trend is having a big impact on original supply chains.”

A report issued in July (2013) by the UK Chemistry Growth Strategy Group (SGCG), which includes representatives of the CIA, Royal Society of Chemistry (RSC) and the Institution of Chemical Engineers (IChemE), pinpointed the need for measures to deal with supply chains which had been ‘hollowed out’ by the recession. This had happened not only in commodity chemicals but also in pharmaceuticals and other highend segments. They have to be refilled or replacing by new ones based on innovative products, according to the report.

Corporate restructuring

Some chemical multinationals in Europe have been taking a lead in this regenerative process through the restructuring of their companies to make them predominantly high margin operations.

Among the most radical in reorganising themselves has been Clariant, a Swiss chemicals producer with annual sales of around CHF 6 billion (€5 billion). Five years ago it was struggling with a portfolio with an average EBITDA (earnings before interest, tax, depreciation and amortisation) of less than 12 per cent of revenue.

Now after taking over the German catalysts company Sud-Chemie and starting the process of divesting five low-margin activities, it has already raised its average EBITDA margins above 13 per cent and looks likely to reach a target of over 17 per cent by 2015. This will put it in the second quartile of international speciality chemical companies worldwide against being in the bottom quartile in 2008.

It is transforming itself by concentrating its resources on growth sectors such as personal care chemicals, catalysis, energy storage and oil and mining services. It is concentrating its R&D on its competences in colourants, effect chemicals, formulation technologies, speciality polymers and surfactants. “We are increasing our value added by focusing on high margin segments,” Hariolf Kottmann, Clariant’s chief executive, told a recent media conference in Zurich.

After acquiring the French speciality chemicals company Rhodia two years ago, the Belgian-based chemicals multinational Solvay has also created the foundations for high margins growth.

Out of total sales of €12.4 billion last year, three of its four main operating segments – consumer chemicals, advanced materials and performance chemicals – accounted for 92 per cent of REBITDA (operating result before depreciation and amortisation, non-recurring items, financial charges and income taxes) on sales of €8.4 billion, or 67 per cent of the group’s total. The three had an average REBITDA margin of 22 per cent.

The fourth segment, functional polymers comprising mostly commodities like vinyls and polyamides, had a REBITDA margin of 7 per cent on total sales of €3.8 billion.

The company earlier this year took the first step in easing the burden of its low margin bulk chemicals when it started the divestment of its vinyls business, representing 10 per cent of total sales, by placing it in a 50/50 joint venture with Ineos with annual sales of €4.3 billion. In three years its partner will be taking 100 per cent control of the operation.

“Cycle sensitive activities will represent, once the JV is in place, less than 4 per cent of our consolidated REBITDA,” Jean-Pierre Clamadieu, Solvay’s chief executive, told an analysts conference call. “This will impact our financial profile quite significantly in terms of the quality of our portfolio.”

The deal highlighted the extent of consolidation likely to continue among Europe’s leading commodity and speciality chemicals producers. The vast majority of these are multinationals serving global markets.

It is Europe’s large international companies which are setting the pace in developing and commercialising new chemistries. Solvay and Bayer’s Bayer MaterialScience (BMS) have, for example, showcased Europe’s pioneering of advanced materials through their contributions to the light-weight structures and components in Solar Impulse, the world’s only solar-powered aircraft.

But the major challenge will be establishing new supply chains which will involve, in the new innovative technologies, large numbers of the SMEs accounting for the vast majority of chemical businesses in Europe. As the CGSG of the UK pointed out in its report, they have to benefit more from R&D activities, technology transfers and new links between suppliers and customers as Europe’s chemical industry becomes more of a knowledgebased, high-margin sector. n