Analyst Jeff Mengel thinks about 15 percent of North American plastics processors could enter bankruptcy liquidation over the next 18 months — that's around 1,000 companies.
Leverage will be the big reason. “It isn't all about having good management. It's also currently about having good liquidity. And we need to have both of these,” Mengel said at the Plastics News Executive Forum in Summerlin. He said about 30 percent of the industry is heavily leveraged.
Mengel said the real bloodletting will start to hit in April and May, after the end of the first quarter of 2009. That's when banks will scrutinize loans for violations of terms, known as covenants, and begin to take action.
Mengel, a partner with Plante & Moran PLLC, revealed results of a survey to examine the impact of debt on the strategies of processors, under the current economic conditions.
The credit crunch has hurt companies' ability to reorganize. “It's been really difficult to refinance,” Mengel said in his March 2 presentation to kick off the Executive Forum. Even so, he said, banks have seemed a little hesitant to push loan covenants in early 2009, maybe because of political pressure.
“This first quarter was just a giant holding-your-breath period,” he said.
But banks could be ready to exhale — leading to a wave of tool transfers as weak processors face liquidity problems, he said. Customers will be forced to act and pull molds from custom injection molders that get into trouble.
“I think it's going to be just a matter of time before some of the banks take action and, customers take action. I'm talking about the next several weeks. And that's when we're going to start seeing the transfer tools,” Mengel said.
Forum attendees heard some eye-popping numbers, looking forward through June 2010. The ranks of custom processing establishments will shrink by 15 percent, from 7,800 to about 6,800. Although only a modest number of tools got yanked last year, Mengel said a whopping 360,000 tools will be moving around. Of that total, 240,000 tools will come from liquidated companies; customers will move another 120,000 tools to stronger suppliers.
Some customers will move proactively to reduce their base of plastics suppliers, looking for financially solid processors.
Even reorganizing under Chapter 11 bankruptcy is not easy today, Mengel said.
“The problem with bankruptcy is, the ability to reorganize has really been difficult in this economy. Debt financing is down, so how many companies that go into bankruptcy are able to get out of bankruptcy? We'll have to wait and see,” he said.
Mengel heads Plante & Moran's North American plastics industry studies. The most recent, for 2008, covered 172 companies. Plante & Moran picked 40 of them for a follow-up survey on debt — 20 highly leveraged companies had a debt-to-equity ratio of more than 4-to-1, and the other 20 had low leverage of less than 1-to-1.
Here are some results:
* The majority of high-leverage companies have greater than 90 percent of their sales from shoot-and-ship business.
* So far, for both high- and low-leverage processors, there has not been a significant change in market focus. Mengel did not find automotive molders jumping into other areas, for example.
* Low-leverage companies have beefed up tooling capability and marketing efforts to grab the coming transfer work.
* Low-leverage processors are upgrading internal sales forces, while high-leverage players are hiring outside sales representatives who work on commission.
* Low-leverage companies are using their strong balance sheets to get discounts from vendors.
* Low-leverage companies have cut employees more aggressively than firms with lots of debt, a fact that surprised Mengel. They have made selective layoffs and closed plants, while highly leveraged processors have tended to cut expenses by imposing pay cuts and reducing the number of paid vacations.
* Processors with low debt are still buying some machinery. “The highly leveraged companies have ceased buying equipment whatsoever. They just stopped,” Mengel said.
* Many of the highly leveraged companies are in default of their loan covenants, although they have done an excellent job of reducing expenses and paying debt. Mengel said the automotive plastics business got hit hard beginning in November and December. But now the downturn is broader than just automotive.
“The durable-goods market has been hit big-time,” Mengel said.