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Dow Targets High Pigment Prices With Resins

Today, a story I wrote on the on fortunes of the TiO2 market appears in the current edition of C&EN. TiO2 is the white pigment that gives paint its hiding power. If you ever labored applying coat after coat of white paint on a wall in vain trying to cover up a red finish that refuses to die with dignity, then the manufacturer of the paint you have chosen probably skimped on the TiO2. (It isn’t your fault. Actually, it is, you bought cheap paint.) I can’t think of a single commodity that is more important to the paint industry than TiO2.

And the paint industry has recently been paying dearly for TiO2. Since the 1990s, the TiO2 industry has been plagued by too much manufacturing capacity. That changed when the Great Recession forced the sector to shut down excess output. With the recovery, the TiO2 industry is now seeing the greatest profitability in about 20 years.

For the paint makers that consume the white pigment, runaway TiO2 prices have been painful. These companies are trying to mix in as little of it in their formulations as they can get away with. PPG has one of the more militant stances on this issue in the paint sector. The company wants to reduce TiO2 consumption by 10% by the end of next year. The company has gotten off to a good start, eliminating 2% by the end of the last quarter.

There is a potential market here for chemical companies that I couldn’t really get into in the article in print. Last year, Dow Chemical launched its Evoque pre-composite polymer, meant to address the problem of TiO2 crowding in latex paints. TiO2 crowding is what it sounds like it is, but there is even more to it than that.

David Fasano, a research scientist at Dow, explains that at very high loadings of TiO2 used in white and architectural latex paint—about 20%–TiO2 begins to interfere with its own ability to scatter light. This is because the TiO2 particle has a sphere of influence, called a scattering zone, that is twice the diameter of the TiO2 particle itself. As the particles come closer together, these zones overlap, diminishing the effectiveness of each other. (To understand this, I imagine an overhead projection of two dots on a screen. As the projector goes out of focus, halos form around the dots and expand until they overlap.)

Evoque, an acrylic latex film-forming resin, binds to the TiO2 particles and holds them apart so they don’t get close enough to interfere with each other. Evoque can reduce the paint loading in white and pastel architectural paints by as much as 20%.

Along with Evoque, Dow has been promoting another resin that has been in its stable for about 30 years: Ropaque. It isn’t meant to extend the use of TiO2, it is styrene-based resin that acts like a pigment itself. When Ropague forms a film, it captures little pockets of air that scatter light. This is the same effect that makes polystyrene foam, clouds, or bubble baths appear white.

Dow is quick to point out that it isn’t trying to exploit the high TiO2 prices. Evoque has been under development for a more than 5 years, before the TiO2 prices took off. However, Ashok Kalyana, architectural marketing director for Dow Coating Materials, admits that the product was launched at a fortuitous time. “This wasn’t invented just to take advantage of the situation,” he says. “But certainly the tightness in the TiO2 market has helped us accelerate our plans of introduction.”

DuPont Revises 2011 Guidance

DuPont has reduced its 2011 earnings-per-share guidance by a dime, down to a range of $3.87 – $3.95.

In the company’s press release CEO Ellen J. Kullman said something somewhat disconcerting:

“We are seeing slower growth in certain segments during the fourth quarter, driven by economic uncertainty. This uncertainty is contributing to ongoing conservative cash flow management in some supply chains.”

Inventory drawdowns are very normal this time of year. A bigger inventory reduction than expected can mean many things. For instance, it can mean that customers expect prices in the supply chain to decline. (The most benign option.) Customers can be cashing out their inventories in order to brace themselves for potential Armageddon. (This happened during the 2008 panic.) Or customers, not knowing what the future has in store, don’t want to tie up too much of their working capital in inventories. (Middle of the road, not necessarily bad. This seems to be Kullman’s view.)

Also, keep in mind that DuPont has reset its 2011 guidance a bunch of times. Here are the changes:

Oct. 25, 2011:      $3.97 – $4.05

July 28, 2011:     $3.90 – $4.05

Apr. 21, 2011:      $3.65 – $3.85

Jan. 25, 2011:     $3.45 – $3.75

Dec. 14, 2010:     $3.30 – $3.60

DuPont is still way ahead of where it was in April.

Looking at the list reminds me of Dow Chemical, which rather famously doesn’t give earnings guidance. I do see the wisdom in such a policy. Real numbers come in every quarter. Analysts have their own set of fake numbers. Why have another fake number? (Companies tend to lowball these anyway to set the stage for an artificial earnings beat.)

If I am ever at the helm of a public company*, I would adopt the no guidance policy.

*It would be a breach of fiduciary duty for a board of directors to let such a thing happen.

Oxiteno Considering Bio-based Ethylene Glycol

I just came back from Buenos Aires, where I attended the annual petrochemical meeting put on by APLA, Latin America’s main chemical trade group. The meeting is a great place to connect with chemical executives from the region.

At the event, I ran into Pedro Wongtschowski, the CEO of Brazilian energy and chemical conglomerate Ultrapar. Oxiteno, the company’s chemical arm, makes ethylene oxide, ethylene glycol, ethoxylates, and specialty chemicals.

I have long wondered if the company would get involved in bio-based ethylene glycol. Since 2009, Coca Cola has been using the “Plant Bottle”, in which bio-based ethylene glycol is substituted for petroleum-derived ethylene glycol in the polymer backbone. The bio-based glycol is made from bio-based ethylene, made via the dehydration of ethanol. Coca Cola has been sourcing the ethylene glycol from a firm in India and its sugar has come from Brazil.

Obviously, the supply chain would be simplified considerably with a Brazilian glycol supplier. And Oxiteno, being the country’s main ethylene oxide/ethylene glycol maker, is in attractive position for such business.

So I asked Wongtschowski about this.

He told me that bio-based ethylene oxide and ethylene glycol has been under active consideration.

The company seems to have some options in front of it, such as whether it would feed bio-based ethylene into an existing ethylene oxide plant or build a new plant. The company also seems to be deciding on whether to construct an ethanol dehydration plant itself or buy ethylene from Braskem, which has been making polyethylene from bio-based ethylene since 2010 and recently agreed to supply bio-based ethylene to Lanxess for EPDM production. “We are talking with Braskem to determine the most attractive option for all parties involved,” he said.

Cytec Examines “Options” For Coatings Resins

Cytec Industries CEO Shane Fleming dropped an “O” bomb on Cytec’s coatings resins business during a conference call last week. “We are committed to maximizing value creation in this segment and will take the decisions necessary to do so,” he said. “We are currently reviewing all options for this business and we will provide a further update on our plans no later than our earnings guidance on our fourth quarter conference call.”

“Reviewing options” always indicates that a company is entertaining the idea of selling a business. However, it doesn’t always mean that the company will end up selling the business. They often keep parts of the business and sell off and/or close other bits of it.

The coatings resins business generated operating earnings of $68.2 million on $1.4 billion in sales last year. It makes resins for powder, radiation curable, and liquid coatings. It is Cytec’s largest segment by a mile, representing 52% of its 2010 revenues. Its profit margins, at just under 5%, are also the company’s thinnest, with Cytec earning a total operating profit margin of about 10%.

During the conference call, Fleming said he expects the company to make $57 million to $60 million in operating income on about $1.6 billion in sales.

Fleming did keep the door open to making the business work within Cytec, primarily through favoring specialty resins over more commoditized products. “We’ve got a portion of our coatings resins product line right now that’s just now meeting our return on capital,” he said. “That is out first goal. It’s to get the business to a point where it’s doing that.”

For example, in the conference call, Cytec also disclosed it is closing a powder coatings resins plant in Suzano, Brazil, and took a $9 million charge in the third quarter for this shutdown.

STRATEGIC OPTIONS

But Fleming said that separating the good parts from the bad parts might not be so easy. “You can identify the product areas where you’re covering the cost of capital and generating reasonable earnings,” he said. “But the pragmatic question is, can you pull those apart and operate them separately given the level of entanglement with the asset base?”

Sounds like Cytec might punt that problem to the next owner.

Cytec’s coatings resins business is a bit of a hot potato. It was originally part of Hoechst under the name Vianova Resins. Hoechst sold the business to Morgan Grenfell Development Capital in 1998 for $545 million. Solutia bought the business a year later for about $617 million. In early 2003, Solutia sold the business to Belgium’s UCB for $500 million. It had earned $22 million for Solutia on $559 million in 2002. UCB added businesses to the unit, including, as I recall, rad-cure and amine resins. It sold the unit to Cytec for cash and stock valued at $1,774.3 million in 2005.

During the call, Cytec CFO David Drollick put the book value of the business at $1.4 billion.

The company also had other news last week. In its earnings report last week, the company disclosed it sold its Stamford, Conn., to an undisclosed buyer, for $11 million, on September 30. It said it was leasing back parts of the facility for a seven year period and conducting a $1.1 million environmental remediation on the site. Interestingly, the company estimates the book value of the facility to be $32.5 million. It will take a charge when the remediation project is completed.

Notes On Dow’s Investor Day

Yesterday Dow held its annual investor day. The main theme was that the pieces were in place for strong earnings growth. In an interview after his presentation, CEO Andrew Liveris complained that the company is still being pigeonholed unfairly as a commodity chemical company by Wall Street. The post-recession peak for Dow shares, early this past May, was more than $42. Now they are trading in the low 20s.

I am writing a feature story on the event for C&EN. I do have a couple of observations that I wanted to share on the blog right away.

  • Dow is walking back plans to divest high-density polyethylene. About a year ago, Liveris floated a trial balloon about the sale of HDPE. The distinction the company has been making has been between its “specialty” solution process polyolefins and “commodity” Unipol-based, gas-phase polyolefins. Liveris told me yesterday that Dow now plans to convert gas-phase plants into solution-based plants at “integrated” facilities. He specifically mentioned Alberta. I would gather that this means swapping out the reactors and leaving the rest of the plant infrastructure in place.
  • Polyolefins licensing is a keeper for Dow. Polypropylene licensing was left out of the sale of the polypropylene business to Braskem. Dow really intends to keep this. The same goes for its stake in Univation, which licenses Unipol polyethylene. Howard Ungerleider, who leads the Performance Plastics division for Dow, told me the polypropylene licensing unit is a pretty big earner for Dow and has been gaining market share.
  • Dow AgroSciences is a keeper, too. When Dow was going through a crisis in early 2009 related to its purchase of Rohm and Haas, Liveris indicated that he might sell this unit. I asked him if the company is still on the fence about this. He said that the company is “Not on the fence and fully on the farm.” Though the unit is small compared to competitors like Monsanto, Liveris said that the unit is “punching above its weight.”
  • Dow’s acquisition strategy will be modest. The company is steadily digesting the debt related to Rohm and Haas. One might think that the company would be planning acquisitions again. Not so. Liveris says the company is only considering smaller acquisitions to round out his existing portfolio. He mentioned IBM, where Liveris incidentally is a director, as a model.
  • Andrew Liveris is a Michigan Wolverine fan. I talked football with him while arranging my stationary on the conference table. He is very excited about the 5-0 start. I am too. I warned him, as a Michigan alum, not to put too much faith in a good Michigan start. (I was there.) He said it was a new era with new head coach Brady Hoke. I hope Liveris is right. But I’ll believe it when we beat Ohio State.

Bad Day On Wall Street, Especially For Huntsman

The Dow Jones Industrial Average’s 513 point, 4.3% decline was bad yesterday. Huntsman Corp’s $5.58, 30.5% decline was even worse. (There is no typo in the preceding sentence.)

Such declines among large chemical companies are pretty rare. In fact, they mostly happen to target companies of acquisition attempts that go up in smoke. Huntsman has actually had similar declines. One was in June 2008, when Hexion reneged on its acquisition offer, causing Huntsman stock to decline by 40%. And in December that same year, when the two companies settled their lawsuits against each other and Huntsman lost about half its value.

Huntsman’s quarterly, adjusted per-share earnings were 48 cents, missing Wall Street analyst estimates by a penny. Huntsman actually earned 31 cents in the year-ago period. But this earnings season, other companies like Dow were blowing through estimates, making Huntsman an outlier.

There were few of negatives in the quarter, Huntsman’s earnings were impacted by strong exposure to the Swiss franc. Its advanced materials business—which makes thermoset resins for composites-had difficulty passing along price increases. Its textile effects unit has been impacted by high cotton prices.

From a Reuters report, there seemed to be an interesting exchange during the earnings call:

Jeff Zekauskas, a JPMorgan analyst, was bothered because the company reported results only 90 minutes before the conference call, leaving him little time to wade through unusually complex financial tables.

“It’s very difficult to reconcile all of the income statement numbers to the data that you provide,” Zekauskas told Huntsman executives on a conference call.

Huntsman said he thinks his company gives the right amount of information.

“We’re certainly going to be looking internally as to any changes we would make,” he said. “I think we give plenty of pages of financial information.”

The report does make it seem like there was more of a testy exchange between Zekauskas and Huntsman than there indeed was.

Here is what Zekauskas said, according to a Seeking Alpha transcript:

So if I could just, make one comment. When you report your earnings, it’s about an hour and a half before your conference call and your financials are quite complex and it’s very difficult to reconcile all of the income statement numbers to the data that you provide. And so what you might consider is you might consider a more complete reconciliation so that the adjustments can be made more easily, and so it’s easier for people to focus on the fundamentals of what you reported rather than trying to reconcile the numbers, or it’s at least something to consider.

This seems more of a critique about how Huntsman is presenting the numbers than an accusation of wrongdoing. (Full disclosure, I tried following the adjustments in the release and quickly gave up.)

To Zekauskas’s remark, the Huntsman CFO Kimo Esplin replied “fair enough.” The quote from Peter Huntsman himself apparently comes from a subsequent interview with Reuters.

Another interesting moment in the call came from Andy Cash of UBS. He asked Huntsman is he was going to sell the textile effects and advanced materials units. “I believe those businesses are as profitable in our hands as they would be in anybody else’s,” Huntsman said. It is interesting that analysts are wondering such things.

Update: Huntsman today announced a $100 million share repurchase program, effective immediately.

Notes Dow/Aramco’s Massive Saudi Project

As you may have heard, Dow and Saudi Aramco are moving forward with their new, $20 billion project for the Kingdom of Saudi Arabia. If you haven’t heard, the news story I wrote yesterday has all the relevant details.

Here are a few more observations:

1) The joint venture will be called Sadara Chemical: “SA” stands for “Saudi Aramco”, “D” stands for “Dow”, “ARA” stands for “Arabia”. Dow CEO Andrew N. Liveris says “the word Sadara stands for progressive leadership, enhanced performance, and a status derived from quantifiable talent and proven mastery”. Um, OK.

2) The joint venture, ironically, is a major step forward in Dow’s transformation to more value-added chemicals. The idea here is similar to the one behind its major petrochemical investments in the U.S.: To back-integrate performance chemicals, such propylene derivatives and “solution polyethylene”. Also, there is a strong developing word orientation to the project. Dow projects that 70% of the output of this project will be marketed in Asia (~45%) and the Middle East (~25%). Dow operations downstream, such as a polyurethane systems house,  at a newly established industrial park will be a large customer of the joint venture.

3) I don’t expect much creep upward in the cost of this project. The $20 billion figure is being billed as an upper limit. Engineering, procurement, and construction comprise $12 billion of the cost. Another $8 billion is financing, startup, and stuff. Liveris noted that about half of the costs of the major elements of the project, such as the ethylene cracker, are already locked in. That said, other projects in the Middle East over the last business cycle busted budgets considerably. My suspicion, however, is that Dow built that into the number it is putting out.

4) The venture is really ready to roll. “We have bulldozers moving to the site in two weeks,” Liveris said during a conference call. That said, I have heard chemical engineers chuckle at the notion of site preparation being a sign of progress.

5) This is one of Dow’s last major loose strategic ends. Dow has been kicking this project around since 2007. Originally it was supposed to go up in Ras Tanura, but the partners changed venue last year. Considering all Dow went through during the financial crisis, that is a very minor hiccup in such a major project. Many other companies might have just walked away.

6) Another Dow loose end involves PIC of Kuwait. Dow is seeking $2.5 billion in arbitration hearings from PIC because of the failure of the proposed K-Dow petrochemical joint venture back during the financial crisis. It was the government of Kuwait that scuttled the deal, not PIC. And given that PIC has been a good partner for Dow’s Equate joint ventures in Kuwait (as well as MEGlobal), I would imagine that Liveris is interested in finding a mutually beneficial, and I’m sure creative, solution to the problem. I personally think it involves the purchase of Dow assets, either through buying Dow out of existing joint venture(s) or by the formation of a new HDPE/PP joint venture around Dow’s existing assets.

7) SABIC has indicated an interest in building isocyanates and polyols plants in Saudi Arabia. I wonder if that will still happen now that an existing polyurethanes player is investing.

Dow On TV

Olin isn’t the only company that makes chlorine and ammunition. So does Dow.

Dow paintballs

OK, the polyethylene glycol filling in paint balls aren’t exactly Winchester rounds.

Separately, CBS News did a piece on Dow’s solar shingles:

CBS Report on Dow Shingles

Autoworkers paid taxes that helped subsidize my University of Michigan education. It is nice to see some of them getting back to work.

Berkshire Details Sokol’s Lubrizol Scandal

Berkshire Hathaway has put out a report on top exec David Sokol’s resignation in March over shares he purchased in Lubrizol before Berkshire’s takeover was announced.

At the time, I was wrong on this blog when I said:

“This seems to me a case of an appearance of conflict of interest rather than a real conflict of interest. Sokol thought Lubrizol was a good investment. He suggested that it would be a good investment for his company, too. Engineering an entire deal to make a tidy—albeit $3 million—profit would be the tail wagging the dog.”

Turns out, according to the report, there was more to the story than that:

He did not disclose:

* the amounts and timing of his purchases;

* the fact that he bought the shares after discussing Lubrizol with Citi and after Mr. Sokol had narrowed the bankers’ initial list of 18 chemicals companies to one, namely Lubrizol;

* the fact that Mr. Sokol had bought shares after Mr. Sokol (acting as a senior representative of Berkshire Hathaway scouting acquisition candidates) had asked for Citi’s help arranging a meeting with Lubrizol’s CEO to discuss Lubrizol and Berkshire; and

* the fact that Mr. Sokol bought shares after learning that Citi had discussed his request for a meeting with Lubrizol’s CEO, who told Citi that he would discuss Berkshire Hathaway’s possible interest in a transaction with the Lubrizol board.

Though, the report suggests that Sokol won’t have to exchange his pin stripes for prison stripes.

We appreciate that at the time Mr. Sokol traded, he did not know whether Mr. Buffett would support, or reject, the idea of an acquisition of Lubrizol. We also recognize that Mr. Sokol did not know how Lubrizol would respond to an acquisition proposal if Berkshire Hathaway were to make one. We recognize the view that those uncertainties might have kept Mr. Sokol’s information below the level of probability required to support a finding of materiality for purposes of finding a violation of federal insider trading law. But the Trading Policy requires a higher standard of conduct than what is required to avoid being charged with a federal securities violation.

I like the last sentence. It reminds me of the old Hebrew National commercials.

My take: Why would someone blow their chance to be Warren Buffett’s successor for a measly $3 million? Berkshire doesn’t disclose Sokol’s salary or stock holdings in its proxies. In any case, I’m sure he’ll land on his feet.

Berkshire Exec Resigns (Apparently) Over Lubrizol Bid

Some of you may have heard the news that Berkshire Hathaway executive David L. Sokol has resigned. Sokol bought 100,000 shares of Lubrizol and suggested to Buffett that Berkshire buy the whole company. Here’s the Lubrizol-related excerpt from Buffett’s statement about the resignation:

Finally, Dave brought the idea for purchasing Lubrizol to me on either January 14 or 15. Initially, I was unimpressed, but after his report of a January 25 talk with its CEO, James Hambrick, I quickly warmed to the idea. Though the offer to purchase was entirely my decision, supported by Berkshire’s Board on March 13, it would not have occurred without Dave’s early efforts.

That brings us to our second set of facts. In our first talk about Lubrizol, Dave mentioned that he owned stock in the company. It was a passing remark and I did not ask him about the date of his purchase or the extent of his holdings.

Shortly before I left for Asia on March 19, I learned that Dave first purchased 2,300 shares of Lubrizol on December 14, which he then sold on December 21. Subsequently, on January 5, 6 and 7, he bought 96,060 shares pursuant to a 100,000-share order he had placed with a $104 per share limit price.

Dave’s purchases were made before he had discussed Lubrizol with me and with no knowledge of how I might react to his idea. In addition, of course, he did not know what Lubrizol’s reaction would be if I developed an interest. Furthermore, he knew he would have no voice in Berkshire’s decision once he suggested the idea; it would be up to me and Charlie Munger, subject to ratification by the Berkshire Board of which Dave is not a member.

As late as January 24, I sent Dave a short note indicating my skepticism about making an offer for Lubrizol and my preference for another substantial acquisition for which MidAmerican had made a bid. Only after Dave reported on the January 25 dinner conversation with James Hambrick did I get interested in the acquisition of Lubrizol.

Neither Dave nor I feel his Lubrizol purchases were in any way unlawful. He has told me that they were not a factor in his decision to resign.

Dave’s letter was a total surprise to me, despite the two earlier resignation talks. I had spoken with him the previous day about various operating matters and received no hint of his intention to resign. This time, however, I did not attempt to talk him out of his decision and accepted his resignation.

This seems to me a case of an appearance of conflict of interest rather than a real conflict of interest. Sokol thought Lubrizol was a good investment. He suggested that it would be a good investment for his company, too. Engineering an entire deal to make a tidy—albeit $3 million—profit would be the tail wagging the dog.