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Economic Outlook and Trends
   by Jeff Mengel, Plante & Moran
       Winter  2009
  
2008 began with resin cost increases of as much as 40 percent. Many processors sought price concessions from customers, even in industries that were loathe to adjusting purchase orders. Soon after the resin markets topped out in September, they fell to prices not seen since before Hurricane Katrina. The hope for those who hadn’t received price concessions was to capitalize on the lower resin costs. Unfortunately, the production levels for almost every industry shrank in the last quarter and, for some industries (auto, appliance, and construction), the production volumes plummeted.

The response by many in the industry has been to right-size the variable costs to match the current/projected production levels. However, the fixed costs of operating a plastics processing company are quite high. It’s doubtful that anyone can cut fixed costs in a timely and meaningful manner. The result will likely be losses for many in the plastics industry, particularly those serving industries that don’t reasonably provide for resin costs adjustment. Furthermore, any processor with a bank-leveraged balance sheet will likely see covenant defaults in the first quarter of 2009.

The good news is that the economy is affecting everyone in the industry. The bad news is that not everyone will be viewed the same way by the banks. Those with little or no leverage will be able to use their balance sheets as competitive weapons. Those with good operations but covenant violations will likely have their debts re-priced at higher risk-rated interest rates. And those with poor operations and covenant violations may have difficulty receiving continued funding from their banks.

Our industry study has showed that since 1995, 25 percent of plastics processors have been less than stellar performers. Tool shops suffered even more, with 40 percent being very highly leveraged. The latest 2008 study highlighted the fact that larger companies had a harder time of adapting – they had more at risk with customers and wouldn’t rock the boat unless it was capsizing. (It’s safe to say that in the first quarter of 2009 there will be a fair number of boats capsized!) Unfortunately, many industries are in survival mode and will show very little patience with highly leveraged, underperforming suppliers. The customers may act faster than the financial institutions with poor performers.

So what should processors anticipate in 2009?

  • More bankruptcy reorganizations with fewer businesses successfully emerging from bankruptcy.
  • Fallout from one industry will affect the viability of others; entrepreneurs don’t give up easily and will seek out alternative industries to stay afloat.
  • Mezzanine lenders will be taking a lead role in some private equity-owned processors; as the value of the equity investment nears zero, the private equity fund will be less likely to risk additional funds.
  • More strategic acquisitions, but not at a premium; strong operating companies with strong balance sheets will have a buyer’s market.
  • Many processors will go into hibernation, yielding limited new investments, substantial headcount reductions, and substantial reduction in other variable costs (training, selling, and R&D).

The processing industry will likely react in one of the following ways:

Bunker Mentality — The bunker approach is to restrict all investments, cut costs to the bone, and wait for recovery. This may be a fine option if you have no ‘dry powder,’ emotionally or financially, to invest in a new direction. However, it doesn’t consider your customers’ current needs or competitors’ positions. You’ll be missing out on opportunities to take market share and will probably lose market share. This approach will likely become more dominant the longer the recession remains.

Aggressive Action — The opposite of the bunker mentality is to seize market share through acquisition and competitor poaching. Acquisitions include new facilities (new geographic areas) or new processing skills (including talent upgrades). Competitor poaching includes aggressively pricing existing competitors’ jobs to either impair their ability to survive and/or to selectively secure jobs by opening up new markets. The financially stable company can pursue this strategy. However, be mindful of competitor retaliation, as wounded competitors can be dangerous. Also, this approach doesn’t consider that a customer’s current value proposition may be different in today’s economy than in a future expanding economy.

Strategic Action — A strategy should have a value proposition that resonates with your customers’ needs and your processing skills, while also considering your competitors’ positions. The current economy has changed some, if not all, of these attributes. Customer value propositions should be rethought considering their current competitive orientation. Since your competitors may be in hibernation, this also is a good time for potential customers to take notice of you. Most of all, it’s a good time to invest time to make your organization stronger technically and to think outside the box regarding how to process more efficiently. Radical new approaches to more efficient production may now get approval from customers that was previously withheld.

Who will win in the long run? Clearly, those with strong balance sheets have the luxury of aggressive investments. However, those who tweak their strategies to fit the current economy will ultimately prevail, not those emotionally reacting to the economy. Strategic planning and execution can still occur with limited capital. In fact, most strategic initiatives are internally focused to make the organization stronger.

Plastics Processor Survey
To understand the actions that companies will be taking, as well as their results, Plante & Moran will be surveying 20 processors that are highly leveraged (more than 4 to 1 debt to equity position) and 20 processors with low leverage (less than 2 to 1 debt to equity position) to see how they’re coping with the current economic condition. Our survey will identify:

  1. Volume reduction – year-to-year sales same customer, new customers, customer concentration, industry concentration
  2. Cost reductions – headcount and value add (sales less material and outside processing costs) trends
  3. Debt restructuring – debt to equity ratio and debt coverage trends
  4. Investment spending – trends in level of investment spending as a percentage of sales/net assets

We hope to identify whether any industries are more affected than others; whether size is a factor; whether companies that invest are anticipating a better year; and whether companies that are cutting back the deepest are ahead of the game. We’ll share our conclusions with the participating companies and make public the results. If you’re interested in participating in the survey, please contact me at jeff.mengel@plantemoran.com.

Jeff Mengel is a partner and plastics industry practice leader at Plante & Moran. He can be contacted at (312) 602-3515 or jeff.mengel@plantemoran.com.