Finances May Frustrate Industry This Year

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After two years of tightening margins and rising energy and raw materials costs, chemical manufacturers can finally see some light. As this month's cover story suggests, the economic picture is brightening, but the struggle is far from over.

Ironically, investments made to improve profitability may have left some chemical companies even more vulnerable if a January report by the New York City based ratings specialists, Standard & Poors, is any indicator. Some firms that have borrowed to diversify raw material and market bases, or improve product mixes, may not be able to continue these essential activities, given high debt levels and weakened credit.

Of the nearly 70 chemical companies tracked by S&P, almost 70% underperformed the analysts' expectations, and the chemical industry's overall credit rating has slipped a notch, to the middle of the spectrum, at BB.

Within the past four years, over 15 of the chemical companies followed by S&P have defaulted on bond or bank-loan payments. Between 1989 and 1999, in sharp contrast, only one company defaulted, and that was due to litigation.

Today, even financially stable companies with AA or A credit ratings are far more leveraged than they were in the past, according to the report author, S&P analyst Kyle Loughlin. And difficult economic conditions only tell part of the story, he says.

To illustrate this point, Loughlin selected 21 companies that S&P also rated 10 years ago -- one-third of the companies that were rated then aren't around, most of them were acquired by other firms, and many have defaulted on loans. For those 21 survivers, the average debt-to-capitalization ratio increased from 46% to 52% between 1992 and 2002, while cash flow fell from 50% to 31%.

Credit ratings slip

As a result, it's likely that credit ratings will slip further, S&P predicts, making it harder for companies to fund the new investments needed for survival. As Loughlin puts it, "Chemical industry managers may increasingly be confronted with limitations imposed by their own financial policies and past balance-sheet management decisions."

The result: more consolidation, globalization, and strategic joint ventures, particularly for key raw materials such as natural gas. Only this time around, the analysts suggest, only those with the strongest credit will be able to play.

And even without considering debt and credit issues, chemical companies, and all manufacturers, process or discrete, have quite enough to worry about. A December report, "How Structural Costs Imposed on U.S. Manufacturers Harm Workers and Threaten Competitiveness," published by the National Association of Manufacturers (Washington, D.C.) last month sounded a note of doom and gloom. According to the study, U.S. manufacturing companies spend an average of 25% more on pollution abatement, energy, tort litigation, and other structural costs than their peers in the nation's nine largest trading partners, including France, Germany, the United Kingdom, South Korea and Japan. Pollution abatement costs run to 7.6% of total U.S. manufacturing output, and 1.6% of U.S. GDP, the study says.

The cost of tort litigation -- in particular, an explosive increase in new asbestos lawsuits, is adding to cost pressures. Tillinghast-Towers Perrin reported last February, the study says, that the costs of U.S. torts reached $205 billion, or 2% of GDP, in 2001, an increase of 14.3% vs. 2000. That figure should reach 2.33% of GDP by 2005, the study says. Tort costs added up to 4.5% of manufacturing output in the U.S., the study says, compared with 3.2% in France, 3.8% in Germany and substantially lower figures for other trading partners.

Among other things, the study recommends that the government reduce statutory corporate tax rates, repeal the corporate alternative minimum tax and the taxation of after-tax profits. (For a copy of the study, click here.)

What impact will all these economic pressures have on R&D and innovation in the U.S? NAM proposes that the U.S. government step in to lower innovation costs by making the R&D tax credit permanent. Recent studies, such as one published last month by the Chemical Industry Vision 2020 Technology Partnership, suggest that companies adopt a collaborative approach. Collaborative research, bringing together would-be competitors, end users, academics and research labs, led to tremendous gains in metallocene catalyst development in the past and may speed new R&D.

Whatever the indicators, 2004 promises to be a challenging year for any professional in the chemical processing industries. Here's hoping it's also a good one.

By Agnes Shanley, managing editor

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