ICI pays a price for tempting the fates

IN 1980, ICI cut its dividend. It was a symbolic act which heralded an impending recession. A stunned stock market reacted accordingly, and sold. Nearly two decades later, British manufacturing no longer looms large in the economy, nor is ICI considered a symbol of its health.

Under the leadership of Charles Miller Smith, 59, ICI aims to become a specialist chemicals group, producing fragrances, flavourings, food additives and coatings rather than ethylene, polyester and fertiliser.

Unfortunately, ICI shares have halved in value in the past year and the City again fears that ICI might have to cut its dividend.

Last week, Mr Miller Smith's strategy was called into question when the sale of Crosfield, the detergents company, fell through. The shares shed 10 per cent on Thursday to below pounds 5 from a May peak of pounds 12.44.

In theory, this strategy should create a stronger company by jettisoning the heavily cyclical bulk chemicals business and acquiring higher-margin and more stable speciality chemicals companies - similar to the Swiss groups Clariant and Ciba Specialty Chemicals.

In practice, this has meant a vast restructuring of ICI and a heavy programme of deal making dependent upon favourable markets. This high-risk strategy is coming unstuck; buying is proving easier than selling.

In 1997, ICI paid pounds 4.7bn to Unilever for its speciality chemicals companies, Quest and National Starch. A fortnight ago, Mr Miller Smith expressed his delight with the purchase; he expected both companies to grow healthily and show double-digit margins, even in a downturn.

The purchase left ICI with a record loan and massive debts. It cut them by pounds 3bn last year, selling a stake in ICI Australia and its businesses in polyester, explosives, forest products and UK fertiliser.

Mr Miller Smith stated that a further pounds 3bn could be raised despite falling stock markets and declining profits. Yet few analysts were convinced.

A crucial blow was struck last year by the US anti-trust authorities, which insisted on investigating two vital ICI sales: the $450m (pounds 265m) disposal of Crosfield to W R Grace and the $750m sale of Tioxide to DuPont. Last week, W R Grace used the investigation to stop its purchase; DuPont might follow suit. This would leave ICI with unwanted assets in petrochemicals, pigments, detergents and industrial chemicals.

"I feel ICI paid top dollar for Quest and National Starch. Then it did not sell off fast enough in a deteriorating market. It had to raise pounds 4.3bn in 1997, not by the end of 1998. It needed to sell quickly rather than obtain the highest prices," said Philip Morrish of Nikko Securities.

Now ICI is a distressed seller. Currently it has net debt of pounds 4.4bn and minimal shareholders' funds, and is facing a downturn that could undermine its income and its disposal programme.

Industrial chemicals have already moved into loss. Speciality chemicals are now responsible for 90 per cent of group profits and even they cannot be immune to recession.

The downturn is being exacerbated by a vast programme of Far Eastern investment in the chemicals industry. This new capacity was always likely to lead to a price-induced recession in world chemicals this year. Now the collapse of the Asian economies will worsen the situation as these countries drive their new assets hard to pay off debts.

"I do not understand how ICI did not know about the deteriorating market. They have economists, consultants, advice from the City, people on the ground, and yet they still did not see it coming," said Mr Morrish.

Less critical was Peter Blair at Salomon Smith Barney, who said: "Miller Smith has been visionary in his restructuring and had some bad luck over the past few months."

The first signs of trading problems came in July when Mr Miller Smith conceded that analysts' forecasts for this year were too high. At the height of the euphoria, projections for 1998 reached pounds 1bn, based on a successful disposal programme. Now they have fallen to pounds 300m-pounds 400m; Mr Morrish is predicting they will reach pounds 295m this year and slide to pounds 195m in 1999, with little improvement in 2000.

ICI is being squeezed by a strong pound and a weakening dollar, as well as the downturn in the Far East. Meanwhile, its strategy is progressing agonisingly slowly. The one bright spot is that Tioxide is benefiting from a cyclical upturn and rising prices, so it might still attract the full price from DuPont.

This is not the case for other potential disposals. Petrochemical assets, notably the ethylene cracker at Wilton, face a depressed market. The loss-making industrial chemicals businesses, such as the chlorine/caustic plant at Runcorn, are currently unlikely to attract fierce bids.

"Potential buyers are using delaying tactics to capitalise on ICI's dilemma, in the expectation of buying cheaper," said Mr Morrish.

A fortnight ago, Mr Miller Smith made some optimistic statements about the sale of the bulk businesses, while claiming that they would raise pounds 2bn. This helped the shares stage a temporary recovery.

"We recognise that the market will only fully value ICI as a specialty company when the more cyclical elements of the portfolio are removed," he said. "So we will drive our strategy to its logical conclusion relentlessly and boldly."

There seems to be little alternative. During the 1980s, ICI endured a mediocre financial performance because of the swings of its cyclical businesses. In 1996, polyester profits collapsed because of new capacity coming on-stream, principally in the Far East. The logical response was to switch the weak bulk businesses for higher-quality assets.

"The downturn in the world economies has emphasised the validity of our strategic change," Mr Miller Smith said. Unfortunately, the downturn leaves ICI floundering until the sales are implemented.

ICI's figures for the third quarter next Thursday should reveal signs that even the specialty businesses are suffering from poorer margins. And the slowdown in the world's economy takes its toll of an awful last quarter.

The dividend will not be covered by earnings this year, and if Mr Morrish is correct, not until 2001 at the earliest.

"Personally, I think they will pay the dividend this year," he said. "But if they cut it, there will be blood in Millbank. The institutions will not stand for it."