BASF’s second profit warning highlights scale of the downturn now underway

The chemical industry is easily the best leading indicator for the global economy.  And thanks to Kevin Swift and his team at the American Chemistry Council, we already have data showing developments up to October, as the chart shows.

It confirms that consensus hopes for a “synchronised global recovery” at the beginning of the year have again proved wide of the mark.  Instead, just as I warned in April (Chemicals flag rising risk of synchronised global slowdown), the key  indicator – global chemical industry Capacity Utilisation % – has provided fair warning of the dangers ahead.

It peaked at 86.2%, in November 2017, and has fallen steadily since then. October’s data shows it back to June 2014 levels at 83.6%. And even more worryingly, it has now been falling every month since June. The last time we saw a sustained H2 decline was back in 2012, when the Fed felt forced to announce its QE3 stimulus programme in September.  And it can’t do that again this time.

The problem, as I found when warning of subprime risks in 2007-8 (The “Crystal Blog” foresaw the global financial crisis), is that many investors and executives prefer to adopt rose-tinted glasses when the data turns out to be too downbeat for their taste.  Whilst understandable, this is an incredibly dangerous attitude to take as it allows external risks to multiply, when timely action would allow them to be managed and mitigated.

It is thus critical that everyone in the industry, and those dependent on the global economy, take urgent action in response to BASF’s second profit warning, released late on Friday, given its forecast of a “considerable decrease of income” in 2018 of “15% – 20%”, after having previously warned of a “slight decline of up to 10%”.

I have long had enormous respect for BASF and its management. It is therefore deeply worrying that the company has had to issue an Adjustment of outlook for the fiscal year 2018 so late in the year, and less than 3 weeks after holding an upbeat Capital Markets Day at which it announced ambitious targets for improved earnings in the next few years.

The company statement also confirmed that whilst some problems were temporary, most of the issues are structural:

  • The impact of low water on the Rhine has proved greater than could have been earlier expected
  • But the continuing downturn in isocyanate margins has been ongoing for TDI since European contract prices peaked at €3450/t in May — since when they had fallen to €2400/t in October and €2050/t in November according to ICIS, who also reported on Friday that
    “Supply is still lengthy at year end in spite of difficulties at German sellers BASF and Covestro following low Rhine water levels”
  • The decline is therefore a very worrying insight into the state of consumer demand, given that TDI’s main applications are in furniture, bedding and carpet underlay as well as packaging applications.
  • Even more worrying is the statement that:
    “BASF’s business with the automotive industry has continued to decline since the third quarter of 2018; in particular, demand from customers in China slowed significantly. The trade conflict between the United States and China contributed to this slowdown.”

This confirms the warnings that I have been giving here since August when reviewing H1 auto sales (Trump’s auto trade war adds to US demographic and debt headwinds).

I noted then that President Trump’s auto trade tariffs were bad news for the US and global auto industry, given that markets had become dangerously dependent on China for their continued growth:

  • H1 sales in China had risen nearly 4x since 2007 from 3.1m to 11.8m this year
  • Sales in the other 6 major markets were almost unchanged at 23m versus 22.1m in 2007

Next year may well prove even more challenging if the current “truce” over German car exports to the USA breaks down,

INVESTORS HAVE WANTED TO BELIEVE THAT INTEREST RATES CAN DOMINATE DEMOGRAPHICS

The recent storms in financial markets are a clear sign that investors are finally waking up to reality, as Friday night’s chart from the Wall Street Journal confirms:

“In a sign of the breadth of the global selloff in stocks, Germany’s main stock index fell into a bear market Thursday, the latest benchmark to have tumbled 20% or more from its recent peak….Other markets already in bear territory are home to companies exposed to recent trade fights between the U.S. and China.

The problem, as I have argued since publishing ‘Boom, Gloom and the New Normal: how the Ageing Boomers are Changing Demand Patterns, again“, in 2011 with John Richardson, is that the economic SuperCycle created by the dramatic rise in the number of post-War BabyBoomers is now over.

I highlighted the key risks is my annual Budget Outlook in October, Budgeting for the end of “Business as Usual”.  I argued then that 2019 – 2021 Budgets needed to focus on the key risks to the business, and not simply assume that the external environment would continue to be stable.  Since then, others have made the same point, including the president of the Council on Foreign Relations, Richard Haas, who warned on Friday:

“In an instant Europe has gone from being the most stable region in the world to anything but. Paris is burning, the Merkel era is ending, Italy is playing a dangerous game of chicken with the EU, Russia is carving up Ukraine, and the UK is consumed by Brexit. History is resuming.

It is not too late to change course, and focus on the risks that are emerging.  Please at least read my Budget Outlook and consider how it might apply to your business or investments. And please, do it now.

 

You can also click here to download and review a copy of all my Budget Outlooks 2007 – 2018.

BASF warns on outlook; Dow warns on China, ethylene cycle

ACC Jul5BASF and Dow Chemical both warned on the outlook when presenting their H1 results last week:

  • BASF CEO Kurt Bock warned, “We have for second quarter in the row in chemicals no growth worth mentioning . . . that is not a gratifying development.  We have the impression that there is little growth dynamic at the moment and our customers remain extremely cautious about building up inventories.”
  • Dow CEO Andrew Liveris warned, “”China remains a mixed bag. A very solid Q2 for us is not necessarily a harbinger of Q3“.  And he went on to add, “This is not yet a [peak of the ethylene] cycle discussion, but it’s starting to mimic one with outages.

Equally, as Reuters note:  ”Dow has benefited from cheap U.S. shale gas.  This cheap fuel had given Dow a cost advantage over its European rivals dependent on crude oil-derived naphtha. But with crude prices slipping, that advantage is now eroding.”

Both major companies are thus confirming the message of the chart above, based on American Chemistry Council data.  This shows that global capacity utilisation (CU%) in May was just 83.5%.  Equally worrying is that the economic recovery created by the start of the stimulus programmes in 2009-10 has clearly weakened.  As a result, average CU% levels are down by nearly 10% – from an average of 93.4% between 1987 – 2008, to just 84.5% since 2009.

One key issue is that the recent rally in oil prices, and the major problems with force majeures, have not caused prices to increase further down the value chain. This confirms the underlying weakness in the market, as consumers are not able to pass through today’s higher prices to their customers.

China’s change of economic direction under its New Normal policies is, of course, the catalyst for this downturn. In the longer-term, this should be extremely positive.

But unwinding the problems of the past will be [painful in the short-term.  The Bank of England has already warned that China’s GDP growth may fall to 1.7% in Q4.   And whilst clearly some areas of the economy, such as the mobile internet, will likely continue to do well, it would be no surprise at all if China’s real GDP growth hit zero next year.

WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 47%
Naphtha Europe, down 47%. “Abundant naphtha supply (up 15%in June versus 2014) continues to exert pressure on prices”
Benzene Europe, down 39%. “Players noted that several fundamental factors are likely to weigh down on the market in the coming weeks”
PTA China, down 37%. “Producers continue to face squeezed margins in the market and low demand from polyester makers.”
HDPE US export, down 21%. “Trading was thin as buyers waited to see how low oil prices will drop.”
¥:$, down 21%
S&P 500 stock market index, up 6%

World Aromatics and Derivatives Conference next week

Aromsa Nov14Our 13th annual World Aromatics & Derivatives Conference takes place in Berlin next week.  Jointly organised as always by International eChem and ICIS, it features a must-hear list of speakers:

  • ExxonMobil:  Europe Business Director Tim Stedman will give a global market overview
  • Dow Chemical: Global Business Director Pieter Platteeuw will discuss the future for benzene
  • BASF: Business Manager Klaus Ries will look at the styrene value chain
  • Shell: General Manager Elise Nowee will ask the question, “What about Europe?”

In addition, we will benefit from expert presentations on key issues:

  • International Energy Agency:  Analyst Fabian Kesicki will present the IEA’s energy outlook to 2035
  • BMW: Senior Researcher Peter Phleps will look at how Mobility trends will impact car markets
  • Nexant: Global Manager Stewart Hardy will focus on the outlook for paraxylene and polyester
  • VCI: Senior Economist Christian Buenger will analyse global economic megatrends
  • Biorizon: Business Development manager Florian Graichen will look at opportunities in the bio area
  • ICIS price reporters Rhian O’Connor and Rob Peacock will highlight toluene and phenol/acetone developments

I will also be giving a presentation discussing the likely impact of the Great Unwinding of policymaker stimulus on the industry.

As the chart above highlights, chemical markets suggest a major economic slowdown is underway, caused by China’s new policies.  We are therefore in the New Normal world of slow demand growth and deflation.  How can companies create new markets for the future?

Full details of the agenda and registration details can be found by clicking here.

“BASF slashes 2015 targets on slowing global growth”

ACC OR Oct14a

BASF, the world’s biggest chemical maker by sales, has slashed its revenue and earnings targets for 2015, following a further weakening of the European economy and a slowdown in China.”

Saturday’s Financial Times headline said it all.  BASF’s statement adds to the growing evidence of a major slowdown taking place in the global economy, and highlights how recovery seems as far away as ever.

Latest data from the American Chemistry Council also confirms that hopes for a recovery are fading.  It showed no increase in Capacity Utilisation in the global chemical industry.  In fact, as the chart shows, the rate fell 0.1% to 83.2% in September and remains well below the historical average of 92%.   As the ACC note:

Gains in production were centered in North America (aided by the shale gas revolution) with nominal gains in Central & Eastern Europe and Asia-Pacific. Over the same period, chemical industry production contracted elsewhere.”

Next Monday, I will publish my annual Budget Outlook.  And so as usual, today’s post looks back at last year’s Budget Outlook.  Past performance may not be a perfect guide to the future, but it is the best we have.  All previous Budget Outlooks are also now available in a new Research Note – please click here to download a free copy.

A quick summary of the Budget Outlooks since they began in 2007 is as follows:

•The 2007 Outlook ‘Budgeting for a Downturn‘, and the 2008 ‘Budgeting for Survival’, forewarned readers of the coming Crisis, when most expected the good times to continue
• 2009′s ‘Budgeting for a New Normal’ was then more positive than the consensus, suggesting “2010 should be a better year for the chemical industry, as demand grows in line with a recovery in global GDP“
• The 2010 Outlook was titled ‘Budgeting for Uncertainty’. This introduced the concept of Scenario planning, to help deal with “today’s increasingly uncertain New Normal environment.”
• 2011 was titled ‘Budgeting for Austerity’.  It anticipated weak growth across Europe as a result of the austerity measures being introduced, and disappointing global growth, whilst arguing that major new opportunities were opening up as a result of changing demographic trends.
2012 was titled ‘Budgeting for an L-shaped recovery’, arguing that the idea of a recovery back to SuperCycle levels of growth would prove wishful thinking.  This was again a contrarian view, as policymakers at the time were insistent that full recovery was now inevitable, if slightly delayed.

Reading back through last year’s 2013 forecast, ‘Budgeting for a VUCA world’, it is also hard to find much that one would wish to change today.  Most of the key issues that it highlighted have now become more widely accepted, although they were controversial at the time:

  • Its argument about the negative impact of policymaker stimulus and the risks of a “boom-bust cycle” in emerging economies are now the subject of major political debate
  • Oil and commodity prices have, of course, also tumbled as forecast, whilst the impact of China’s new economic policies is clearly now a major concern
  • Even those issues which have been less prominent are starting to attract attention again
  • Few now believe the Eurozone crisis has been solved
  • US political dysfunction seems likely to move centre stage again after next week’s US mid-term elections

So all in all, companies would have had few surprises had they followed this Outlook.  And “no surprises” is always the key for a successful Budget.  It creates a positive dialogue with investors and allows employees to execute agreed plans without sudden panics setting in.

I hope readers found the 2013 Budget Outlook helpful in making their own plans.  Encouraged by this latest success, the Budget Outlook for 2015-17 will be published next week.

 

WEEKLY MARKET ROUND-UP
The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
PTA China, down 24%. ”End users were citing difficulties in passing down such additional costs to their customers, on the back of relatively weak global macroeconomic conditions”
Naphtha Europe, down 21%. “Demand from outlets such as the Asian export market remains weak, and consequently naphtha supply in Europe remains long.”
Brent crude oil, down 18%
Benzene Europe, down 11%. “Traders pointed to shutdowns across Europe keeping supply tight.”
S&P 500 stock market index, up 1%
HDPE US export, up 4%. “Prices remained unchanged – or unworkable, as one trader described them. Other sources agreed, describing a big difference between US prices and lower international levels.”

 

BASF worries about China, India

Martin Brudermuller.pngBASF opened its first China plant 20 years ago. Its Asian strategy focuses on China, Japan, S Korea and India.

Thus yesterday’s comments by vice chairman Martin Brudermüller deserve careful study by any company or investor who is interested in the outlook for the region.

The background was an unexpected 5% fall in BASF’s regional sales in Q1. Of course, Q1 2011 had been very strong, as buyers built stocks whilst crude oil prices rose. But crude also rose in Q1 this year, so clearly something else has been happening.

Brudermüller suggested that “the region is becoming more vulnerable”, and highlighted two key issues, which will both be familiar to blog readers:

China’s political direction. He expressed a “certain amount of unease” over the leadership transition now underway, and added that “the struggle over China’s future direction seems to be harder fought than we had imagined.”
India’s slowdown. “The political paralysis in certain areas does hold things up, and its sad to see how the country is currently falling short of its potential.”

BASF is not about to retreat from the Asian positions it has worked so long to develop. And it continues to consider further expansion in SEA, even into Myanmar, as part of its next leg of growth.

But when BASF worries about something, then the blog worries with it.