AKRON, OHIO (Sept. 1, 11:30 a.m. EDT) — In 2003, North American compounders are more concerned with what they don't know, rather than with what they know.
They know business is down across the board. And they know some of their customer base has moved business to Asia, with little hope of returning. But they're less certain of when their market is going to return to health — and what it will look like when that comeback arrives.
“A lot of our customers are very unsure about the future,” said Paul Cusolito, executive vice president of polypropylene compounder Washington Penn Plastic Co. in Washington, Pa. “They don't see a lot of strong signals that would indicate improvement in the economy.”
“All the leading economic indicators — like consumer confidence and industrial production — are positive, but our customers aren't yet talking about a positive upswing in the second half,” added Lance Mitchell, vice president of plastic compounds and color for market leader PolyOne Corp. of Cleveland. “As a result, we're not counting on an economic recovery this year.”
More importantly, the very shape and nature of the North American compounding market may be changing, according to Bill Ridenour, president of Polymer Transaction Advisors Inc., a consulting firm in Newbury, Ohio.
“The compounding market in the U.S. is maturing, so margins are getting squeezed,” Ridenour said. “There will always be a place for the small, specialty compounder to do things, but there won't be more chances to create companies like RTP, LNP or Americhem — multi—site companies with a major focus on the U.S.”
And even when the economy returns to health, a number of market watchers think that North American compounding might have annual growth rates of 2-3 percent, instead of the rates of 4-6 percent — or higher — that it enjoyed throughout the 1990s.
Checking on China
Compounders don't agree on many things, but they all see major market opportunities in China. Officials cite the need to follow their customer base, as well as lower labor and operating costs, as reasons for Asian expansion.
In a market study recently completed by Phillip Townsend Associates Inc. of Houston, North American compounders that said they were “actively looking to expand” weren't looking to expand in North America, according to Townsend analyst Kevin Smith.
The long list of North American compounders with Chinese projects on the table includes:
* Ampacet Corp. of Tarrytown, N.Y., opening a color concentrates plant near Shanghai by late 2005 or early 2006.
* Americhem Inc. of Cuyahoga Falls, Ohio, opening a color concentrates plant near Shanghai by the end of 2004.
* A. Schulman Inc. of Fairlawn, Ohio, building a color concentrates plant near Hong Kong by mid-2004. The plant, which was delayed six months because of the SARS virus outbreak, will supply masterbatch concentrates to film and packaging producers, said President and Chief Executive Officer Terry Haines. The 75,000-square-foot plant is expected to employ 40.
* Ferro Corp. of Cleveland adding compounding capacity at the firm's nonplastic sites in Shanghai by 2006. The Chinese government's decision to replace PVC in IV bags and other medical uses is creating opportunities for Ferro's Rxloy-brand polyolefin-based thermoplastic elastomer, according to John Comanita, vice president of Ferro's specialty plastics group.
* PolyOne — which already operates plants in Singapore, Shanghai, Suzhou, and a joint venture in Thailand — opening a plant in Zhongshan by mid-2004. The plant will focus on business equipment, packaging, electrical/electronic markets and color concentrates and engineering material compounds.
“A lot of targeted future investment is outside the U.S., where it's following burgeoning markets in mainland China,” said Ridenour. “China is expecting a 400 percent increase in vehicle production between now and 2020, and those vehicles will need a lot of plastic parts.”
Elsewhere in Asia, Schulman is enjoying what Haines calls “an excellent return on investment” on the plant it opened in Indonesia five years ago. Teknor Apex Co. of Pawtucket, R.I., also completed a major expansion of its compounding plant in Singapore earlier this year.
Asia's impact also is being felt in the amount of plastics-related work, particularly in injection molding, that's left North America.
“We're seeing the China factor in ways we never thought we'd see it just three years ago,” said Dwight Morgan, president of Accel Color Corp., a concentrate maker in Avon, Ohio. “You used to see some impact in the West and Southeast [U.S.], but now it's in the entire marketplace.”
Morgan estimated that some of the North American injection molders his firm does business with are using only 30 or 40 percent of their machines.
John Jones, president of Applied Market Information LLC, a consulting firm in Wyomissing, Pa., said this exodus of business to Asia “has hurt [the compounding market] as much as anything.”
N. America struggles …
The challenges facing sales within North America are hard to ignore. Results posted by publicly held compounders PolyOne, A. Schulman and Spartech Corp. of Clayton, Mo., in the first half of 2003 show financial losses in spite of increased sales. Market watchers believe this trend to be the result of those firms passing on portions of raw material price increases while not growing their base volumes.
The cuts have been deep at PolyOne, which ranks as the region's largest compounder with a 10 percent market share, according to this year's Plastics News industry estimate.
The company successfully refinanced its debt earlier this year, but is still looking for ways to cut costs, even after closing more than a dozen sites and cutting at least 800 jobs since mid-2001. Counting the first half of 2003, PolyOne has lost about $130 million in the last 2½ years.
AMI's Jones observed that “some relatively small companies” are benefiting from PolyOne's troubles by “serving people in a niche and serving them well in a stated geographic area.”
Yet PolyOne's Mitchell remains optimistic, pointing out that the $50 million the firm spent last year on upgrading or refurbishing two-thirds of its North American lines will make those operations more efficient when demand picks up.
Mitchell admitted that PolyOne has lost PVC compounding volume through reduced sales into the wire and cable market, leading the firm to cut production from seven days a week to five at its PVC compounding plants. But he added that demand for PolyOne's color concentrates and compounds “has been stable as far as the demand pattern goes, even if the overall demand level isn't where we'd like to see it.”
“There's been an inventory adjustment [in color concentrates], and a large part of it is the packaging business, which is driven by consumer products,” Mitchell said.
Schulman hasn't been unscathed by the downturn. The firm has cut capacity by 30 percent since late 1999, mostly by closing large, older plants in Akron, Ohio, and Orange, Texas.
“We've put that capacity [from Akron and Orange] into lower-cost plants,” said Schulman's Haines. “We've organized our production relative to individual polymers and have each plant running a more specific product mix.”
For example, Schulman's Bellevue, Ohio, plant is running PVC compounds, while a plant in Nashville is focused on engineering plastic compounds and a smaller remaining plant in Orange is only producing olefinic TPEs.
“We're trying to balance the cost side with opportunities for growth in the right kind of applications, Haines said. “But we had to downsize the company and refocus on engineering plastics to do that.”
Engineering plastics compounds brought in about 24 percent of sales in Schulman's 2002 fiscal year. Haines said he would like to see that number increase to 27 or 28 percent, with a similar reduction in the firm's reliance on color and additive concentrates, which generated 38 percent of 2002 sales.
“We have to move away from the 'me too' commodity stuff,” he said.
Elsewhere, Washington Penn idled some capacity in 2003, but declined to offer details. Likewise, Spartech alluded to $2 million in unspecified compounding-related “cost reductions” in a recent financial report. The firm also recently announced 350 job cuts, but declined to say how many of those would come from compounding sites.
At GE Plastics' LNP Engineering Plastics unit, work weeks have been cut from seven to five days in some cases, but the firm has avoided capacity cuts, according to LNP President and Chief Executive Officer Charles Crew.
“Our core business is lower and new business hasn't kicked in,” said Crew, adding that in 2003 his firm has seen lot-size requests that are 10-15 percent smaller than those they saw last year.
First-half sales tallies from the American Plastics Council — which tracks resin sales into various end markets — were mixed. Compounders bought more nylon, low density polyethylene and high density PE in the first half, but less polystyrene, PVC, PP and linear LDPE, according to Arlington, Va.-based APC.
The issue of overcapacity still is a thorny one in the North American compounding community. The Townsend study placed capacity utilization rates at 74 percent for the 385 compounding plants it covered. That number is up slightly from 72 percent in 1997 — the last year the firm did the study — but still less than what's needed for reliable profitability.
“There are still too many plants providing the same products and the same services to the same customers,” Ferro's Comanita said. “And the market's not robust enough to handle that.”
“Consolidation is still needed to eliminate cost, more than anything,” added consultant Ridenour. “That's true of any materials industry where there's not enough growth for everybody to be happy.”
… but all is not lost
There are still a number of companies investing in North America, mainly smaller independent firms growing their sales bases. But a smattering of activity from the majors remains present.
One project of note is Accel Color's plan to open a site in Knoxville, Tenn., by late October. The 15,000-square-foot site will operate two extrusion lines. Accel also is on track to complete a 30,000-square-foot expansion in Naperville, Ill., by the end of this year. The firm's sales are expected to hit $16 million in 2003.
Other North American initiatives include :
* Custom compounder Foster Corp. moving from Dayville, Conn., to a new, 43,000-square-foot site in Putnam, Conn.
* Color concentrates producer OK Color America adding 8,000 square feet and a fourth extrusion line in Torrance, Calif.
* Resin distributor Kal-Trading Inc. entering the compounding market with two lines at a site in Mississauga, Ontario.
* Exton, Pa.-based LNP expanding its research and development sites in Exton and Columbus, Ind.
* LNP also will start making LNP products at a former GE Plastics site in Coburg, Ontario, next year. The firm also plans to expand its long-fiber-reinforced thermoplastic [LFRT] technology from nylon and PP into PC and PPO and PC/PBT.
* Engineering resins compounder Lati USA Inc. adding another twin-screw extruder in Summerville, S.C., in 2004.
F* Ferro spending $2 million in 2003 to upgrade lab capabilities and add personnel and equipment in R&D.
Fueled by high costs for natural gas and other raw materials, resin prices took off like a shot in 2002, and only receded slightly before doing the same thing in 2003. Prices for most commodities are up at least 20 percent this year, while even more specialized products like polycarbonate and nylon are up 10 percent.
To put it mildly, compounders are not amused.
“There's been unprecedented speeds and amounts in price increases,” PolyOne's Mitchell said. “The price increases are the effect of a traditional margin squeeze, but it's been impossible to pass it all along to our customers.”
As a result, PolyOne is in the process of consolidating its number of resin sources.
“We're getting co-specified on a number of materials and we'll re-evaluate that from year to year,” Mitchell explained. “We're looking to get down to the point where we have three or four suppliers of polyethylene and poly-propylene.”
“It takes a lot of time to pass on the increases,” added Cusolito at Washington Penn. “So instead of working on new projects, you spend time on raising prices. Some customers are very fair about paying increases, but some try to hold out on you as long as they can.”
High prices for additives such as titanium dioxide and carbon black also have pinched compounders in 2003. Both PolyOne and Ferro are looking into sourcing lower-cost additives from outside North America.
Schulman's Haines, a 35-year industry veteran, described 2003 as “an environment of low growth and competitive pricing that we've never experienced before.”
But Ridenour countered that the pricing picture is part of an expected — if painful — maturation process.
“We've seen a similar thing in the auto industry for a number of years,” he said. “[North American compounders] are crying about resins costs, material costs and how their customers are beating them up, but their products either aren't specialized enough or they don't have the economy of scale they need to remain competitive.”
Caught in a speed trap
North American auto production is expected to clock in at 15.9 million units this year, according to CSM Worldwide, a consulting firm in Northville, Mich. That represents a drop of more than 2 percent vs. 2003, and it creates another hurdle to profitability for North American compounders, many of which are involved heavily in the automotive market.
“We're concerned about automotive,” Ferro's Comanita said. “The market is saturated and there's just not as much consumer demand for new vehicles.”
Nonetheless, Ferro continues to work on getting its thermoplastic olefin compounds into instrument panel skins and other auto-focused PVC replacement oppor— tunities.
Cusolito estimates that Washington Penn's sales into the auto segment are down 5-7 percent this year.
For Lati USA, the market “has been steady, but a little weaker than we thought it would be,” said operations manager Ciro Longo.
“Some [automotive] customers have slowed down product introductions,” Longo said. “And we've had some struggles with existing accounts.”
The auto market “has been on a pretty good run for the last three or four years,” said LNP's Crew, who added that his firm still is seeing interest in safety-related and under-the-hood uses.
At Schulman, engineers are at work on a number of interior and exterior projects, such as film for fascias and several opportunities for PVC replacement, Haines said.
M&A gone AWOL
Given the sluggish market, it's not surprising that merger and acquisition activity is off among North American compounders.
There have not been any major deals since GE snagged LNP and ExxonMobil Chemical Co. bought the half of Advanced Elastomer Systems LP that it did not already own. Both of those deals went down in the first half of 2002.
“People are more concerned about cash flow and as a result they're seeing fewer opportunities in M&A,” Ferro's Comanita said.
“A lot of compounders are getting back to their knitting,” added Crew at LNP. “They're trying to grow organically rather than through acquisition.”
Ridenour, who has worked extensively in the M&A area, estimated that valuations of compounders with sales of $75 million or less have dropped in recent years.
PVC compounding businesses in that range have seen their value shrink from six times pretax earning to four times, while similar-size, polyolefin-based compounders now command only six times pretax earnings instead of eight times.
“Some buyers are still interested, but they're bargain hunting or looking for fill-ins or tuck-ins to their existing businesses,” Ridenour said.
Embers into flames?
For North American compounders, optimism is there in small amounts. It's tightly guarded, but it's there.
At Lati USA, sales are up 5 percent this year, thanks mostly to growth in nylon. The firm also has seen increased interest in compounds based on polybutylene terphthalate, according to Longo.
“We're hoping things will be better in the fourth quarter,” he said. “But no one is protected.”
Comanita cited renewed interest in Ferro's Nimex-brand metallic colorants in vacuum cleaners for Hoover Corp. and other products. Nondurable markets like packaging and semi-flexible products also have been improving, he said.
Accel's Morgan sees some hope in the simple fact that customer inventory reduction is “a finite practice.”
“At some point, customers will have to start buying again,” he said.
Comanita, for one, continues to believe in the inherent strength and value of the core product.
“If you provide something unique,” he said, “your customers can help you get through difficult times.”