Chemicals find a winning formula

None of the FTSE 350's chemical groups has discovered the science of alchemy, yet investors who bought their shares a year ago have hit gold. The weighted-average gain in 2010 was 59 per cent - and that includes the FTSE 100 industrial conglomerate Johnson Matthey, which has limited chemicals exposure these days and lagged its more focused peers.

The mid-cap players make components for a wide variety of markets, from electronics and medicine (Victrex) to beauty products (Croda) and construction (Elementis and Yule Catto). But all except Croda, whose personal care niche proved impressively resilient, were hit when their clients reduced inventories in the recession. They promptly cut any costs they could.

Yet destocking abated in the second half of 2009 and was followed by some restocking. Most end-markets also recovered as 2010 progressed, sparking a further upswing in chemical sales. Revenues at Victrex, which sells an ultra-resistant polymer called Peek mainly to industrial markets, finished the year to 30 September more than a third higher than the previous 2008 peak. Such was the explosion of profits that Victrex returned excess cash to shareholders in a sizable one-off dividend.

Victrex has long been considered the jewel of the sector, yet the other groups too are expected to report impressive profits and sales for 2010 in the upcoming reporting season. That’s partly because they all make the vast majority of sales abroad, and have benefited both from a weak pound and the buoyancy of emerging markets. Yule Catto and Elementis, in particular, have strong presences in east Asia. Profits have also been boosted by lay-offs and the low oil price in 2009.

One consequence of the recovery was a flurry of private equity sales. In November Carlyle Group and Vespar Capital floated AZ Electronics, which has a strong position selling high-purity chemicals to the likes of Toshiba and Samsung. And Yule Catto, which makes fairly low-margin polymers for paints and latex gloves, announced a major rights issue last month to finance the purchase of its closest European competitor, PolymerLatex, from TowerBrook Capital. The deal is daringly transformational and the target looks an excellent fit - it's reasonably priced, too, at about 6.5 times 2010's cash profits.

There’s no reason to doubt that sales growth will continue this year. But the going will be tougher, with more demanding comparables and possibly the headwind of a rising pound. The margin outlook is another worry - at around $90 (£58) a barrel, oil - the principal component of many chemicals - is now much pricier.

AZ ELECTRONIC MATS.(DI)2971,1320.0No IC View
CRODA INTERNATIONAL1,6202,22423.91.5100.4
JOHNSON MATTHEY2,0014,29619.32.023.7
YULE CATTO21773915.90.090.5

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