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Credit FAQ: Europe's Chemical Sector Feels The Chill In A Cooling Economy

Softening demand is weighing on European chemical companies' performance amid the global economic slowdown and high inflation. Persistently high interest rates will also eat into cash flows and result in refinancing risks, especially for lower-rated companies. In S&P Global Ratings' view, margin resilience, earnings quality, and financial policy are important for maintaining rating headroom. Below, we address frequently asked questions on the sector's performance and our expectations for 2023 and 2024.

Frequently Asked Questions

What are the key drivers behind European chemical companies' recent profit warnings?

We have seen a series of profit warnings and downward revisions of full-year guidance in the European chemical sector including Lanxess (unrated), Clariant AG (BBB-/Positive/A-3), Evonik Industries (BBB+/Stable/A-2), BASF SE (A-/Stable/A-2), ICL Group Ltd. (BBB-/Stable/--), and K+S AG (BBB-/Stable/A-3). This is mainly due to broad demand weakness across various regions and end markets--including even typically resilient ones like health and personal care--exacerbated by longer-than-expected customer destocking. In comparison to the V-shaped recovery after the COVID-19 pandemic, we have observed steady demand weakness since second-half 2022.

A slower-than-expected economic recovery and significant drop in consumer confidence amid high inflation have led to subdued demand. This slowed global industrial production and resulted in stagnant global chemical production in first-half 2023. In addition, heightened macroeconomic uncertainty and decreasing raw material prices have spurred extended destocking in the chemicals value chain since second-half 2022. According to Verband der Chemischen Industrie (VCI; association of the chemical industry), German chemical production declined roughly 11% in first-half 2023 after a 12% drop in full-year 2022. Although the business climate and chemical industry expectations in Germany improved slightly in July, according to Ifo Institute, both indicators remain clearly negative, stressed by lowered export expectations. Capacity utilization also reduced to 75.2% in July 2023 from 81.2% one year ago, considerably below the normal range of 82%-85%.

Chart 1


Commodity chemicals companies have been suffering from severe downward pressure on volumes, pricing, and margins since second-half 2022. This comes at a time when new industry capacity--mainly in Asia and, to a lesser extent, in the Americas--is coming online at a pace far surpassing current soft demand. Specialty chemicals players also face headwinds across end markets like construction, consumer goods, industrial manufacturing, agriculture, and animal nutrition. Moreover, we think demand might start to soften in the auto end market over the next six-to-12 months, after recent resilience due to a still-healthy order backlog. Fertilizer prices, especially for potash and phosphate, have also declined sharply versus the record highs seen in 2022 due to demand destruction and weather-related yield impacts in North America, notwithstanding the structural supply shortfall following the Russia-Ukraine war.

What is your outlook for the European chemical sector?

We anticipate chemical companies' volumes and margins will remain constrained in second-half 2023. Despite continued high macroeconomic uncertainty and modest GDP growth, we then assume demand will moderately improve in 2024, since most customer industries have reduced their chemicals inventories to a low level. However, the timing and magnitude of the turning point are highly uncertain. For fertilizers, all else being equal, we anticipate 2023-2024 prices for potash and phosphate will decline to below 2021 averages, but clearly above those over 2017-2020. Industrial gases companies are among the few for which we continue to foresee healthy earnings growth in 2023-2024 given their nondiscretionary products, long-term contracts with take-or-pay clauses, and the highly consolidated and geographically diversified nature of the industry.

In addition, most European chemical companies we rate are implementing and/or reinforcing cost control measures and efficiency improvements to safeguard earnings, which will contribute to cost savings from 2023 and ramp up in 2024. For example, BASF initiated extensive cost-saving programs in early 2023 with a focus on Europe and a large headcount reduction, from which it expects to achieve annual cost savings of more than €300 million by year-end 2023 and more than €500 million by year-end 2024. Evonik is also targeting cost savings of €250 million in 2023 through strict contingency measures and another €100 million in 2024 and €200 million in 2025 through improving the cost position and capacity utilization of its methionine assets. Moreover, we expect working capital reductions will support free operating cash flow (FOCF) amid eased supply chain disruptions and declining raw material prices.

On average, we forecast S&P Global Ratings-adjusted EBITDA for our rated European chemical companies (excluding fertilizers) will decline roughly 14% in 2023, followed by a recovery of about 10% in 2024 (see chart 2). While an average decline of 14% in 2023 appears moderate in the context of first-half results across the industry, the range is much wider and depends on company-specific factors. For most large chemical companies with adjusted EBITDA above €1 billion (excluding industrial gases and fertilizer companies) we expect S&P Global Ratings-adjusted EBITDA to decline 20%-30% in 2023. EBITDA margins will also slightly decline in 2023 after a significant reduction in 2022 due to much higher input costs, followed by a moderate recovery in 2024, helped by gradually returning demand and realized benefits from cost-cutting measures. We note that fertilizer companies reported record EBITDA growth in 2022 due to extremely high prices, which have continued to normalize this year.

Chart 2


How competitive is the European chemical sector?

Exchange traded prices for electricity and gas peaked during 2022 due to curtailed supply from Russia, which led to much higher input costs for most European chemical companies and negatively affected margins. Many companies, especially those in specialty chemicals, have been able to pass most cost increases on to customers so far. However, this might change with softening demand and gradually decreasing raw material prices--putting more pressure on pricing.

Although energy prices have reduced significantly this year, we expect them to remain relatively high compared to historical levels. Increased energy prices; limited access to low-price gas feedstock in contrast to U.S. or Middle East producers; lower growth prospects; and rising carbon dioxide (CO2) costs in Europe have resulted in higher production costs. This has left European chemical companies at a competitive disadvantage and we expect the gap in margins to industry peers with production footprints more focused on the U.S. or Middle East will remain given continued higher energy costs.

Chart 3


As a result, we have already seen capacity utilization in the German chemical industry decline since July 2022, to about 75% now, with an increasing gap to the normal range of 82%-85%. In addition, there have been temporary and permanent shutdowns of inefficient plants in Europe's chemical sector, which we expect to continue. For example, BASF is engineering structural and process alterations for its Verbund site in Germany and closing plants in the TDI complex and in the ammonia and adipic acid value chains, which are energy and CO2 intensive.

Among our rated chemical companies in Europe, Ineos' Project One is the only green-field petrochemical complex under construction, a €4.0 billion investment into a new ethane cracker in Antwerp to be completed in 2026. Strategic benefits include that the cracker would allow the company to use its U.S. ethane feedstock, which currently has a better cost position relative to European peers relying on naphtha. It would also replace an external supply of ethylene with a cheaper, internal source. However, we note that the environmental permit for Project One has been annulled, despite being planned as one of the most energy-efficient ethane crackers in Europe with relatively low carbon emissions. The company is reviewing its options and plans to regain its permit to resume work on the site. Similarly, the pre-production of cathode materials at BASF's plant in Finland has been blocked by the Finnish judiciary for environmental reasons. These examples highlight the high environmental requirements and regulatory concerns for building new chemical plants in Europe.

The U.S., by contrast, has adopted a more incentive-based approach to encourage investment in low-carbon solutions, which could benefit chemical companies. The U.S. Inflation Reduction Act's subsidies and incentives may shift production to the U.S. for tax reasons, emphasizing the EU's competitiveness concerns amid pressure from energy price differentials triggered by the Russia-Ukraine war.

The conflict has highlighted the need for European chemical companies to diversify their energy sources and reduce dependence on Russian oil and gas. This, alongside regulatory requirements to reduce CO2 emissions, is accelerating the transition to green energy in Europe and driving increased investments to lower the CO2 intensity of operations. However, it is a challenge for the industry and from a credit perspective because higher capital expenditure (capex), especially for the switch to renewables, is needed to keep up with Europe's energy transition and the long-term target of carbon neutrality. Fast movers will reap the benefits, with an improved environmental footprint contributing to higher operating efficiency and stronger positioning in sustainability-related technologies in the long term. That said, FOCF will be constrained by the significant related capital outlays in the interim.

Which rated European chemical companies have limited rating headroom and are therefore vulnerable to challenging market conditions?

We have identified several companies with limited headroom compared to our downside triggers, leaving the ratings vulnerable if market conditions are weaker than we expect (see table 1).

Table 1

List of European chemical companies with limited headroom*
Company Long-term rating Outlook Business risk profile Financial risk profile Downside triggers S&P Global Ratings' forecast

Akzo Nobel N.V.

BBB Stable Satisfactory Intermediate FFO to debt of <30% FFO to debt of 23%-27% in 2023, improving to 28%-32% in 2024

Draslovka Holding A.S.

B Negative Weak Highly Leveraged Debt to EBITDA of >9x incl. PECs or >6x excl. PECs Debt to EBITDA of 7.5x-8.5x (< 6.0x excl. PECs) in 2023 and 7.0x-8.0x in 2024

Envalior Finance GmbH

B Stable Fair Highly Leveraged Debt to EBITDA of >8x incl. PECs (>7.5x excl. PECs) by 2024 Debt to EBITDA of nearly 9.0x in 2023 (8.5x excl. PECs), improving to <8.0x in 2024 (<7.5x excl. PECs)

Herens Midco S.a.r.l. (Arxada)

B- Stable Fair Highly Leveraged Siginificant deterioration in liquidity due to negative FOCF or further increase in leverage Debt to EBITDA of >10x in 2023 and >8.5x in 2024, negative FOCF in 2023 and slightly positive in 2024

Ignition Topco B.V. (IGM Resins)

CCC Stable Weak Highly Leveraged Inability to cover liquidity needs and refinance debt Negative FOCF of €30 million-€35 million in 2023, and broadly neutral in 2024; debt to EBITDA 9.0x-9.5x in 2024

Nitrogenmuvek Zrt.

B Negative Weak Aggressive Debt to EBITDA of >5x, or FOCF <HUF10 billion Debt to EBITDA of 4.9x-5.1x in 2023, improving to 3.2x-3.4x in 2024; negative FOCF in 2023, strengthening to >HUF10 billion in 2024

Rohm HoldCo II GmbH

B- Stable Fair Highly Leveraged Unsustainable capital structure or deteriorated liquidity Debt to EBITDA of 9.0x-9.3x in 2023, down to 6.4x-6.9x in 2024; negative FOCF in 2023, around breakeven in 2024

Root Bidco S.a.r.l. (Rovensa)

B Negative Fair Highly Leveraged Debt to EBITDA of >7x or FOCF remains negative Debt to EBITDA of 7.1x-7.3x in FY2024 (ended June 2024) and further to <7.0x in FY2025; FOCF turning positive from FY2024

Sika AG

A- Negative Strong Intermediate FFO to debt of <35% by 2024 FFO to debt of 30%-35% in 2023, improving to >40% in 2024

SK Neptune Husky Intermediate IV S.a r.l. (Heubach)

B- Negative Weak Highly Leveraged Debt to EBITDA of >8x for prolonged period or liquidity pressure Negative EBITDA in 2023 due to high one-off costs, double-digit leverage in 2024, negative FOCF in 2023-2024

Synthomer PLC

BB Negative Fair Significant Debt to EBITDA of >4.0x Debt to EBITDA of 5.5x-6.0x in 2023 pro forma the proposed rights issue, down to 3.6x-3.8x in 2024
*We do not take into consideration potential mitigators like planned asset disposals or capital increases because uncertainty is typically high for the timing and proceeds of these transactions. FFO--funds from operations. FOCF--Free operating cash flow. HUF--Hungarian forint. PECs--Preferred equity certificates. All metrics as adjusted by S&P Global Ratings.
What are the key differences in headroom for European chemical companies rated investment grade (BBB- and above)?

Margin resilience, quality of earnings, and financial policy are important for maintaining adequate rating headroom in the current challenging market environment.

Despite a more than 12% decline in volumes, Solvay S.A. (BBB/Negative/A-2; negative outlook driven by pending group split) increased its underlying EBITDA and margin in first-half 2023. Imerys SA (BBB-/Stable/--) also maintained relatively resilient margins in the first half. Besides continuous cost discipline, this was thanks to sustained pricing power, reflecting earnings and portfolio quality. Both companies have leading market positions in high-value innovative specialty products with healthy market fundamentals--for example linked to the transition to electric vehicles and higher resource efficiency. This helps them generate premium margins and mitigate earnings pressure from overall challenging market conditions.

We lowered the ratings on BASF to 'A-/Stable/A-2' from 'A/Negative/A-1' in early August because we anticipate its leverage will increase in 2023, given weaker demand and lower earnings, and remain elevated in 2024 due to peaking capex. The downgrade also reflects the competitive disadvantages of BASF's European production assets due to high energy prices and CO2 costs in Europe.

While we expect a more than 30% decline in EBITDA for Evonik and a more than 70% decline for K+S in 2023, we still forecast adequate rating headroom for both companies. This is mainly supported by their strong balance sheets and cautious financial policies, as evidenced by preservation of sufficient headroom ahead of potential market downturns. Evonik's adjusted funds from operations (FFO) to debt has remained above 30% since 2017 including a challenging 2020. We upgraded K+S to 'BBB-/Stable/A-3' from 'BB+/Positive/B' in June, factoring its very cautious financial policy and a material drop in gross financial debt. This has resulted in much less volatile credit metrics despite the unchanged cyclicality of the industry and the company's high vulnerability to potash prices fluctuations.

In contrast, despite an increase in full-year guidance for 2023 and gradually improving credit metrics, we expect Akzo Nobel N.V.'s rating headroom will remain very limited in the next 12-18 months due to elevated leverage. This stems from the significant earnings decline in 2022 and higher debt to finance the build-up of working capital, generous share buybacks, and large mergers and acquisitions (M&A) in past years--the key reason for the downgrade to 'BBB/Stable/A-2' from 'BBB+/Stable/A-2' in November 2022.

Our negative outlook on Sika AG is driven by temporarily elevated leverage due to the debt-funded acquisition of MBCC Group. Despite challenging macroeconomic conditions, we anticipate that Sika's resilient operating performance in 2023-2024, along with the early redemption of its convertible bond, will lead to improved credit metrics. This includes adjusted FFO to debt returning to above 35% in 2024, which is commensurate with the rating.

On average, we forecast S&P Global Ratings-adjusted FFO to debt will decline more than 30% for investment-grade European chemical companies in 2023, and recover only modestly in 2024 (see chart 3).

Chart 3


What are the key risks for European chemical companies rated speculative grade (BB+ and below)?

Lower earnings under current challenging market conditions will lead to higher leverage. High energy costs are also hitting the cost competitiveness of companies with production concentration in Europe. In addition, persistently high interest rates will eat into cash flow, which could reduce companies' capital allocation options and make them more vulnerable to operational challenges. This could even result in potential liquidity pressure and refinancing risks, especially for lower-rated companies. Prevailing interest rates of 8.5%-10.0% for 'B' category refinancing transactions in the chemical sector so far in 2023 mean an average increase of 300 basis points (bps)-400 bps compared with 2021, when debt was priced at historically low levels. Therefore, selected companies rated 'B-' and below will have to lower their debt quantum to maintain a sustainable capital structure.

SK Neptune Husky Intermediate IV S.a r.l. (Heubach) has been suffering from not only weak demand and customer destocking, but also cost disadvantages given its mostly Europe-based production footprint with energy costs 30%-50% higher than those of U.S. and Asian peers, according to the company. As a result, Heubach's commoditized products face intense competition from low-cost producers in China and India, leading to continuous margin pressure. In addition, high costs related to the integration of the acquired Clariant Pigments business have weighed on performance and the realization of synergies has been delayed in the current challenging market environment. We expect leverage to remain very high and S&P Global Ratings-adjusted EBITDA to remain negative in 2023, indicating minimal headroom under the current 'B-/Negative/--' rating.

We revised the outlooks to negative on Synthomer PLC (BB/Negative/--) in March and Root Bidco S.a.r.l. (Rovensa; B/Negative/--) in July due to elevated leverage resulting from weak demand, customer destocking, cost pressures, and supply chain disruptions. Like many companies in the 'B' rating category, we expect current higher interest rates and the larger debt load to finance acquisitions will lead to Rovensa's interest expenses almost doubling from fiscal 2024, reducing cash conversion in the future.

The negative outlook on Nitrogenmuvek Zrt. factors in the company's ongoing negative FOCF driven by very high working capital outflows, increased capex, and elevated leverage in 2023 given a sharp decline in fertilizer prices. However, normalizing gas prices and supportive demand should support improving performance and credit metrics in 2024.

Draslovka Holding A.S. was severely affected by very high natural gas prices in Europe, with production curtailment and weak demand from key mining customers in the U.S. owing to much higher input costs in 2022. The negative outlook reflects the peak in our adjusted debt to EBITDA to 10.1x (7.3x without preferred equity certificates [PECs]), indicating minimal headroom given our expectation of below 9x leverage (above 6x excluding PECs) for the rating. Unlike other chemical companies, we expect performance has already bottomed out and EBITDA will return to normalized levels in 2023, which will lead to 7.5x-8.5x debt to EBITDA (comfortably below 6.0x without PECs).

Low market demand, combined with continued competitive pressure from Chinese players, underutilization of plants, and significant exceptional expenses related to the turnaround and ramping-up of a new facility in China, are depressing EBITDA at Ignition Topco B.V. (IGM Resins) and turning FOCF negative this year. We lowered the rating to 'CCC/Stable/--' from 'CCC+/Stable/--' in July because we forecast a rising likelihood of a covenant breach and increased risk of a debt restructuring, given the revolving credit facility and term loan maturities in December 2024 and July 2025, respectively.

Subdued demand--especially in the personal care, hygiene, and nutrition markets--is pressuring Herens Midco S.a.r.l. (Arxada)'s operating results with EBITDA (as adjusted by the company) down 32% in first-half 2023. In addition, still-high separation costs from the carve-out from Lonza Group Ltd. and the integration of acquisitions will continue to weigh on earnings this year. The recently completed divestment of the hydrazine business will improve liquidity buffers, mitigating pressure on the 'B-/Stable/--' rating despite very high leverage.

We also view the headroom under the 'B-/Stable/--' rating on Rohm HoldCo II GmbH as limited. We expect its performance will remain weak in 2023 given difficult market conditions, and leverage will increase to above 9x adjusted debt to EBITDA. We note that the high leverage and negative FOCF this year was also driven by its large investments in new capacity (LiMA project), which will come on stream next year. Combined with the Polaris acquisition, this will contribute to a more than 40% increase in EBITDA and swift deleveraging in 2024.

New ratings like Envalior Finance GmbH with high starting leverage--adjusted debt to EBITDA estimated at almost 9.0x in 2023 (roughly 8.5x without PECs)--and large exposure to cyclical end markets are facing risks of slower-than-expected deleveraging. Demand and EBITDA growth is likely to fade in the next 12-18 months amid slowing economic growth, especially in historically fast-expanding regions like China.

Similarly to lower-rated chemical peers, Fire (BC) S.a r.l. (Italmatch; B/Stable/--) managed to refinance its 2024 maturities earlier this year at a higher interest rate (€300 million, 2028 notes at 10% and €390 million, 2028 floating rate notes at 5.5%).

Nouryon Holding B.V., which has comfortable headroom under our 'B+/Stable/--' ratings, raised a $750 million incremental term loan and completed an amendment and extension of its term loans totaling $4.2 billion at Euro Interbank Offered Rate +4.25% and Secured Overnight Financing Rate +4.0% margins in first-half 2023.

The negative outlook on recently upgraded OQ Chemicals International Holding GmbH (B+/Negative/--) reflects the refinancing risks for its €475 million tranche B1 and $500 million tranche B2 term loans due in October 2024 despite the potential of parental support.

On average, we expect debt to EBITDA will increase to about 5.2x, which is a similar level to 2020, for speculative-grade European chemical companies. It should then reduce next year to slightly above 2022 levels of about 4.6x. Interest coverage will significantly weaken in 2023, before increasing in 2024, but remain clearly below 2019-2022 levels, reflecting persistently higher interest rates.

Chart 4


Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Wen Li, Frankfurt + 49 69 33999 101;
Secondary Contact:Paulina Grabowiec, London + 44 20 7176 7051;

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