THE CRITICAL CHANGES FACING THE CHEMICAL INDUSTRY IN THE WAKE OF THE GLOBAL PANDEMIC

Kevin Duffy, senior valuation director at Hilco Valuation Services joins Steve Katz to discuss the critical changes facing the chemical industry in the wake of the global pandemic and how demand levels and industries ranging from automotive to packaging are affecting that overall landscape.

Transcript

Steve Katz  0:08  
Hello again and welcome to the Hilco Global Smarter Perspective podcast series. I'm your host, Steve Katz. Today we're speaking with Kevin Duffy, senior valuation director at Hilco Valuation Services about the critical changes facing the chemical industry in the wake of the global pandemic and how demand levels and industries ranging from automotive to packaging are affecting that overall landscape. Just as a little quick background, Hilco Valuation Services is the leader in valuation for the chemical industry with more than 300 appraisals delivered on asset values ranging from 10 million to over $1 billion. The company works closely with the management consulting team at Hilco Performance Solutions to provide a wide range of manufacturing operations supply chain people, M&A and commercial expertise to the chemical industry. With that said, welcome to the podcast, Kevin.

Kevin Duffy  0:54  
Steve, great to be here today.

Steve Katz  0:56  
Well, we're glad you can join us. I know, Kevin, that Q3 earnings season is upon us for several large U.S. based chemical companies. And although there may be some improvement over Q2 and preliminarily, forecasts overall, aren't looking notably more promising than they were. So I'd like to spend our time today talking with you about what you've quite cleverly called the good, the bad, and the ugly of the chemical industry in this quote, unquote, age of COVID-19. And let's start with the industries that fall into the good demand performance category beginning with packaging, what are you and the team seeing there?

Kevin Duffy  1:30  
The major drivers of that is an increase of e-commerce over people going to brick and mortar stores. Every one of those products that go out the door need to be packaged.  In the world of chemicals, that includes items like tape, film, and then like little styrofoam balls. I saw on the news the other day, they're calling it "Shipageddon." This packaging season, they're projecting something like seven and a half million more packages a day during the holiday season this year. Another major driver of the increase in chemicals in packaging is social distancing and hygiene-related uses of packaging. An example of this would be packaged utensils that you get from a restaurant or even the grocery store, as opposed to just having non-packaged utensils. Additionally, kind of along the same grocery store theme, you're seeing things like packaged salads and prepared foods over where you might have seen like a salad bar previously. And then when you get to the stores, there's been also an increased use of plastic bags over you know the trendy recycled bags as we're seeing these bags as having that better hygiene. And then another area that we've seen a lot of chemicals used, I think everyone can attest to this, that there's an increased use of plastic partitions, whether it's at your office or the store, they're kind of everywhere now. So you know, all those plastic partitions are all made out of chemicals. Plastic packaging is pretty strong and a lot of the industries that have seen increased use of packaging are food and beverage like we've talked about dairy, homecare, and healthcare. Packaging continues to be strong, and it looks to be strong going out into the future.

Steve Katz  3:14  
Yeah, interesting, right. So I think we've all seen that, that increase in the use of these containers or is bringing things back from the from their favorite restaurants, grocery stores are putting food now in some of that packaging. So quite a bit of that in addition to the partitions that you talked about. So yeah, makes a lot of sense. So in addition to packaging, you also identified medical health care as part of your good demand performance category. And I read recently that medical equipment and supplies in the U.S. are now made from roughly I think 50% plastic, which I have to say surprise me quite a bit. Clearly the need for personal protective equipment right now is a contributing factor to medical healthcare falling into that good category. But what else is helping to drive demand there during the pandemic?

Kevin Duffy  3:57  
So yes, the PPE is definitely one and the chemicals, nylon, and masks most of those masks that everyone wears are actually made out of chemicals, rubber, and gloves, those little face shields. And then not PPE, but one of the drivers in the general chemical industry would be thermometers. They now have your temperature everywhere you go. But both industrial thermometers and personal thermometers are an example that has seen extreme increases in medical supplies. I've actually done a valuation that had  thermometers and health equipment and their sales this year were the highest sales they've ever had. It's kind of funny because the pandemic has definitely impacted things very strongly and some very weakly. Some of the volume increase in the chemical industry is expected to likely stay. One of the drivers of the increased usage are things like cleaning supplies and sanitizers, which most of those are petroleum-based. Both cleaning supplies and the PPE are likely to stick around a little bit longer than this virus. Some of it may be an increase in volumes that may stay around forever. This is kind of related to the packaging side of the world but also relates to medical as well. Things that have been packaged in aluminum have had to change to be packaged by plastics because there has been an aluminum shortage during this time. Many drink bottles, as well as that are packaged in metal containers that are now being packaged to plastic, at least for the short term as there's a limited supply of aluminum. And then not everything is roses in the medical world though.  I did an evaluation of a pigment manufacturer Ti02 manufacturer, and I found it funny that one of their product areas that they were having problems with actually related to dyes that went into haircare. As people can't go into the hairstylist, so people weren't dyeing their hair as much these days. So even within the industries that are doing well, there's definitely some good news and bad news stories everywhere. 

Steve Katz  6:02  
Okay, well, let's look at the flip side of that for a minute, then. I know it's a well known fact that the automotive industry has continued to consume increasing quantities of petrochemicals as it's worked to make vehicles lighter and more fuel efficient over the years, I see that automotive is in your bad category for demand performance right now. What are you seeing there?

Kevin Duffy  6:19  
All right, yeah, automotive sales on the year are down about 20% year over year. A big driver of that relates to shutdowns and pretty significant slowdowns during the first few months of COVID. And auto sales now we're seeing have recovered significantly. But that said they have not recovered to pre-COVID levels. They're projected to be down for the total year 20% likely not to get back to pre-COVID levels until the middle of next year. That said, the sales of automotives were already down. They hit a high in about 2017, and they had fell in '18, fell in '19, and were kind of projected down that continual slide. Actually what's happened is it's kind of reversed, auto sales are not continued to come back to that 2017 level. How that impacts the world of chemicals is 17% of all plastic sales are projected to go into the automotive industry.  It's projected that about more than one-third of the average raw material cost of the vehicle is a plastic or petrochemical-based chemical. This decrease in volume obviously impacts the chemical industry as volumes are down drivers of the uses of chemicals are plastics. And those are things like polypropylene, PVC, different nylons, urethanes, and a significant number of resins. Braskem, which is a major supplier of polypropylene resin to the automotive industry. Their sales bottomed out at about 20% down from the pre-COVID levels and that's as far down as they got and then they've been coming back. So the suppliers into the automotive industry at 20% levels, probably a good number for how bad things got. So ultimately not that bad since it was a short period.

Steve Katz  8:20  
Okay, pretty much the same question, I guess for aerospace, which you've also cited in your bad demand performance category. The commercial airline industry, which is a huge piece of aerospace overall, has obviously been devastated by the crisis. And I'd be willing to bet that at least some of our listeners would be surprised to learn just how pervasive the use of chemicals and chemical based polymers is in aviation products and maintenance, because I know that I really was.  So with that in mind, what detail can you provide about why the hit that aerospace has taken to such a significant and concerning development for the chemical industry, and whether you see any signs of potential improvement on the horizon there?

Kevin Duffy  8:55  
Sure. So aerospace has been hit hard, as the number of passengers have basically evaporated from where it was at. The size of the chemical market with just plastics is over $770 million and then there's other coatings and other chemicals that are used. So just the plastics into the aerospace industries is about $770 million so it's a significant amount of consumption. The demand for new planes has essentially evaporated. But most planes are tied to committed orders and payments that are made throughout the production process. It's the planes that are being manufactured now are all have committed orders tied to them. It is very difficult to get those orders canceled to have been deferred pretty much as long as they can be in many cases, up to five years. And I do know that some of the contracts have been canceled, which is tough for the suppliers. Right now the plane producers are making more planes than they are shipping to their customers. So it's a little bit of an offset as the impact of the suppliers to the industry are not hit as badly as the sales to the industry are. But that's a pretty thin silver lining. Chemical companies with a large presence in the aerospace industry include 3M, BASF, ExxonMobil, Sherwin-Williams, among others. A positive side to the airline industry, which is devastated right now, is that airlines are assuring passengers flying on airplanes is safe. On the news the other day, I think they put out a report that said something like the virus stays airborne in a plane at significantly lower levels than it would in your house. Basically pointing out stories that flying on planes is safe, which is good because it's going to push more plane and help this industry get back to some sort of normalized level. Another potential positive side for the chemicals industry to the airline industry relates to kind of some of the health and PPE side of things that we talked about earlier. As airlines are trying to get planes, they're putting in more sanitizing and hygiene measures just like everywhere else. So that side is helping the chemical industry. But from a long-term perspective, this is going to take a long time to sort out and is in my opinion, one of the most heavily hit industries in this pandemic also throw in the hospitality industry of restaurants and hotels. Long-term on a positive side and this is for both planes and automotive is that both automotive and aerospace have a trend called lightweighting, which essentially, they try to adjust the cost and weight of their planes and automobiles to be more efficient. And generally, this results in the usage of some sort of chemical replacement material. And in the world of airplanes, they use higher usage of carbon fiber to make the plane is the best current example of higher usage of chemicals in the airline industry. It's going to be a tough slide. This one's probably taken one of the largest hits in the face in this pandemic.

Steve Katz  12:19  
That's for sure. Absolutely. All right, let's move to what you have, quote unquote, called the "ugly" in your good, bad and ugly assessment of the situation, which is the economy itself. And I guess that certainly isn't surprising based on what's going on right now. So to wrap us up today, if you would, I'd like to get your thoughts on the uncertainty related to the economy, and also on how job loss such as since we were talking about it, the massive layoffs we've just seen in the airlines, as well as business closures and any other factors you've identified, are likely to play in the recovery curve for the chemical industry moving at.

Kevin Duffy  12:57  
Yes, great. In Q2 the economy contracted at an annualized rate of over 30% has been coming back strong since then. There is a reported 3.4 million permanent job losses through August, which is up 2.1 million since February. Well as a significant number of small businesses closing, some of those closures are for short-term since the government, many governments won't allow any customers. But unfortunately, more than half of those small business closures are permanent.  Future stimulus is unknown. Many people have blown through what they have. I was talking to one of my friends the other day who unfortunately just opened up a restaurant, he is still working through the PPP money. He said many of his friends in the industry have blown through that money and are unfortunately getting closer and closer to having their businesses fail. And unfortunately, that story is going to be true everywhere. How that's going to hit the economy? It can't be good. Although today it's interesting because we're seeing strong retail spending. As you know, places like people were spending on movies and restaurants and especially vacations are moving to things like higher retail sales and higher required sales and even higher automotive sales. I have a friend who has a luxury car dealership and that part of the economy's doing fine. He said that he ran out of his BMWs and Porsches attributed that too many people spending their money on cars. Additional losses and jobs cannot help the economy and I just don't think that we've seen the full impact yet. So there's a lot of noise in a lot of different directions that will take a long time to fix.  In automotive and aerospace we're projecting the long term to be that which in automotive is not bad because it's coming back to more normalized levels. So aerospace is definitely from a chemical industry perspective, one of the worst industries hit.

Steve Katz  15:03  
Okay. Well, great perspective, particularly on those pockets of demand that are helping to sustain the industry right now, but certainly many challenges ahead into 2021, as Kevin has indicated.  And given that for those asset based lenders and others involved in the chemical industry who've been listening in today, if you have questions or concerns pertaining to portfolio or business exposure in this area, we encourage you to reach out to Kevin and the Hilco Valuation team who can also get the management consultants at Hilco Performance Solutions involved in that conversation if the need requires. Kevin's email is kduffy@hilcoglobal.com that's kduffy@hilcoglobal.com. Kevin, thanks again for joining us.

Kevin Duffy  15:41  
It was my pleasure, Steve. Thank You.

Steve Katz  15:43  
You bet. And listeners. We hope that today's Hilco Global Smarter Perspective podcast provided you with at least one key takeaway that you can put to good use in your business or share with a colleague a client to help make them that much more successful moving forward. Until next time for Hilco Global, I'm Steve Katz.