2013 Chemicals Industry Perspective
by Richard Verity, Dr. Marcus Morawietz, and Jayant Gotpagar
Originally published by Booz & Company: December 13, 2012
There are no easy choices for chemicals companies this season. Leading companies are taking a fresh look at their portfolios, their operations, and their strategies in Asia.
We would like to offer our thoughts on the current business environment for the global chemicals industry, what the future might hold, and the priorities for operators in the near future.
Global chemicals revenues have retreated in 2012, as the economic malaise has continued in the developed world and customers in struggling industries such as construction and automotive have cut back on orders. Overall chemicals revenues fell by about 4.4 percent in the first half of this year, and there is little indication of a turnaround in the second half.
The lack of growth has even affected specialty chemicals companies, which have been the industry’s best performers in recent years. The specialty chemicals sector generally grows at about two or three times the rate of commodity chemicals and overall GDP, and although that has remained true in 2012, allowing many specialty companies to eke out increases, growth has been at a slower pace.
With the slowdown in revenues, some of the more agile chemicals companies have embarked on internal transformation programs—restructuring their operations and making other adjustments to get their costs in line with lower expected revenue growth. The caution has extended to M&A, which fell by 47 percent on a dollar basis in the first half of 2012 compared with the year-earlier period.
An area of particular concern is Asia, where demand has slowed in comparison with the much higher growth rates of recent years. Many Western chemicals companies have spent years investing in Asia and now derive a substantial portion of their revenues from the region. But the bets haven’t paid off in terms of profits. On the contrary, Western companies have discovered that the business models that have served them in developed markets—and which they’ve tried to replicate in emerging markets—have not worked in places like China and India. They entered these countries with specialty products that weren’t in demand, or at price points that end customers weren’t willing to pay, or without the scale advantages needed to succeed as high-volume producers. As a result, many of them will need to make substantive changes—including to their regional business models—if they are to see meaningful improvements in their Asian businesses.
There are no easy or obvious levers for chemicals companies to pull in 2013. Success may well come down to a CEO’s ability to look deep inside his or her organization to find new sources of profitability. The question is how to do that.
Here are our ideas:
Like all companies going through challenging times, chemicals companies need to make a realistic assessment of their competitive positions and reset their priorities. Once a direction has been chosen, companies have to reorganize to meet those priorities, and they need to increase their operational excellence. There are, in fact, many things that operators can do in the way of Fit for Growth℠ initiatives, a framework we at Booz & Company have for driving out unnecessary costs so companies can create resources for the activities they most need.
BASF, DSM, DuPont, and Evonik are among the specialty chemicals operators (or diversified companies with specialty businesses) that have responded to slowing demand with internal transformations. In addition, another global specialty chemicals company, which often partners with Booz & Company, has begun standardizing processes within its functions and simplifying its organization. The company is increasing its investment in areas where it has special capabilities, such as performance management, by reducing complexity in its product portfolio and further improving its margins. But in areas that matter less to its customers, the company is lowering costs to an extraordinary degree by reducing several non-client-facing overhead positions.
DuPont’s decision to divest its automotive paint business represents a similar transformation. The slow but steady growth of the segment—and its potential for high cash-flow generation as a stand-alone entity—made it attractive to Carlyle Group, the private equity firm that agreed to buy it earlier this year. This was a strategic realignment for DuPont, which has been turning its attention to faster-growing end markets, including agriculture and nutrition.
Acquisitions are another potential new source of profit. However, with the industry struggling, most chemicals companies have not been in a position to make high-profile acquisitions. Indeed, the average deal size fell to US$73 million in the first six months of this year, from $132 million in the first half of 2011. But a deal doesn’t have to be big from a dollar standpoint to have a big impact.
For instance, at $1.02 billion, BASF’s planned acquisition of Becker Underwood, a crop technology company, is a drop in the bucket for BASF, which had revenue of €73.5 billion ($95 billion) in 2011. But Becker Underwood’s technology—including a way of applying chemicals coatings to seeds to protect them from insects and other problems—should allow BASF to bolster its position in crop protection and create new agriculture offerings in markets where it is investing heavily, such as South America, Europe, and Asia.
It is becoming harder to innovate and grow in the basic chemicals segment, in that products like polymers and plastics serve mature, slow-growth markets. By contrast, the use of chemicals products in other markets—such as pharmaceuticals and nutrition—is evolving rapidly and growing quickly.
Agriculture has become a particularly promising market, as farmers everywhere—including in the developing world—look for more efficient methods of growing and protecting their crops. For chemicals companies that have hitched their fortunes to the fast-growing agricultural segment, the rewards (in terms of shareholder returns) have been dramatic in some cases. For instance, the share price of the Swiss chemicals company Syngenta, which sells seeds and crop protection products, has increased more than sixfold in the last 10 years, including a 30-plus percent rise so far in 2012. These gains have gotten the attention of other chemicals companies, many of which are looking to expand their agriculture portfolios.
What’s gone wrong here? In many cases, European and North American operators have assumed that definitions that were clear in the West (the difference between specialty and basic chemicals, for instance) would also apply in Asia—and that their products would find an enthusiastic reception there. It turns out that the Asian market is different in some fundamental ways, at least for now.
To take just one example, many regulations that are taken for granted in the West haven’t been introduced in Asia—and Asian customers, quite naturally, are unwilling to cover the cost of safeguards they don’t need. In this context, Western companies will need to reassess their distribution strategy or their operations. They may also need to look for other ways of gaining expertise in Asia, including partnerships that might provide access but require them to relinquish some control. In short, many Western companies may have to press the reset button in Asia and take a close, critical look at how they are positioned there.
The rise of North American shale gas has created an interesting dynamic in the global feedstock for chemicals intermediates and petrochemicals. While North American players have become competitive again for ethane-/ethylene-based chemistry, European producers continue to suffer with high naphtha costs. Interestingly enough, Asia—primarily China—is moving toward greater diversity in feedstock with coal-based chemistry. However, the Middle East remains the most competitive region for both oil- and gas-based petrochemicals.
On the product side, a global shift to lighter feedstock has created a structural shortage of key chemicals intermediates (propylene, butadiene, and so on), resulting in historically high price premiums compared to ethylene.
This dynamic has created unique opportunities for players, including the following:
- Capture growth created by North American shale gas and use it as a hedging position to protect European markets.
- Use Middle East feedstock flexibility to configure a product slate, in order to capture premiums for key intermediates in the market.
- Reverse-integrate or utilize on-purpose technologies—now profitable again—to close the gap in the key chemicals intermediates.
We hope that this letter stimulates your thinking about the strategic priorities your organization should focus on to compete in this unsettled but potentially very rewarding period for the chemicals industry. We welcome the opportunity to hear your thoughts about the year ahead and discuss how you might create a more prosperous 2013.