Key Takeaways
- Overall, U.S. chemical companies faced more challenging growth prospects this year because of high inflation and supply-chain disruptions, but some manufacturers still increased earnings by raising prices.
- Higher interest rates are making refinancing more expensive, but this hasn't yet affected most chemical companies because they opportunistically refinanced when rates were lower.
- However, lower-rated companies with maturities in 2024 and beyond could face refinancing difficulties, which could translate into downward ratings pressure.
Many U.S. chemical companies had strong earnings growth in 2021, but they've faced various headwinds throughout most of 2022. Nevertheless, despite inflation and supply-chain challenges, some speculative-grade chemical companies in the U.S. saw earnings growth in 2022 through price changes as opposed to volume growth. In addition to inflation, the ongoing conflict between Russia and Ukraine has led to an increase in input prices across the board, which has resulted in chemical companies increasing product prices.
Debt issuance has also been rare across the sector given the high interest rates. However, in the broader U.S. chemical sector, most companies were able to take advantage of low interest rates prior to 2020 and opportunistically refinance, leading to minimal refinancing risks over the next 12-24 months. As a result, our outlooks on speculative-grade chemical companies largely remain stable, as these companies continue to improve from the depths of the COVID-19-driven recession in 2020. However, looking beyond the next 12 months, many speculative-grade chemical companies face refinancing risk, as they have upcoming debt maturities, and borrowing costs are high.
Chart 1
Chart 2
Industry And Macroeconomic Drivers
Our forecast for first-quarter 2023 indicates that the U.S. is tipping further toward a recession given various macroeconomic factors, our economists are now expecting a shallow recession in the U.S. for 2023. They now forecast U.S. GDP growth of negative 0.1% in 2023, which is worse than previously forecasted. The Federal Reserve has increased the Fed Funds rate to the highest it's been since the financial crisis in 2007-2008. Furthermore, the Fed is expected to increase the rate to 5.00%-5.25% by second-quarter 2023. This has led to a slowdown in capital markets and unfavorable borrowing terms. For the majority of 2022, we have seen the term loan B market dry up, and this has been a key tranche of capital structures for many speculative-grade chemical companies tapping the capital markets. Chemical companies have rarely issued new debt over the past few months, and some have maturities in the next 12-24 months. Given high interest rates and a potential economic downturn, refinancing this debt could be very difficult, and if any deals are done, they'll come with significantly higher interest costs and less-favorable terms.
| History Of U.S. Recessions | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Peak | Trough | Length (months) | Previous expansion (months) | GDP decline (%) | Stock market decline (%)* | Unemployment rate increase (percentage points) | Federal funds rate decline (percentage points)¶ | |||||||||
| Apr-60 | Feb-61 | 10 | 24 | (1.3) | 1.5 | (1.30) | ||||||||||
| Dec-69 | Nov-70 | 11 | 106 | (0.7) | (32.1) | 2.4 | (3.37) | |||||||||
| Nov-73 | Mar-75 | 16 | 36 | (3.1) | (41.2) | 3.8 | (4.49) | |||||||||
| Jan-80 | Jul-80 | 6 | 58 | (3.1) | (13.4) | 1.5 | (4.79) | |||||||||
| Jul-81 | Nov-82 | 16 | 12 | (2.5) | (15.5) | 3.6 | (9.84) | |||||||||
| Jul-90 | Mar-91 | 8 | 92 | (1.4) | (15.6) | 1.3 | (2.03) | |||||||||
| Mar-01 | Nov-01 | 8 | 120 | (0.4) | (20.3) | 1.3 | (3.89) | |||||||||
| Dec-07 | Jun-09 | 18 | 73 | (3.8) | (41.1) | 4.5 | (4.03) | |||||||||
| Feb-20 | Apr-20 | 2 | 128 | (10.1) | (27.0) | 11.2 | (1.53) | |||||||||
| Baseline | ||||||||||||||||
| Dec-22 | Jun-23 | 6 | 33 | (0.8) | 0.2 | 1.0 | 1.23 | |||||||||
| *S&P 500 reflects percentage change from the peak before the recession until the trough during the recession. ¶Discount rate in 1960 and 1970 recessions. Fed is expect to raise rates through the recession in first-half 2023. Sources: NBER, BEA, S&P, BLS, Federal Reserve, and S&P Global Ratings Economics' estimates for 2023 recession. | ||||||||||||||||
Given the broad end markets in the chemicals industry, it is difficult to paint a broad overarching picture of the effects if the U.S. were to enter a recession, as some companies in the sector have resilient end markets that are better able to withstand a recessionary environment. Generally, we expect demand to drop across the board, and chemical companies might have difficulty retaining the higher prices to combat inflation over the past year. An increase in supply from corrected supply-chain disruptions, or increased supply from new plants coming online (particularly in Asia and the U.S.), combined with decreased demand, could lead to an oversupply situation for the broader chemicals industry.
Ratings Implications
The inability to refinance upcoming debt maturities could have a strong impact on companies' liquidity and free cash flows in the coming years. In addition, speculative-grade chemical companies that are able to refinance their debt in the next year or two will face higher interest rates and less-favorable terms when they extend their maturities. There could be significant original issue discounts (OIDs) and tighter financial covenants, most of which aren't present in current credit agreements.
Chart 3
The ratings on speculative-grade companies that are unable to refinance some of their upcoming debt maturities could be pressured. Large increases in leverage ratios, weaker coverage ratios, or decreases in cash flows could lead to weak credit metrics. When contemplating downgrading companies into the 'CCC' rating category (as opposed to those in the 'B' category), we look at unsustainable leverage metrics, liquidity, and nearer-term default risk. This is because 'CCC' companies must rely upon favorable business, financial, and economic conditions to meet their obligations. In an economy where the capital markets for speculative-grade companies have been severely constrained and maturities start sneaking up, we could see some of the lower rated 'B' credits with high leverage downgraded into the 'CCC' category as liquidity becomes more of an issue. The greatest risk of this occurring will most likely be in 2023, depending on the status of the economy and potential upcoming recession. Collectively, U.S. speculative-grade chemical companies have roughly $10.7 billion maturing in 2024 and roughly $6.5 billion in 2025. If rates are to remain high through 2023 and into 2024, many companies with 2024 maturities could be strapped for liquidity and unable to refinance on favorable terms.
Going Forward
Given the economic uncertainty and potential recession, chemical companies will rely on two main factors: If commodity and input prices remain high due to inflation, companies will continue to try to push price increases to customers, which could prove more challenging in a difficult operating environment. If companies across the chemicals industry see a decrease in demand from a potential recession and experience an inability to retain high prices, we expect a falloff in cash flows and earnings. Companies such as Vantage Specialty Chemicals Inc. (B-/Stable/--), FXI Holdings Inc. (CCC+/Negative/--), and Zep Inc. (CCC+/Negative/--) have large maturities approaching in 2024 and could have difficulty refinancing because they're relatively low rated. Companies such as Calumet Specialty Products Partners L.P. (B-/Stable/--), SK Mohawk Holdings S.a.r.l. (B-/Stable/--), and Trinseo PLC (B-/Stable/--) have large maturities in 2025 and could have difficulty refinancing in the next year or two, depending on the macroeconomic environment. Overall, we believe the capital markets and broader economy have been very uncertain throughout 2022 leading into 2023 and chemical issuers will look for opportunistic windows to get new deals done and look to push out maturities that may become current over the next 12 months. If no such windows open, there could be some negative actions in the next 12 months given the 2024 maturity walls coming due.
This report does not constitute a rating action.
| Primary Credit Analyst: | Edward J Hudson, New York + 1 (212) 438 2764; edward.hudson@spglobal.com |
| Secondary Contact: | Daniel S Krauss, CFA, New York + 1 (212) 438 2641; danny.krauss@spglobal.com |
| Research Assistant: | Tommy Pendleton, New York |
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