Higher costs have had a negative impact on margins recently for many chemical companies. PPG Industries, a coatings manufacturer, stated its costs were rising at the fastest pace in two years. Increases in raw material costs and higher freight costs are driving the cost increases. Sherwin Williams, one of PPG’s competitors, raised the price of paint even while reporting a decline in Do-It-Yourself demand. PolyOne, a producer of specialty plastic compounds and colorants, was consistent in reporting higher raw material and freight costs. PolyOne also experienced an abrupt demand slowdown with certain customers delaying orders at the end of September 2018, citing concerns over tariffs, rising input costs, and weaker consumer demand. Building and construction, appliances, and Asian sales are the markets that PolyOne pointed to as driving the reduction in demand.
The chemical industry is coming off a period of significant tailwinds aided by global economic growth, low interest rates, and a natural gas feedstock advantage. The tailwinds have turned to headwinds, however, with rising interest rates and a reduced feedstock advantage due to increases in the cost of Ethane. Additionally, global demand is softening and chemical manufacturers around the world have begun to reduce production levels. Tariffs are playing a role in the market uncertainty, especially as it relates to demand and production rates in China. Tariffs on $250 billion in Chinese imports into the U.S. are in place, and on January 1, 2019, $200 billion of the affected imports are scheduled to increase from 10% to 25%, bringing the rate to 25% for all products. For plastics and chemical products, the tariffs impact approximately $16 billion in products imported from China and $11 billion in U.S. exports. Approximately 45% of the tariffs on Chinese imports relate to finished plastics products. U.S. export tariffs have a significant impact on bulk chemicals like polyethylene, styrene, polypropylene, and monoethylene glycol.
Many chemical companies are projecting a challenging fourth quarter in 2018 as well as a challenging environment in 2019. Increased costs are already putting pressure on margins, which will continue to decline if demand and operating rates drop further. The ultimate impact of the tariffs on the chemical industry will need to be monitored. Currently they are playing a large factor in market uncertainly, especially since the impact of the trade war is still unknown.
Chemical companies in general experience strong inventory valuation recovery rates, especially for finished goods, which generally exhibit strong turnover. In the case of inventory valuations and chemical companies, lower margins can have a material impact on recovery rates and should be monitored for any further deterioration.
Kevin Duffy is a Senior Valuation Director who specializes in the plastics and chemicals industries. He has valued numerous plastics and chemical-related companies in North America that are involved in distributing, compounding, and manufacturing chemicals, resins, films, sheets, and molds. Kevin received his B.A. in finance from Illinois State University,
and passed the CPA exam in Illinois. Kevin has diverse business experience in accounting, manufacturing, distribution, and retail.