Gearing Up Germany's chemical firms braced for a toxic 2019

The good times are over in the country's heavyweight chemical sector, due to a dangerous cocktail of weakening demand in key markets and rising raw materials prices.
As long as the lights are still on.

Martin Brudermöller, the boss of BASF, didn’t beat about the bush when asked about the state of his company. “We’re not satisfied with our business development or with our share price,” he said after reporting a sharp drop in third-quarter earnings last month. Since the start of 2018, shares of Europe’s biggest chemical group have fallen 25 percent.

It is little consolation that BASF isn’t alone. Covestro, Lanxess and Evonik have all suffered big drops in share price since September. The sector is now among the weakest performers in the stock market and investors are bracing themselves for more earnings declines.

The writing is on the wall. Germany’s third-largest industry is approaching a downturn after enjoying strong growth in revenues and earnings over the last year.

Figures released Wednesday by the VCI chemical industry association confirmed what the corporate earnings season heralded: Volumes are shrinking.

Still, the sector managed to increase revenues to €48.1 billion ($55.1 billion) in the third quarter, mainly thanks to price increases. If the industry excludes the pharma sector, which is traditionally more resilient to economic cycles, chemical production fell.

The canary in the coal mine

That’s a bad sign for Europe’s largest economy because chemicals are a bellwether. They are used in almost every segment of manufacturing and when demand falls, it’s a harbinger of economic woes.

Industry leaders attribute the sector’s problems in part to a slowdown in economic growth in China, due to the country's trade dispute with the US. China is the world’s biggest market for plastics and chemicals. BASF's Brudermöller said he hoped the Chinese government would counter the trend by stimulating domestic demand with tax cuts.

Another reason is weakening demand from carmakers. Major players including Daimler and BMW are investing heavily to overhaul their combustion engines and meet Europe’s more-stringent emissions standard WLTP.

Not to mention, Germany's ongoing drought that created record-lower water levels in the Rhine, a vital transport artery for chemical groups. As a result, shipping volumes were seriously reduced. “The situation regarding the Rhine is very critical,” said Christian Kullmann, head of the specialty chemical group Evonik. Firms are forced to switch to rail transport which is costing time and money.

“There are increasing signs of a slowdown in the German and European economy,” VCI President Hans Van Bylen said. “Demand from clients is weakening.” Van Bylen is also CEO of consumer products giant Henkel.

However, CEOs don’t like to speculate publicly whether this is a temporary dip or the start of something serious. But analysts said the remaining weeks of 2018 and especially 2019 will be tough for the industry.

Weaker demand for chemicals in 2019 makes it impossible for companies to repeat the price hikes they imposed for many quarters to boost their bottom lines. As a result, profit margins face a squeeze. Especially since the price of oil, a crucial base product for chemicals, is expected to keep rising after a 45 percent jump in the third quarter.

Deals becoming smaller

The downturn is unlikely to put a stop to the merger mania that gripped the sector. Although megadeals like the Bayer-Monsanto and Linde-Praxair tie-ups are unlikely in the foreseeable future, Deloitte consultancy's Wolfgang Falter said.

Deals will likely be confined to small and medium-sized acquisitions in specialty chemical sectors. This would allow firms to profit from their technological strengths and rake in good earnings with relatively small capital outlays. Firms are also likely to divest non-core divisions where they lack the size to be profitable.

This "flight into higher-value segments," as Falter calls it, is a trend that will further separate European chemicals firms from mass producers in Asia and the Middle East.

Bert-Friedrich Fröndhoff leads a team of reporters which covers the chemicals, healthcare and services industries at Handelsblatt. Siegfried Hofmann is Handelsblatt's chemical and pharmaceutical industries correspondent. David Crossland adapted this story into English for Handelsblatt Global. To contact the authors: [email protected] and [email protected]