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Tuesday, July 23, 2024

Two important lessons for chemical companies

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The analysis of the top quarter of special chemical companies reveals the significance of value creation.

Specialty chemicals is a diversified market with over 50 chemical value chains covering a wide range of products such as additives, adhesives, flavors and engineering polymers. Market participants include not only pure game companies focusing on one or two value chains, but also comprehensive enterprises participating in multiple value chains.

As executives in the specialty chemicals industry optimize their portfolios to maximize shareholder value, a long-standing question is whether the conglomerate model can win. Historically, the highest level answer has been “no”. However, this issue needs more detailed analysis.

We surveyed nearly 100 listed specialty chemicals companies and compared the return on investment capital (ROIC) of the top quarter enterprise groups and pure enterprise groups in the past 20 years. Our findings are very enlightening: pure players can not only create higher ROIC, but also the gap will expand over time. The median ROIC of special chemical enterprise group is 6 percentage points lower than that of pure business enterprise. In addition, for the top quarter of players, the gap will widen to 11 percentage points.

This paper decomposes ROIC into key driving factors profit margin and capital turnover 1, and finds that there are significant differences in capital turnover. In fact, the top quarter of big business groups have completely caught up with their profit margins in the past eight years.

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This discovery provides two important inspirations for special chemicals group

Margin improvement can only stop there. Once a chemical company reaches the highest quarter of its EBITDA (historically 15% to 20%), the further improvement of its value is more likely to come from the increase or growth of capital turnover.

Capital turnover rate is the key to narrow the value gap. The most important leverage to effectively solve the problem of capital turnover is the portfolio driven by the asset strength of the relevant value chain. It is essential to continuously evaluate the portfolio to find additional light assets, “truly professional” value chains with attractive growth.

In fact, enterprise groups should continue to focus on radical capital allocation while transferring capital and talents across departments. This will enable them to seize new growth areas and transfer excess profits to their parent companies for future investment. In view of this, the integrated enterprise group will promote the next level of value creation in the field of special chemicals.

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