The AkzoNobel comment today on completing its share buyback is a reminder that the chemical industry, in general, is reporting earnings that for the most part include record or near-record profits today and very strong momentum into 2Q 2021. They should all be prepared to answer the question of what they plan to do with the cash. The temptation is to build because prices are high and in some cases, customers are short of product and pleading for more supply. We often talk about the economics of NOW being used to justify spending far more than it should be – not just in Chemicals but also in other industries. In some areas, we are genuinely short of materials and semiconductors are a clear example of where underlying global demand has caught up with supply. Materials suppliers into this space are likely to see new capacity well utilized. For many of the other chemical segments, there is too much near-term noise to say with any certainty what is structural versus an immediate shortage. COVID, weather, a blocked canal, and unusual patterns of consumer spending have all played a part in inflating demand relative to supply, and we could be looking at a very different dynamic in 6 months.
Our company-specific advice is driven by circumstance, but in general, we would encourage companies to resist shareholder pressure to buy back stock (at what could be a peak) or pay special dividends (just before they sell the stock because it does not meet new ESG criteria) and instead focus on paying down debt. We have no idea how the ESG and Sustainability crowd will view the chemical and associated industries in the next 24 months, but there is a risk that we could find the industry branded like the E&P or mid-stream groups today with consolidation the most logical path forward – generally those with the strongest balance sheets fair best in consolidation discussions. The obvious counter to this argument is that you would not want to pay off long-dated cheap debt, as you might not be able to replace it. Building cash is a credible second option.
Source: Bloomberg, C-MACC Analysis, April 2021
Reflecting on our comments above about what to do with cash, the China headline linked is relevant, as when all of the near term dislocation, weather based, and other shutdowns (that have driven US ethylene to recent record highs this week - as shown in the chart above) are over, we will be facing a Chinese market that is much more self-sufficient for many products than it was in early 2020, and in other products has either become an exporter or become a more significant exporter. Domestic demand for chemicals and polymers in China continues to grow quickly, and we note investments to add capacity in China every week – see separate DuPont and Sinochem headlines today– but, some of the recent and current demand in China is supporting a durable goods demand surge (bubble) in the West that has been caused by COVID and is highly unlikely to be sustained.
In a complete opposite of our comments on crude oil above, China’s chemicals and polymer surpluses are not centrally controlled, although they likely channel through a handful of traders, and new China production facilities will be competing with each other to find incremental export opportunities. Adding more (and new) players to an oversupplied international market is never a good thing in times of oversupply. No one is thinking much about this right now because markets in Europe and the US are tight, but the gap between US and Asian ethylene prices, and the disconnect from history, is illustrative of how far apart the markets have moved – the current situation is unstable. Falling glycol prices in Asia for ethylene glycol in May is perhaps a leading indicator of what is to come.
