Solid Operating Performance In 2021 And Early 2022 Has Created A Ratings Buffer

Following the weak operating environment in 2020 due to the COVID-19 pandemic, which resulted in negative rating actions, S&P Global Ratings upgraded several chemical companies in 2021 amid faster-than-expected commodity price recovery, supported by strong global demand and supply disruptions. This positive momentum continued into early 2022, with most companies reporting strong first-quarter, and in some instances strong second-quarter results. Companies have also focused on using a portion of their excess cash toward absolute debt reduction, which should lend support to their credit measures even in a weak operating environment. We believe this has created a ratings buffer for most global chemical companies we rate, with close to 80% in this group having stable outlooks.

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Rating Activity In The First Half Of 2022 Has Been Largely Positive

Positive rating actions have been primarily spurred by continued stronger operating performance and balance-sheet strength. Although positive rating actions on the speculative-grade issuers have been spurred by stronger credit metrics; upgrades on the investment-grade issuers have been focused on companies that have prioritized gross debt repayment.

In early 2022, commodity producers continued to benefit from strong demand, enabling chemical companies to more than offset escalating raw material costs through increased prices. Based on their stronger earnings and credit measures, we revised the outlook to positive from stable on petrochemical producers Westlake Corp. (BBB/Positive/--) and Dow Chemical Co. (BBB/Positive/A-2). Dow has also been focused on absolute debt repayment (repaying about 15% of its total debt in 2021) and expects to pay down further in 2022, which will benefit its credit profile. Debt reduction was also one of the key drivers in revising the outlook on Olin Corp. (BB+/Positive/--) to positive from stable, as the company had repaid approximately $1.1 billion in 2021 (about 30% of gross debt). We also upgraded NOVA Chemicals Corp. to 'BB' from 'BB-' and methanol producer Consolidated Energy Ltd. to 'BB-' from 'B+'. The outlook on both companies remained stable.

In addition, we took positive rating actions on agricultural companies Nutrien Inc. (BBB/Positive/--), LSB Industries Inc. (B/Stable/--), K+S AG (BB/Stable/B), and OCI N.V. (BBB-/Stable/--), all of which continue to benefit from robust fertilizer prices that have been on an upward trajectory since 2021 and accelerated in 2022 due to supply shortfalls resulting from the Russia-Ukraine conflict. Export restrictions from Russia and sanctions on Belarus (together 40% of the global potash volumes) have, in our view, created a structural shortfall in supply, benefitting potash producers such as Nutrien and K+S. The positive rating actions on these producers also factored in meaningful debt reduction, with Nutrien having repaid US$2.1 billion in 2021 (20% of reported debt) and K+S' gross debt declining by more than €2 billion from asset sale proceeds.

We also upgraded two cross-over credits Huntsman Corp. and OCI N.V. to investment-grade, the latter benefitting from strong nitrogen prices due to higher feedstock prices (namely natural gas) and production curtailments in Europe because of natural gas shortages. OCI has also been focused on gross debt reduction and committed to maintaining leverage below 2x across the commodity cycle. Not only has Huntsman reduced gross debt in 2021 (about 25% of reported debt), the company has also strengthened its business risk profile by improving the business mix, transitioning toward a specialty focused company and maintaining a lower cost base. This combined effort has allowed the company to improve its EBITDA margins, and we believe it can maintain them at least in the mid-teens percentage area.

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Notwithstanding some positive rating actions in the first half of 2022, we believe that momentum has plateaued and expect some downside pressure in the second half of this year and into 2023. Chemical companies are still contending with supply-chain challenges and volatile raw material costs, with an oversupply situation on the horizon. In our view, operating rates and margins for petrochemical companies will likely weaken in the second half of 2022 and into 2023 due to softening demand and meaningful new capacity additions. Regardless, our current expectation is that most companies will maintain appropriate credit metrics for the ratings. Financial policy decisions will be key for S&P Global Ratings' analysis in terms of how issuers deal with a more challenging macroenvironment.

Inflationary Cost And Supply-Chain Headwinds Are Creating Credit Pressures For U.S. Chemical Companies

More recently, we have taken negative rating actions in the U.S. chemical sector, especially on specialty companies more sensitive to margin weakness from inflationary cost pressures and supply-chain issues amid a looming recessionary scenario, which S&P now estimates at 45%, with further downside in 2023. Key raw materials producers use include olefins, natural gas, and caustic soda, the prices for which have increased significantly over the past 12 months. While Henry Hub natural gas prices have subsided from their peak levels of US$9.00 per mmBtu in August 2022, they are still trading at higher levels, at about U$8.3 per mmBtu on Sept. 12, 2022, almost twice the level seen in the same period in 2021. Most producers have implemented price increases; however, this will not be sufficient to offset the significant inflation cost. For instance, Diamond (BC) B.V., a supplier of hygiene and cleaning chemicals, expects direct product costs to increase 28% in 2022 compared with 2021. Others have cut their EBITDA guidance. Trinseo Plc, which manufactures and markets latex and plastics, has cut its EBITDA guidance by US$100 million (a 15%-20% decline) due to the company's exposure to the challenging European market (which accounted for 57% of net sales in 2021). At the same time, historically low unemployment rates are also keeping labor costs high. Accordingly, we believe 2022 margins will remain stressed for these companies and could weaken by an average of 250 basis points compared with 2021 levels.

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Natural Gas Supply Risk Is A Key Concern For European Chemical Producers

Rating actions on European chemical companies have been based on gas supply risks due to the uncertainty related to Gazprom's Nord Stream 1 pipeline, which was running at about 20% of its nameplate capacity but is now on an indefinite closure. Companies are facing operational challenges because natural gas serves as a raw material in the chemical value chain. For instance, BASF SE runs the largest European chemical site in Ludwigshafen, and if the natural gas supply falls below 50% of requirement, the site could see significant production curtailments or could even shut down. Further compounding the situation is the sharp increase in European title transfer facility prices--currently at almost six times 2021 levels--and we expect they will remain elevated through at least 2024 because Russian supply meets only about one-tenth of average European demand and cannot be fully offset by other sources since no significant global liquefaction capacity is expected to come onstream before at least 2025.

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Maturity Risks Are Controllable, But Managing Liquidity Will Be Key

Debt issuances have been muted in the recent past, given high yields and negative sentiment among investors due to economic uncertainty. We rate 24 chemical companies globally at 'B-' and lower, and except for Flint Holdco S.a.r.l. (CCC+/Positive/--), none of the companies in this category has debt maturing before 2024. Most of the chemical issuers took advantage of the strong credit conditions over the past two years, proactively refinancing their debt. Despite maturity risks being minimal for the most vulnerable credits; preserving liquidity in a rising cost inflationary environment will be key. This was evident in our outlook revision on petrochemical producer Grupo Idesa S.A. de C.V. (rated 'CCC+') to negative from stable on concerns that the company might struggle to satisfy its interest and coupon payments. We believe refinancing risk is manageable for the sector overall, but lower earnings and higher interest payments could cause liquidity risks.

While defaults have largely abated in this sector, we downgraded TPC Group Inc. to 'D' (default) from 'CCC' on Feb 1, 2022, on missed interest payments and subsequently the company filed for bankruptcy protection. In April 2022, we had lowered the rating on EurChem Group AG to 'SD' (selective default) from 'CCC-' (and on CreditWatch Negative) due to missed coupon payment and subsequently we withdrew the rating.

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Looking Ahead, Persistent Macroeconomic Headwinds Could Eventually Lead To Further Negative Rating Actions

We believe subsectors such as petrochemicals could experience weakened earnings due to demand destruction. Combined with new capacity coming online, especially in North America, we believe the ratings buffer could diminish due to margin compression. Further rating actions could result from additional pressure on gas supplies, reflecting the criticality of those supplies to European companies in the chemical sector.

Regionally, we believe companies in Asia-Pacific might be more vulnerable given their reliance on using naphtha as an upstream raw material, reducing their competitiveness relative to North American peers. Currently, we estimate about two-thirds of our rated issuers in the region can absorb a 30% EBITDA decline in 2023 without triggering downgrade thresholds. However, if demand remained weak for a prolonged period amid new capacity additions, the ratings buffer would diminish.

We believe financial policy will be key credit factor in a recessionary environment, focusing on how high yield credits manage their liquidity. We view ratings pressure to be more of a risk for speculative-grade issuers given their higher leverage and less flexibility to withstand periods of weakness. We expect investment-grade chemical companies would typically have more flexibility given their ability to cut back on discretionary spending, specifically shareholder returns.

Related Research

• The Russia-Ukraine War Is Reshaping The Fertilizer Industry, Sept. 12, 2022
• Will Buffers Hold For Rated Chemical Companies In Asia-Pacific?, Aug. 16, 2022
• Various Rating Actions Taken On Several European Chemicals Companies On Gas Supply Risks, Aug. 1, 2022