The pricing effect is very evident in the IFF results and projections, highlighted below. The company projected higher revenue expectations for the year but no increase in EBITDA with that higher revenue. We expect this trend to continue through at least the next couple of quarters, even if energy prices do not rise any further, as we believe that there is still some energy-related pass-through to come in many sectors. As the ammonia chart below shows, inputs in the agriculture/food industry keep rising.
The recent Dow guidance is worth some further comment as it is being heralded in the stock market as an earnings miss, or at least that is what is implied in the stock performance, even though the signals around margin squeezes in 4Q have been in place for weeks and have been covered extensively in our work. Some elements of modeling chemical company earnings are complex, but rising energy (and therefore feedstock) prices is not one of them. We have commented several times over the last couple of years about the lack of almost any effort being made by the sell-side to rethink estimates mid-quarter, choosing instead to take or interpret company guidance (generally in the first month of a quarter) and then wait until earnings are reported. This does a disservice to both the institutional investors and the chemical companies, as the investors quickly conclude that estimates are likely too high – simply looking broadly at what sectors get hurt by rising energy – but generally do not have a good measure of by how much earnings will be impacted, so they sit on the sidelines, expecting the surprise. That said, there are so many algorithms working today that the alternative of gradual negative revisions to a more reasonable target for the quarter is also likely to hurt stock performance.
Our Sunday Thematic research a week ago (see linked report) discussed slowing growth investment in the traditional commodity chemical industry and suggested that ESG and climate pressures might slow investment even further. Yesterday, our Sunday Thematic made the argument that some of those dollars will target strategic M&A. We have recently seen an uptick in global chemicals sector M&A, and we find few items suggesting activity levels will slow in the near-to-medium term. In part, we think strategic M&A will be easier to get Board approval for than “new build” capacity additions, and it can be viewed as better use than holding cash or complementary to dividends and buybacks. Also, ESG and climate concerns could spur M&A activity, as companies look to separate bad emission assets from good ones – especially if the market values them very differently.