Like many of the European producers, DuPont has taken a risk in our view by holding guidance flat in the face of inflation, weakness in China, and a potential further economic slowdown in Europe and the US. We struggle with what an alternative approach should be for DuPont and others, given that it would be challenging to map out a credible downside scenario today. What we would note, however, is that when things turn negative for the materials industries they tend to fall quickly and sharply. For all of the base chemical and specialty chemical companies what might upset things for 2022 are largely outside of their control, and it is hard to second guess cutbacks in customer demand until they happen, especially in an environment where all are looking at volatile costs from energy and consumer spending uncertainty because of inflation. For more see today's daily report.
The Lanxess guidance below is likely the right way to go for now. The medium-term effects of the Russia/Ukraine crisis are unknowable today and all companies can monitor is the immediate impact on their businesses. Most had entered 2022 seeing very strong demand growth and the promise of a much better year as COVID restrictions were lifted and economic activity picked up generally. Now all bets are off, as it is not just the primary impacts that matter – such as a companies’ direct exposure to Russia or Ukraine – note McDonald's is suggesting that pulling out of Russia will cost the company $50 million a month, for example – but also the secondary impacts of what the conflict is doing for supply-chains and pricing. Higher hydrocarbon pricing in Europe, for example, will impact the economics of all production, not just the products sold to Russia or Ukraine. There will also be some demand adjustments directly related to the conflict – disaster relief for example – more PPE – more spending on defense and defense-related materials – DuPont’s kevlar business should be seeing a benefit for example.
While it has been a long time coming, and it is unclear whether COVID hindered or helped, the DuPont materials exit is not a surprise and we noted after the IFF deal that we believed that Ed Breen was not done. During his time at Tyco, Mr. Breen showed a very clear ability to identify better owners for businesses that were lost in a conglomerate structure. We had always anticipated the same with DuPont and the business that is moving to Celanese is one we had expected to move and we had discussed previously. This should be a win for both companies as DuPont begins to look much more like a stable margin specialty chemical company with a portfolio that is becoming more ESG centric – see today's daily – while Celanese now has a large and comprehensive portfolio of polymers that are critical to the transport sector and should be able to drive both revenue and cost synergies if the company manages the integration well.
As Avient and the linked paint article remind us, there are sectors of the US chemical industry that rely on imported products – in these cases pigments, and the supply chain challenges and logistic delays have caused production problems in the US and price increases in 2021. The automotive segment of the paint industry has seen lower demand because of the auto OEM production slowdown, and pigment shortages and price spikes would likely have been worse if automakers had been running at full rates. There is no sense of impending relief in the logistic issues as we go through 4Q earnings reports and we could continue to see issues for a while. This should be good for US-based pigment suppliers, but while Chemours, Venator, and Tronox all have capacity in the US, they also have capacity outside the US which likely faces some supply chain challenges.
We are not surprised by some of the DuPont stories this morning. We had predicted a long time ago that Mr. Breen was far from done on the restructuring of the company and that COVID might have caused a delay in some of the plans but not changed them. Mr. Breen did a very value-enhancing job of taking Tyco from a slightly out of control, then GE wannabe, to a group of focused companies, separated from the whole. What he has panned for DuPont comes from the same playbook in our view. The divestments and acquisitions announced today will create a core at DuPont – focused on electronics, water, protection, industrial technologies, and “next generation” automotive. Given some of the recent industry moves, we would expect significant interest in the engineering polymers and other resins platforms. After these moves are complete, while not yet obvious from a valuation perspective, we could see a further split, carving out an ESG friendly piece focused around water and protection, although the moves announced today may be enough to get the company an earnings multiple boost.