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COVID-19 Hurts U.S. Chemical Credit Quality

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COVID-19 Hurts U.S. Chemical Credit Quality

S&P Global Ratings anticipates the COVID-19 pandemic will significantly disrupt global chemical markets in an unprecedented way in 2020. We reflect this in a large number of recent downgrades for many of the chemical companies we rate. Our year-to-date 2020 downgrades versus upgrades are the most skewed (toward downgrades) in any single year in recent memory--including in the recessionary years of 2008 and 2009 (Chart 1).

Chart 1

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We have downgraded this year (as of May 15) more investment-grade credits--12--than in any other recent year, and more than in 2008 and 2009 combined. The downgrades reflect our belief this recession will cut deeper and damage credit quality across a wider rating spectrum than recent recessions or cyclical downturns. Still, we currently don't expect any fundamental long-term business weakness arising from this recession at downgraded investment-grade companies. We have lowered investment-grade issuer credit ratings by one notch in our downgrades. None has slipped into speculative-grade thus far, and we have no 'BBB-' issuer credit ratings with a negative outlook.

We discuss here:

  • Our revised assumptions for the U.S. chemical sector in 2020 that contributed to our recent rating actions.
  • How they differ from our previous assumptions.
  • Ultimately how these revised assumptions will continue to affect credit quality and ratings.

An Economic Recession In 2020, Not The Stable Growth Previously Forecast

  • S&P Global Ratings anticipates a global economic recession in 2020, with GDP shrinking 2%. GDP in the U.S. (around 5%) and eurozone (7%) shrink even more. We anticipate a global recovery in 2021, and specifically in the U.S. at slightly over 6%, while acknowledging a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. In our downside forecast, we consider a sharper contraction and slower recovery in consumer spending and related investment by businesses, resulting in a U.S. GDP contraction of 8.2% in 2020 with a weaker recovery in 2021 at just 5.7% growth.
  • See our commentary "COVID-19 Deals A Larger, Longer Hit To Global GDP", dated April 16, 2020, for a detailed discussion of our economic forecasts, and a comparison with our previous forecasts.

Chemical Credit Quality Weakens

Chemical demand declines

The impact of our lowered GDP estimates cascades into specific end markets for chemicals such as autos, housing and construction, and general industrial. We project contraction in demand in several such end markets and expect that in turn demand for chemicals from these markets will shrink sharply, at rates disproportionately higher than the 5% decline in GDP. For example, we anticipate 2020 U.S. new light vehicle sales will decline about 25%. In some previous downturns, chemical sales dropped less than the decline in new vehicle sales. Instead, demand for chemicals from auto aftermarkets partly offset new vehicle demand declines.

Not in this recession. In 2020, we expect miles driven will also shrink, given vast portions of the U.S. and global populace are subject to stay-at-home restrictions. This will reduce chemical demand from auto aftermarkets, where sales of chemical-consuming products including lubricants, engine coolants, and tires tend to correlate to miles driven. Consequently, we expect declines approaching 25% (with deviations across auto end markets and chemical products) in chemical sales to auto markets. Similarly, we expect demand from an array of other end markets will also weaken for commodity as well as specialty chemicals.

We generally view specialty chemicals as less volatile. However, in the current exceptional circumstance, the magnitude of the weakness at end markets is creating volatility in specialty chemical demand. A case in point is our downgrade of PPG Industries Inc., which we consider a specialty chemicals producer. PPG's paints and coatings sell into a wide variety of markets including the auto segment, contributing to our expectation for a significant hit to 2020 EBITDA.

End markets with especially severe demand loss

We assume demand from several important chemical end markets will decline by double-digit percentages. These include automobiles, housing and construction, aerospace, and the industrial sector in general, where chemicals form raw material inputs, aid in manufacturing processes, or are generally utilized (e.g., waste water treatment, lubricants for machinery, or as catalysts).

End markets where demand loss is less severe, or not at trough levels

These include industrial gases, agriculture (where we typically assume volatility, including in 2020, but not an across-the-board demand trough this year), medical, packaging, health care, and pharmacy. This also includes parts of the paper and pulp sector that sell into packaging, cleaning, and sanitation that is consumer or health care focused (as opposed to chemicals ultimately sold to hotels and travel).

Pricing weakens

We expect prices for many chemical products, to decline in 2020. For example, in the petrochemical sector, despite some strengthening in the first quarter relative to the fourth quarter of 2019, we expect lower pricing than 2019 on average for many grades of polyethylene and polypropylene, and below five-year average prices. We believe chemical customers feeling the need to shore up their own bottom lines could pressure even specialty chemical makers to reduce prices.

The extent of pricing weakness will vary, with higher declines for commodity chemicals such as polyolefins, where new U.S. capacity has built up with an eye on export markets and U.S. producers will lose much of their "shale gas advantage" versus naphtha-using global competitors. Lower oil prices have driven down naphtha prices, and reduced or eliminated the input cost advantage U.S. producers enjoyed, in addition to pushing down chemical product prices linked to oil. Our downgrades of several petrochemical producers including The Dow Chemical Co., Chevron Phillips Chemical Co. LLC, and LyondellBasell Industries N.V. in part reflects risks related to weaker product pricing, demand, and margins.

Margins drop

Margins across several chemical chains are expected to weaken sharply in commodity chemicals, including petrochemicals (olefins and polyolefins), titanium dioxide, chlor-alkali, methanol, and acetyls. We believe variable margins with many chemical products will decline because of a pricing fall. In addition, negative operating leverage arising from lower volumes will result in another hit to many chemical margins. We expect EBITDA will decline more (in percentage terms relative to 2019) than revenue.

EBITDA falls

Our assumptions on demand and pricing softness ultimately lead to projected EBITDA declines in the sector. In practically every rating action so far, we estimate a double-digit percentage EBITDA decline relative to 2019. The median anticipated EBITDA decline when we downgrade an issuer is approximately 20% [1]. We model a broad range of EBITDA declines for chemical companies based on several idiosyncratic company-specific issues, including a unique combination of products, end markets, and geographies plus factors including M&A and management's response to the ongoing downturn.

Earnings recover modestly in 2021

The timing and extent of the recovery is uncertain, dictated in part by several company-specific variables such as cost structure and competitive positions. In general we assume earnings and leverage improve in 2021. Nonetheless, even with an assumed 2021 recovery, we expect debt metrics to be weaker than our pre-coronavirus assumptions, a key factor in our negative rating actions.

Other Factors That Influence Our View Of Credit Quality

Relatively low cushions at the rating category

Credit metrics at the start of 2020 relative to S&P Global Ratings' expectations played an important role in our view of future credit quality. Most credits on which we took rating actions had insufficient cushions at the start of 2020 to offset our assumed weakness caused by the recession. For many of these companies, 2020 is the second successive year of demand loss. Demand and earnings shrank in 2019, in part because buyers held off on purchases given trade tensions between the U.S. and China. For example, at Westlake Chemical Corp., EBITDA declined by nearly 33% in 2019 (versus very strong 2018 earnings). Leverage was still within our range of expectations, albeit with only modest cushions. However, another estimated decline in 2020 tipped projected metrics over a downgrade threshold.

On the other hand, at companies such as Axalta Coating Systems LLC large cushions under ratings have not resulted in negative rating actions despite our assumptions for meaningful earnings declines in 2020.

Debt maturities in 2020 or 2021

Although credit markets appear to have held up so far, we believe refinancing debt will be tougher, or more expensive, than in a typical recent year. We think credit risks are higher than typical, especially for credits at the lower end of the spectrum (in the 'B' category or lower) that have debt maturing in 2020 or 2021. For example, we lowered our ratings on AgroFresh Inc. and placed them on CreditWatch with negative implications in part because of refinancing risks related to debt due in 2020, which we believe would create liquidity pressure.

Tight covenant cushions

We lowered ratings on some credits at the lower end of the scale that had low cushions under their covenants. Our view was that lower 2020 earnings would erode much or all of those low cushions and led to downgrades. We assumed these companies would have little to no access to credit facilities subject to covenants, tightening liquidity. This was an important reason for our downgrade of UFS Holdings Inc., which we assume will no longer have access to its credit facilities subject to covenants, increasing default risk.

Impact On Credit Ratings

Increased leverage in 2020

The assumptions we make regarding 2020 and beyond, including key assumptions discussed above, raise leverage relative to 2019 and to our previous expectations at virtually all chemical companies we rate. This contributed to several downgrades and other actions such as revisions of outlooks to negative. While our current assumptions for lower earnings are the key factor in increased leverage, a buildup of debt in the past decade has been a minor contributory factor. Some companies increased leverage in the past decade or so for several reasons including the relatively low cost of debt, M&A activity, and shareholder friendly actions.

Table 1

Select U.S. Chemical Sector Rating Actions In 2020
Company Date Previous rating Current rating Rating action

Olin Corp.

May 12, 2020 BB/Negative BB-/Negative Downgrade

PLZ Aeroscience Corp.

May 12, 2020 B/Stable B/Negative Outlook revised to negative

CPG Intermediate LLC

May 12, 2020 B/Stable B-/Stable Downgrade

CF Industries Inc.

May 8, 2020 BB+/Positive BB+/Stable Outlook revised to stable

Ferro Corp.

April 30, 2020 BB-/Stable B+/Negative Downgrade, outlook negative

PolyOne Corp.

April 29, 2020 BB/Stable BB/Negative Outlook revised to negative

Sherwin-Williams Co.

April 24, 2020 BBB/Stable BBB-/Stable Downgrade

Albemarle Corp.

April 23, 2020 BBB/Stable BBB-/Stable Downgrade

FXI Holdings Inc.

April 23, 2020 B-/Negative CCC+/Negative Downgrade

Diamond (BC) B.V.

April 20, 2020 B-/Negative CCC+/Negative Downgrade

Koppers Holdings Inc.

April 17, 2020 B+/Stable B/Negative Downgrade

Element Solutions Inc.

April 17, 2020 BB-/Stable BB-/Negative Outlook revised to negative

RPM International Inc.

April 16, 2020 BBB/Stable BBB-/Stable Downgrade

Cornerstone Chemical Co.

April 16, 2020 B/Stable B-/Negative Downgrade

Cabot Microelectronics Corp.

April 16, 2020 BB/Stable BB/Negative Outlook revised to negative

Kraton Corp.

April 16, 2020 B+/Positive B+/Negative Outlook revised to negative

Calumet Specialty Products Partners L.P.

April 15, 2020 B-/Positive B-/Negative Outlook revised to negative

ASP Chromaflo Holdings L.P.

April 14, 2020 B-/Stable B-/Negative Outlook revised to negative

Polymer Additives Holdings Inc.

April 14, 2020 B-/Stable CCC/Negative Downgrade

H.B. Fuller Co.

April 13, 2020 BB+/Stable BB/Negative Downgrade

Aruba Investments Inc.

April 9, 2020 B-/Positive B-/Stable Outlook revised to stable

Methanex Corp.

April 9, 2020 BB+/Stable BB/Negative Downgrade

The Dow Chemical Co.

April 9, 2020 BBB/Stable BBB-/Stable Downgrade

TPC Group LLC

April 7, 2020 B/Watch Neg B-/Negative Downgrade

Eastman Chemical Co.

April 7, 2020 BBB/Stable BBB-/Stable Downgrade

Celanese US Holdings LLC

April 3, 2020 BBB/Stable BBB-/Stable Downgrade

Kronos Worldwide Inc.

April 3, 2020 B/Stable B-/Negative Downgrade

LyondellBasell Industries N.V.

April 3, 2020 BBB+/Negative BBB/Negative Downgrade

Trinseo S.A.

April 2, 2020 B+/Stable B/Negative Downgrade

DCG Acquisition Corp.

April 2, 2020 B-/Stable CCC+/Negative Downgrade

Tata Chemicals North America Inc.

March 31, 2020 B+/Stable B+/Watch Neg Ratings placed on CreditWatch negative

UFS Holdings Inc.

March 31, 2020 B-/Negative CCC/Negative Downgrade

DuPont de Nemours Inc.

March 27, 2020 A-/Watch Neg BBB+/Watch Neg Downgrade

Tronox Ltd.

March 27, 2020 B/Stable B/Negative Outlook revised to negative

Road Infrastructure Investment Holdings Inc.

March 27, 2020 CCC+/Stable CCC+/Negative Outlook revised to negative

Westlake Chemical Corp.

March 26, 2020 BBB/Stable BBB-/Stable Downgrade

AgroFresh Inc.

March 25, 2020 B/Stable B-/Watch Neg Downgrade

Hexion Inc.

March 25, 2020 B/Stable B-/Negative Downgrade

PPG Industries Inc.

March 24, 2020 A-/Negative BBB+/Negative Downgrade

Cabot Corp.

March 24, 2020 BBB/Stable BBB-/Stable Downgrade

Chevron Phillips Chemical Co. LLC

March 24, 2020 A-/Stable BBB+/Negative Downgrade

The Chemours Co.

March 20, 2020 BB-/Stable B+/Negative Downgrade

Momentive Performance Materials Inc.

March 13, 2020 BB-/Stable B+/Negative Downgrade

Olin Corp.

March 12, 2020 BB+/Stable BB/Negative Downgrade

Nexeo Plastics Parent Inc.

March 10, 2020 B/Stable B/Negative Outlook revised to negative
Source: S&P Global Ratings.

Some Offsetting Factors

Lower working capital requirements

Lower product and input prices in general translate into lower working capital requirements, and we believe cash flow generation at several companies could benefit. A caveat is that we are mindful of potential increases in receivables or supply chain problems that could offset much or all of the working capital gains.

Management actions to conserve cash

Some companies have taken steps and others have plans to cut expenses or cash outlays (or both) on items such as capital spending, shareholder buybacks, or other restructuring of costs. We think firms may consider other options, including cutting back on dividends in some instances. (We recognize cutting dividends is not commonplace, and may be especially challenging for company management to undertake.) Our view of the credit impact of these measures varies. Some of our considerations:

  • In general, we believe such measures help credit quality but do not entirely offset the negative impact of the downturn.
  • Such measures, especially those already executed, demonstrate management intent.
  • There are limits to the extent costs and cash outlays can be cut, and there may be other consequences.
Lower input costs

Lower input costs may help, but not sufficiently: We expect most input costs to decline in 2020. This includes inputs from basic feedstock such as ethane and propane to input for downstream chemical products. Ultimately, despite this credit-positive development, we expect the demand and product pricing decline will reduce EBITDA margins.

Comparison To 2008-2009

2020 will be more severe

We believe the ongoing recession will be deeper than the 2008-2009 recession in terms of demand declines for chemical companies. This is mainly because we expect a greater annual GDP contraction at approximately 5% in 2020. The previous annual trough was a 2.5% contraction in 2009. The greater GDP decline will translate into higher demand loss from end customers.

More widespread in impact

The demand downturn is more broadly spread across sectors. We believe more end markets will suffer, resulting in greater demand contraction for chemicals. Although the impact on the housing sector, which was particularly heavy hit in 2008-2009, is not expected to be as bad this time around, we believe other sectors such as transport, auto, and travel will be harder hit and offset the lower decline in housing. In the decade since the 2008-2009 recession, chemicals have become more ubiquitous, with a presence in a greater number of sectors. A broad-based recession in 2020 as we expect has contributed to a high proportion of investment-grade and specialty chemical downgrades to total downgrades relative to previous downturns.

Generally higher leverage

Leverage at chemical companies is generally higher at the start of this recession relative to the previous one. In fact, pre-recession debt to EBITDA at year-end 2018 was higher than at year-ends 2008 or 2009 at nearly 50% of the companies we rated then through 2018.

Improved cost structures

A potential partial mitigator to higher leverage is the improved cost structure at U.S.-based chemical companies. Either as a result of management actions or benefitting from developments such as the availability of low-cost gas, U.S. producers have worked to improve cost structures.

Greater role of China

China overtook the U.S. as the world's largest chemical market around the 2008 recession. The gap widened over the past decade in China's favor. China's role as a producer, exporter, and consumer of chemicals is becoming increasingly consequential for U.S. chemical producers. A stark example of this is the U.S. petrochemical sector, which has been ramping up domestic capacity with a clear eye on export markets. Global markets for most petrochemicals are driven by China's need to import them. Even when the U.S. doesn't directly export polyolefins to China, the price and demand for several such products/grades are influenced by China's imports of these products.

An Evolving Situation

We consider uncertainty in chemical demand and operating conditions a key credit risk in the evolving situation related to the COVID-19 pandemic. We believe the unprecedented nature of social restrictions and demand collapse in key end markets have not played out entirely, and expect the second quarter of 2020 will be the worst. The timing and extent of a recovery beyond that is still murky.

Our rating actions are based on key assumptions, some of which we discuss here. Our outlook distribution (Chart 2) indicates nearly half the issuer credit ratings have a negative outlook or are on CreditWatch negative, pointing to the direction in many instances of potential rating actions if our base-case expectations are not met. We will continue to test our assumptions, modify, or change them if necessary to reflect our views of the evolving situation, and reflect changes in future rating actions when appropriate.

Chart 2

image

Endnote

[1] We exclude in this calculation downgrades of companies with higher S&P Global Ratings EBITDA in 2020 versus 2019 because of one-time or inorganic events, including M&A. The increase in 2020 EBITDA in such instances is below our previous expectations.

Andrew Stafford and Daniel Marsh contributed to this report.

This report does not constitute a rating action.

Primary Credit Analyst:Paul J Kurias, New York (1) 212-438-3486;
paul.kurias@spglobal.com

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