Apologies if this sounds familiar, but is the chemical industry racing ahead or just running to stand still? The question is timely given the decidedly mixed third-quarter numbers the sector has reported in the past few days. Chemical companies are hurting from the euro zone crisis, lower demand from China, and the sharp drop in activity in the auto and construction sectors. A severe industry correction on the scale of 2008-09 may be unlikely. But the sector needs to justify its lofty-looking valuation.
Consider just a few of the headlines from the latest set of results. Dow Chemical's earnings fell by a third, prompting it to cut some of its planned investments. DuPont is cutting jobs and seeking to boost productivity. BASF was bearish on the outlook for demand; earnings at its chemicals division this year will not match last year's. The going is also tough for smaller players. DSM, the Dutch chemicals group, is cutting costs and bulking up in nutrients. Profit at Lanxess of Germany was down 40 per cent, partly due to its exposure to tires.
The chemicals industry is deeply cyclical; its companies are used to dealing with economic headwinds, so this should be business as usual. The main thing is to avoid a repeat of the slump that followed the global financial crisis, when prices and volumes tumbled between 10 and 20 per cent. That led to a clearing out of inventories and capacity cutbacks that should have left the industry better armed against the latest downturn.
The question is where the downturn leaves valuations. The U.S. chemicals sector has traded broadly in line with the S&P 500 this year. In Europe, however, chemicals companies have done twice as well as the wider market; the sector now trades on a steep 14.5 times 2013 earnings. That masks individual standouts: Lanxess is up 60 per cent this year (it joined the DAX index in September). That suggests that parts of the chemicals sector may have further to go. But first it has to navigate what could yet be a longer-than-expected downturn.