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US Moody’s Newly Rated Chems To Likely Miss ’17 Targets

Posted on July 18th, 2017 by in Chemicals Industry News and Analysis

A Moody's sign is displayed on 7 World Trade Center, the company's corporate headquarters in New York, February 6, 2013. REUTERS/Brendan McDermid

A Moody’s sign is displayed on 7 World Trade Center, the company’s corporate headquarters in New York, February 6, 2013. REUTERS/Brendan McDermid

Chemical companies newly rated by Moody’s Investors Service over the last 18 months will likely miss their 2017 targets because of slow growth in some of their end markets. The outlook is part of a report by the ratings agency, which looked at the 38 chemical companies it rated from January 2013 to May 2017.

Moody’s typically rates companies when they get new owners and they want to issue debt. This gives the report a somewhat limited sample pool since it is made up of only about a third of the rated companies, many of which are businesses that other rated companies wanted to divest.

However, the report still illustrates how slow growth has manifested itself among many different chemical companies and their end markets.

For example, KMG Chemicals makes a range of chemicals, including wood-treating chemicals. This is a fairly mature end market that is potentially subject to regulatory pressures, said Ben Nelson, vice president – senior credit officer for the North American chemicals team for Moody’s.

DuBois Chemicals produces a variety of chemicals for industrial end markets, including metal-working fluids, at a time when industrial activity has not been great, he said.

ANGUS Chemical make paint additives, and Versum Materials makes electronic chemicals. The markets for both of these products are in rather late economic cycles. Other companies in the report are exposed to commodities.

Despite the large differences among these issuers, they are often exposed to end markets with slow growth.

This slow growth is one of the reasons why newly rated chemical companies will likely continue to miss their financial targets for 2017, Moody’s said.

This has been an ongoing pattern among chemical companies newly rated by Moody’s.

Among the eight that were rated in 2015, they were nearly 30% short of their own 2016 targets for earnings before interest, tax, depreciation, and amortization (EBITDA), Moody’s said.

The new issuers in 2014 missed their 2015 EBITDA targets by 13%. The 2013 new issuers missed their 2014 targets by 11%.

Even though these companies missed their EBITDA targets, their ratings were remarkably stable. That’s because Moody’s did not factor in significant earnings growth when it issued its ratings.

Something similar happened with debt reduction. Moody’s did not factor in a large amount.

These companies did intend to lower their debt, according to Moody’s. However, once they received their ratings, their debt often rose because they pursued acquisitions or sponsored dividends.

“This willingness indicates that credit quality and protecting the rating are not always top priorities, especially in dealing with a low growth environment,” the report said.

The new owners of companies typically make their acquisitions because they expect their targets to grow, Nelson said. If their new business cannot meet targets with organic growth, sometimes they attempt to reach them with further acquisitions.

Similarly, companies may decide to use dividends to obtain a rate of return they would have normally achieved with higher earnings.

Raising dividends and acquiring more companies are especially common if the new owner is a private equity firm, Nelson said. Investments from such firms come with growth expectations.

Private equity has been absent from the recent wave of deal making that resulted in new ratings. This was caused by the decline in commodity prices, which made it more difficult to obtain financing, and less investor interest for chemical private equity deals, Nelson said.

While financing costs are still elevated, they have since fallen with the recovery in commodity prices. With that, private equity firms could resume making chemical deals.

Looking ahead, there should be more opportunities.

The industry is going through a wave of large mergers, with the one between Dow Chemical and DuPont being the most prominent.

Already, DuPont has agreed to sell a portion of its crop-protection business to FMC. Dow Chemical will sell its ethylene acrylic acid copolymers and ionomers business to South Korea-based SK Global Chemical.

Once these deals close, the combined companies will likely review their portfolios and shed the businesses that no longer fit. Anti-trust regulators may also force them to sell segments.

This should open up opportunities for private equity firms. However, financing costs could still remain a hurdle. Meanwhile, some strategic buyers have significant synergy opportunities or could close deals more quickly.

For example, Axalta Coating System recently acquired the North American industrial wood-coatings business of Valspar, a deal first announced in April.

“Financing costs for lower-rated new chemical companies are not back to what they were in 2014 and I don’t think investors are as exuberant as they were in 2014 when we saw more very low rated deals”, Nelson said. “You may see businesses that come out of the mega-deals that are big enough for private equity firms to take an interest, but they might end up with a strategic anyhow.”

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