Outlook for film & sheet: gradual demand growth

The base-case outlook for the film and sheet segments of the plastics industry in the coming months is mixed. There are some positive forces in the market which should support demand for these products. But there are also some negative forces which will constrain growth in the near term.

If I were to draw a graph of the overall trend in film and sheet demand during the coming year, it would be mostly flat.

Now, lest you think I am contributing to the spate of negative sentiment that has emerged in recent weeks, allow me to clarify. A forecast of "mostly flat" is not too bad considering we have been trending mostly higher for the past 10 years. I will gladly take another decade of a trend which can be described as 10 years of gradual increases interspersed with a few quarters of mostly flat.

The plastics film and sheet sectors are large and highly fragmented categories with a lot of products and end markets. So, there will be some divergence in the growth rates among the various segments and companies that comprise this category. But there are some prevailing macroeconomic trends and risks, which will likely be of interest to almost everybody in the industry.

To arrive at my "mixed" outlook, it means there are some downside risks, so I will address these first. The most significant is the fact that the U.S. manufacturing sector and the plastics industry are both in a period of modest cyclical contraction. For the plastics industry, the downtrend began in the first quarter of this year, and for the year to date, the industry is down just a bit more than 1 percent on average.

Most segments of the film and sheet sector have been negatively affected this year by the downward pull of the mild contraction in the overall manufacturing sector, but there are a couple of other factors weighing on some film and sheet markets. The first is the rise in the value of the U.S. dollar so far in 2019. Exports of film and sheet products are a small part of the total market for U.S. processors, but the recent slowdown in global trade combined with the strengthening of the dollar are a negative factor.

The second negative factor for some segments of the film and sheet sector is the deselection of certain types of plastics products. I have not yet seen any good data on the impact of bag bans and other efforts to limit the consumption of certain plastics products, but I cannot ignore this risk in my outlook for the industry.

Now for the good news. I cannot yet say the contraction phase in the plastics industry data is over, but there is increasing evidence we are either at or very near the bottom. One of the best leading indicators for the film and sheet sector is the trend in U.S. retail sales, and particularly retail sales at grocery stores.

I have generated a rate of change chart from the monthly grocery store data provided by the Census Bureau. I would guess most people assume grocery store sales correlate with population growth, and they do. But as this graph illustrates, there is also a clear cyclical pattern in the data. This cyclical pattern corresponds closely with the cyclical pattern in the plastics products data. This means that the growth rate in demand for film and sheet products is strongest when the curve for the retail sales data is headed upward or near the peak.

It is clear the latest peak in the growth cycle for the grocery store data occurred at the end of last year, and the trend has been steadily downward so far in 2019. But if you look closely, the slope of the curve has flattened in the past couple of months. So this might just represent the bottom of the latest contraction phase in the grocery store data, and this would likely occur just before the cyclical bottom in the curve for the plastics products data.

If we take a longer-term look at this data, the average annual rate of growth in grocery store sales during the past 10 years is just over 3 percent. Adjusting for inflation gives us a real growth rate between 1-2 percent per year. This is comparable to the average rate of growth for many segments of the packaging industry during the past decade.

I think it is also worth noting that this pattern of slow, but steady, growth is one of the main contributors to the rising trend of mergers and acquisitions in the film and sheet sector. The lack of volatility in these data mitigates risk for potential investors. When you combine this low volatility with low interest rates and stable resins costs, which are also at relatively low levels, then scalable businesses become even more attractive to investors.

And all these recent trends in the grocery and plastics industries are currently occurring in an overall economic environment in which the stock and bond markets are performing well, interest and inflation rates are low, and wage and income data are gradually accelerating.

These factors should continue to support demand for film and sheet products during the next few quarters, and this should be enough to offset the negatives.