Asia competition barometer petrochemicals and chemicals

Asia’s growing importance for corporate performance and global competitiveness 5 Case study: Tata Chemicals 12... •The number of players in Asia’s PeC sector has risen since 2004, thoug

An Economist Intelligence Unit report

Supported by

Asia’s growing importance for corporate performance and global competitiveness 5

Case study: Tata Chemicals 12

in key sectors and assessing the intensity of competition in them Drawing upon company-level data on profitability and other indicators, the Barometer quantifies the changing dynamics of competitiveness in Asia for select industries between 2004 and 2009

This report focuses on the Barometer findings for the petrochemicals and chemicals manufacturing (PeC) sector Assessing a universe of over 550 PeC companies that are publicly listed in eight countries—China, India, Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam—the Barometer examines changing profitability and the competition landscape for the sector

Other reports in this series look at the information technology services, pharmaceuticals, precision engineering, and transport and logistics sectors in Asia

February 2012

Preface

•The number of players in Asia’s PeC sector has risen since 2004, though recent consolidation suggests that this growth may be moderating The number and size of publicly-listed firms in the

PeC sector in Asia has increased dramatically, from 376 firms in 2004 to 549 in 2009 Total combined revenues more than doubled from US$113.2bn to US$256.3bn during the period However, with ongoing consolidation the growth in the number of firms may be moderating—from 2008 to 2009, the number

of publicly-listed PeC companies in Asia actually declined from 559 to 549 Meanwhile, in recognition of Asia’s increasing importance to the global PeC sector, foreign MNCs have been building up their presence

in the region The latter are increasingly viewing Asia not only as a key market but also a vital source of production

•Competition has decreased marginally, and large players are growing stronger Competition in the

PeC industry grew slightly between the years 2004 and 2007, largely due to an influx of new players into the sector However, between 2007 and 2009 the largest firms in the industry began to steadily increase their market share, partly by exploiting economies of scale With ongoing consolidation in the industry it seems likely that the bigger firms, with resources to invest in research and development, and seek out lower-cost sources of feedstock and energy, will continue to grow in dominance

•Despite a slight overall decline, profitability in the sector has remained relatively resilient Profit

margins for the PeC industry in 2009 have fallen slightly relative to 2004, and have generally fluctuated broadly in tandem with global economic growth The average gross margin of publicly-listed Asian firms declined from 21.5% in 2007 to 18.4% in 2008 This was largely due to a slowdown in demand amid the global economic downturn, and a spike in the cost of raw materials, such as oil, that year The average gross margin then bounced back to reach 21.4% by 2009 This was partly because of industry consolidation— when revenue growth slowed as a result of the crisis, the smaller players could not keep pace with large MNCs and state-owned companies, who were able to further exploit economies of scale and grow their market share In the coming years, profitability will be largely dependent on innovation, the ability to tap into markets that are relatively underpenetrated, and access to resources

•Access to resources has displaced low labour costs as the key driver of competitive advantage, disrupting traditional industry supply chains In a sector with little product differentiation, one of the

biggest profitability drivers is preferential access to low-cost energy and raw materials such as oil, natural gas, water, metals and minerals Industry supply chains are hence being reworked to tap resources in places such as the Middle East As a result, the sector is also seeing an increasing number of partnerships between MNCs with global networks and technological know-how, and local players, including state-owned firms, with access to resources Following steep rises in 2010-11, the EIU expects the prices of oil and non-oil commodities to moderate somewhat in 2012-16 Nevertheless, PeC firms will continue to compete fiercely for access to these resources, particularly given the supply constraints in many commodity markets

Asia’s growing importance for corporate

performance and global competitiveness

2 The PeC sector includes the following sub-segments: basic chemicals, fertilisers and nitrogen compounds, plastics and synthetic rubber in primary forms, pesticides and other agrochemical products, paints, varnishes and similar coatings, printing ink and mastics, soap and detergents, cleaning and polishing preparations, perfumes and toilet preparations, explosives, other chemical products and man-made fibres.

Figure 1: Share of world manufacturing output

South Korea ASEAN

China

2000 2009

Note: ASEAN here comprises Indonesia, Malaysia, The Philippines, Singapore, Thailand and Vietnam

Source: UNIDO

These new consumers have been spending on products such as cars and houses, which rely directly on the PeC sector for inputs Asia has some of the fastest growing automobile markets as well as some of the largest automobile manufacturers in the world In 2009, China overtook the United States as the world’s biggest car market Between 2011 and 2015, the EIU expects Asia to see 157.5m more passenger vehicles and 54.7m more commercial vehicles on its roads Rising vehicle sales have a direct and noticeable impact

on PeC sector performance, with a lag of about six months, according to Ramakrishnan Mukundan, the managing director of Tata Chemicals, an Indian chemicals manufacturer

On average, the production of one car requires about 155kg of polymers and other chemicals, valued at about US$2,300.4 Examples of chemical products used in automobile manufacturing include polypropylene, polyethylene, polycarbonate, polyvinyl chloride, polyester fabric, adhesives, primers, powder coatings, surface coating materials, paints and metal handling and polymer adhesives They are used in a whole variety of ways including dashboards (vents, gauges, dials and panelling), steering wheels, seats (armrests, headrests, foam), coatings for the outside of the vehicle, tyres, and foam for roofing, among others

Rising incomes in Asia have also led to a boom in the region’s construction sector, which uses a range

of PeC inputs, including cellulosics, whose market grew by 15% in 2011 “New construction is mainly driven by infrastructure and housing needs of countries with strong migration movements of young populations into urban economic centres,” Tilman Krauch, head of BASF’s construction chemicals division, was quoted as saying.5

The world market for construction chemicals is expected to grow at an annual average of 5% per annum from US$30.7bn in 2009 to US$39.2bn in 2014, according to SRI Consulting.6 China will account for much of this growth, with its market expanding by an annual average of 9% per annum from US$7.9bn

to US$12.1bn over that period To meet the growing demand, global companies are investing in Asia American firm Dow Construction Chemicals, for instance, plans to expand its cellulosic production capacity in Asia.7

In the area of infrastructure, many Asian economies, despite years of rapid growth, still face huge infrastructure deficits As a result, there is much public and private spending on roads, ports, bridges and other infrastructure, all of which require PeC inputs for their construction

Asia’s growing food consumption is another demand booster According to Mr Mukundan, agriculture and farm-related chemicals is the segment showing the “most robust growth” in terms of profitability

“The margin structures of fertiliser companies have been in keeping with food prices,” he adds

A third trend that will drive the PeC industry is the growing emphasis on sustainable development and alternative energy sources Chemical producer BASF sees “strong potential in solutions that contribute to sustainable development,” says Albert Heuser, the firm’s president for market and business development

in Asia Pacific For instance, BASF estimates that by 2020 the global market for its wind power products—including epoxy systems, core foams, advanced coatings and hydraulic fluids—will be worth some €300m (US$390m) Much of this segment’s growth will come from China, which is already the world’s largest wind power market

Competition and profitability at Asian firms

The number and size of publicly-listed firms in the PeC sector in Asia has increased dramatically, by 46%

between 2004 and 2009, from 376 firms to 549 Over the same period, the total combined revenue

of publicly-listed PeC companies more than doubled from US$113.2bn to US$256.3bn; these firms’ combined total assets rose from US$104.2bn to US$254.2bn

Competition: Declining since 2008

With many companies raising their expectations of Asia to deliver growth and profits, it is reasonable

to expect competition intensity in the region to increase To capture this intensity we have used the Herfindahl–Hirschman Index (HHI), which measures the market concentration of an industry’s largest firms HHI values can range from 0 (extremely fragmented market) to 1.0 (monopoly) Here we have multiplied the values by 100 to achieve a scale consistent with profitability indicators (see below) The HHI for Asia’s PeC industry increased slightly from 8.27 in 2004 to 8.48 in 2009, signifying that the

50 biggest firms in the Barometer saw a marginal increase in concentration between 2004 and 2009 (see Figure 2).8

Competition in the PeC industry grew between the years 2004 and 2007 The HHI dropped from 8.27

to 7.52 over that period, signifying that the market share of the 50 biggest firms declined This is largely because of an influx of new players into the sector—in those two years, 157 new Asian companies entered the industry, capturing much of the rapidly growing market

However, between 2007 and 2009, the largest firms in the industry began to steadily increase their concentration once again The HHI rose from 7.52 to 8.48 over that period This is mostly because

of the global economic slowdown’s impact on smaller firms in the region, and the resulting industry consolidation

Profitability in the PeC sector in Asia declined significantly in 2008 (see next section for more details), hurting smaller companies in particular Larger companies, who were flush with cash and had greater

Figure 2: Herfindahl–Hirschman Index

7.0 7.5 8.0 8.5 9.0

2009 2008

2007 2006

2005 2004

Source: Economist Intelligence Unit

flexibility to adjust production, were better able to weather the storm From 2008 to 2009, the number of publicly-listed PeC companies in Asia actually declined from 559 to 549

Mr Mukundan says that before the 2008-09 economic slowdown, several firms made big investments based on how they expected PeC supply chains to evolve “Some of these bets have gone wrong due to insufficient data, some due to inaction and some simply because of the way the markets turned,” he says Tata Chemicals used the crisis to examine its cost structures It decided to close a manufacturing plant in the Netherlands, and then acquired a salt business in the UK “Companies that sharpened their focus on cash came out with better balance sheets,” says Mr Mukundan Many firms were able to bounce back from the recession as “a lot of the belt-tightening happened fairly quickly”

Mr Mukundan believes that segments in the PeC sector are becoming more commoditised and the

“space to add an intangible or service component is getting shaved quickly” With the exception of a few cleaning agents, most PeC products are used as raw materials for the manufacture of other products As there is little differentiation in these products, economies of scale are important

Figure 3: Top ten companies by turnover Company Country of origin 2004 turnover (US$bn) 2009 turnover (US$bn)

The three largest companies by 2009 turnover (see Figure 3)— Indian Oil Corporation, Reliance Industries and Thai Oil Public Company —together account for almost half of the industry’s combined revenues

Mr Heuser at BASF says that larger firms have “a clear edge” over the competition as they can build on their existing global research and development (R&D) platforms Nevertheless, rivalry among the largest PeC firms remains extremely strong, and competition between them is likely to increase

Profitability: Slight overall decline

To measure the profitability of the PeC sector, we developed a composite index of five ratios that measures different aspects of a company’s margins (for more details, see the note on methodology at the end of this report) All profit margins for the PeC industry in 2009 have fallen slightly relative to 2004 (see Figure 4) Nevertheless, profitability has remained relatively resilient After hitting a low of 80.3 in 2008, the Profitability Index recovered to 105.0 in 2009, slightly lower than the level of 117.0 in 2004

In other words profitability has not fallen consistently, but has fluctuated broadly in tandem with global economic growth (see Figure 5) From 2005 to 2007, profitability rose slightly, before a steep

Figure 4: Profitability Index

80 90 100 110 120

2009 2008

2007 2006

2005 2004

Source: Economist Intelligence Unit

a different aspect of a company’s profitability For more information on the Barometer methodology, please refer to the last section

2004

Source: Economist Intelligence Unit

be negative for commodity prices However, loose global monetary conditions and a loss of confidence in sovereign creditworthiness, which is encouraging investors to seek returns in real assets, will offer some support to prices With global demand set to stabilise in 2015-16, commodity prices are expected to nudge higher

Figure 6: Commodity price forecasts

Case study: Tata Chemicals

Tata Chemicals: Competing to secure raw materials and energy

Over the next few years, Mr Mukundan expects PeC firms to compete across three dimensions “The first is a large focus on sustainability The second issue is innovation The third is how companies can implement the first two in order to harness what is referred to as the market at the bottom of the pyramid,” he says, referring to emerging markets in Asia, Latin America and Africa In this regard, Asian companies have an advantage as “they have a touch and feel” of this market Mr Mukundan believes these three factors will be the key drivers of profitability

However, Mr Mukundan stresses that underlying the three dimensions of competitiveness—innovation, sustainability and untapped markets—is preferential access to energy and feedstock

“Firms have to reach out and get that advantage,” he says, pointing out that these input cost arbitrage opportunities have grown over the last few years

Positioning for success in Asia

Asia remains vital both as a market and as a production source

2020 2015

2010 1995

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