LANXESS, the German specialty chemicals giant, has been weathering a storm. Between destocking, weak demand, and Europe's energy crisis, 2023 was brutal. They've been sweating out inventory, slashing costs, and working tirelessly to deleverage. But amid the cautious optimism of their Q1 2024 earnings call <a href="https://investors.lanxess.com/~/media/Files/L/Lanxess-IR/documents/publications/reports/2024/q1/presentation/2024-05-09-praesentation-q1-2024-en.pdf" alt="Q1 2024 Earnings Call">[1]</a>, a curious detail emerged, one that seemingly slipped past the analysts: <strong>LANXESS's utilization rates are on the rise.</strong>

While the company declined to offer specifics on these rates, both CEO Matthias Zachert and CFO Oliver Stratmann emphatically confirmed a "meaningful improvement" in utilization compared to the dismal 60% reported at the end of 2023. This seemingly innocuous detail could be a harbinger of significant things to come, a potent sign that LANXESS is quietly positioning itself for a major rebound, one that could catch the market off guard.

Let's delve into why this utilization uptick is so important. LANXESS has a history of transformative acquisitions, snapping up Emerald Kalama Chemical and IFF's Microbial Control business in recent years. These moves have dramatically shifted the company away from its polymer-heavy past and towards a leaner, more specialized chemical portfolio.

But these acquisitions also left LANXESS with a significant amount of unused capacity. As Stratmann pointed out in the Q4 2023 call <a href="https://investors.lanxess.com/~/media/Files/L/Lanxess-IR/documents/publications/reports/2023/q4/presentation/2024-03-14-praesentation-fy-2023-en.pdf" alt="Q4 2023 Earnings Call">[2]</a>, "When you have an under-utilization of 40%, you better start utilizing your assets before you build capacities." In other words, LANXESS doesn't need to spend heavily on CapEx to grow; they can simply leverage the capacity they already have.

This is where the utilization rate becomes key. An increasing utilization rate, even without additional CapEx, translates to falling unit costs. Every additional pound of product produced spreads those fixed costs further, leading to enhanced profitability even without a corresponding rise in demand.

Hypothetical Scenario: Impact of Increased Utilization

Consider this hypothetical scenario: If LANXESS can improve utilization to 75% in 2024, a 15% increase from their 2023 baseline, the impact on their bottom line could be substantial. Assuming their fixed costs remain relatively stable, this increase in production could drive a significant decrease in unit costs.

Let's take a conservative estimate and assume this improvement in utilization yields a 5% reduction in unit costs across their portfolio. Given their 2023 revenue of €6.7 billion, this could translate to cost savings of €335 million. Even if only a portion of these savings translates to the bottom line, the impact on EBITDA could be substantial, potentially adding hundreds of millions to their profit.

This, in turn, would accelerate their deleveraging efforts, further silencing those concerns about a stressed balance sheet. It's a self-reinforcing cycle: increased utilization, lower costs, higher profitability, faster deleveraging, and ultimately, a stronger position to capture market share when demand truly rebounds.

Challenges and Uncertainties

Of course, this scenario hinges on several assumptions. The magnitude of the utilization increase remains unknown. The degree to which cost savings flow through to the bottom line will depend on factors like pricing dynamics and potential inflationary pressures.

And while there are "green shoots" of recovery in various end markets, as Zachert described, 2024 is far from a "normal" year. The construction industry, crucial for Specialty Additives, remains weak in China and Europe. Agrochemical destocking, a headwind for Consumer Protection, is expected to persist for the first half of the year.

The Potential Upside

However, even with these uncertainties, the potential upside from a rising utilization rate is undeniable. It represents a powerful lever for LANXESS, one that could deliver outsized profitability gains even in a muted demand environment.

This is why the quiet confirmation of improving utilization is so intriguing. It suggests that LANXESS is playing a long game, patiently and methodically building a platform for a potent comeback. The market, fixated on cautious guidance and macro uncertainties, may be overlooking this powerful driver, creating an opportunity for savvy investors who can see the ghost in the machine, the potential roaring back to life within LANXESS's vast production network.

"Fun Fact: Did you know that LANXESS is a major producer of iron oxide pigments used in everything from construction materials to cosmetics? Their pigments can be found in concrete, bricks, paints, plastics, and even the makeup you wear! It's a reminder of the vast and diverse applications of specialty chemicals, often hidden in plain sight."