CHEMARK Interviews Dan Watson of Blairgowrie Associates
Gary Shawhan, Phil Phillips Contributing Editors
The CHEMARK Consulting Group
The Covid 19 pandemic has impacted everyone connected with the coatings market in some way both personally and professionally. China, who was centerstage at the outset of this crisis, along with the rest of the APAC region represents the largest and fasted growing part of the global coating market. In light of the pandemics, it seemed an appropriate time to get a current look at its impact on the market situation and business climate in China and the APAC region.
To get this closer look, we approached Dan Watson the owner of Blairgowrie Associates, who has been actively involved in the coatings and specialty chemicals markets in China and throughout the Asia Pacific region for over 30 years. Dan shared valuable insight into the current market situation in this region and a view of what the future may bring post-Covid 19.
Coatings World: Dan, how has the Coronavirus impacted the Chinese economy?
China’s GDP shrunk 6.8 % in the last quarter as compared with a year earlier. The country’s chemical manufacturing output declined by 21 % and profits by 66% in the first two months of 2020 due to the Chinese coronavirus.
With the virus now under more control in China (according to Chinese government sources), the country hopes to improve these figures during the second half of 2020.
Coatings World: Considering the impact of Covid 19, what is the prognosis for the Chinese economy going forward?
The country’s economy is growing much more slowly now (GDP growth has recently been about 6%, according to the government, compared with 10% in 2003). The banking system is far more fragile and laden with debt.
Last winter, credit had dried up for the private sector which is where most of the country’s growth comes from. Consumers spending also dramatically slowed. These events are not tied to the trade conflicts with the US.
In May of last year, Chinese regulators had to bail-out a bank (Baoshang Bank) for the first time in decades. A few more bail outs followed. Suddenly banks became scared to lend to each other. By June, the Chinese Communist Party was forced to gather all the banks, together and tell them to get their acts together.
The message was simple- grow a backbone and start to trust and cooperate with each other (a concept the bankers had lost familiarity with during the state’s post-crisis credit spree). It is no surprise that the creditworthiness of the Chinese banking system has been trending downward, especially at the lower end.
Coatings World: How is the banking system handling the Coronavirus situation now?
Because of the coronavirus, China’ weakened banking system — slightly more than one year later — will now have to forgive loans for companies large and small and continue financing local governments dealing with the fallout from stagnating economies their efforts to fight the coronavirus. S&P research estimated that if this crisis is prolonged, bad debt in the banking system could increase from 2% at the end of last year to over 6%.
What the Chinese coronavirus did to China was to highlight all the weak spots in the economy. No doubt, China will eventually emerge from all of this but, like the rest of us, they will not be the same as they were prior to the emergence of the Chinese coronavirus.
Coatings World: Dan, what can you tell us about the current business situation within the Chinese chemical manufacturing community?
The chemical industry in China is one of the most dominant industry sectors around the globe. According to a Cefic (European Chemical Industry Council) report titled ‘2020 Facts and Figures of the European Chemical Industry’, China is the largest chemicals producer in the world. In 2018 China contributed 35.8% to global chemical sales.
In the first two months of 2020, chemical manufacturing output declined by 21% and profits by 66% due to the coronavirus scenario, according to the National Bureau of Statistics of China.
As of today, although China has opened up to the world as the number of Covid-19 cases has dwindled (according to Chinese government sources), the damage has already been done.
Table 1: A few Chemical Industry Manufacturing Highlights
- By the end of February, most chemical plants had resumed operations
- The lack of domestic and international orders forced these facilities to operate below capacity.
- Dow’ largest facility in Jiangsu Province, continued to operate during the pandemic and was suffered little impact on output during this period
- BASF plants, which produce critical raw materials used to fight Covid 19 continued to operate during the crisis with other plants re-opening in February.
- Eastman Chemical Company’s plant in Wuhan, which produces benzoates and benzoic acid was shut down during the crisis
- Supply chain disruptions within China also resulted from the virus. Intermediates needed to support manufacturing of products in China were not allowed into certain plant halting production operations
Coatings World: How does Blairgowrie see the market demand for coatings in the region going forward?
Asia Pacific is the largest global coating/adhesive market. Although two countries (China and India) account for 78% of the total volume there are more than 50 countries in APAC with most of them showing higher growth than the U.S. or Europe.
Notwithstanding the impact of the Coronavirus the regions was set to see a vibrant growth in 2020. Obviously, that won’t happen now.
Automotive production has declined in all producing countries combined with automotive parts. As such, China alone may see a decline of up to 1 million vehicles this year. Hundai, Nissan, etc. are also forecasting a steep decline in production.
The real estate market has also been impacted with fewer home being constructed and a curtailment of home renovation due mostly to a lack of available labor under the lockdown in key countries.
All of this decline, across a variety of markets, has negatively impacted the GDP of key countries such as China, India, Korea, and Japan. With the exception of China, all are forecasting a lower GDP for 2020.
Although a devastating occurrence, the coronavirus has to be looked at as a short term happening. Like SARS, H1N1, etc. it will eventually be abated with vaccines and treatment and the global/regional economies will return to a more optimistic level.
I remain convinced that APAC, led by China and India, still represents the leaders in the global coatings market. I do not believe that the APAC market will return to its normal, robust, and healthy growth in the short term but will, over the next 2-3 years, enjoy a healthy resurgence akin to what was happening pre-virus.
China will once again become the largest producer of Automobiles; Architectural coatings will continue to migrate to waterborne and more UV/High Solids coatings will be used in the industrial segments. Over the past decade, the APAC market was changing to a performance driven market which was increasing the value of coatings in that part of the world. That trend should continue. There is lots of “new growth” remaining to be captured in APAC.
Coatings World: Dan, how do you see the current business situation with regard to coatings and adhesive manufacturing in China?
The Asia/Pacific (APAC) region consists of more than 50 countries, the combined coatings production of which represents 53% of the volume and 47% of the value, of the global coatings industry.
Unlike North America, Latin America or Europe, the APAC region is not homogeneous with regards to cultures, history, languages, or economic development. Even more to specific, the size, maturity, technology needs, and growth rates of each country’s coatings market is unique from each other. Of the more than 50 countries in this region, just four represent slightly greater than 87% of the entire region’s total coatings demand in both volume and value:
- China (59+% of regional volume; 60+% of regional value)
- India (18% of regional volume; 12% of regional value)
- Japan (6% of regional volume; 8% of regional value)
- South Korea (4% of regional volume; 6% of regional value).
China has 60% of the entire coatings volume of APAC. As such, China is clearly the most important coatings producer and user in the region. India (with 18% of regional volume) a distant second.
To understand the size situation, China has 32% of the global market volume while North America has only 13%. This relationship changes a bit if we look at global market value where China has 28% of the global value compared to North America with 18%.
Prior to the coronavirus debacle, coatings in China were projected to grow at a rate of about 6.2% compared to 2.5% for North America. Obviously, the pandemic has changed all these projections for 2020.
Coatings World: How do you see the future for China as a global leader in the coatings market?
CHINA has maintained its global coatings leadership position for two important reasons:
- It is a leading manufacturer of coated goods for countries throughout the world, particularly the United States and western Europe.
- It is responding to increased domestic consumption as it and its component countries raise their standards of living.
The pandemic has hit China and APAC fairly hard in numerous areas. On the surface, it would appear that China has been somewhat successful in keeping the virus restricted its area of origin (i.e., Wuhan). However, given the lack of transparency and verification, it is difficult to determine the true impact of the virus inside China. What we do know comes from Chinese business reports.
Citing the impact of the coronavirus epidemic, China’s largest auto manufacturing group warned in mid-May that new vehicle sales could fall more than 10% in the first six months of 2020 and by about 5% for the full year. This could amount to one million vehicles not being produced. However, it goes further than that, Hyundai is suspending production in its South Korean plants because of a shortage of Chinese-made parts, and even European car manufacturers could be hit.
In essence, the supply chain in all industries has been impacted and that affects not only Chinese producers but the rest of the world that depends on Chinese manufactured parts. There are a lot of unverified rumors that China has reopened and operating today.
Coatings World: Dan how what has been the impact on market demand for coatings and adhesive products?
According to most reports, 91% of the more than 500 Chinese companies recently surveyed had reopened by early May, and about three-quarters were working on-site again, but just 42% were able to operate at more than half their capacity.
Worse, demand for goods and services from Chinese companies has plummeted. Foreign orders have fallen more than twice as fast as domestic ones, with orders from the U.S. contracting the most among China’s major trading partners. With all of this happening, the Chinese government has not yet admitted that they’re not likely to hit their 6% GDP growth target for 2020, even though “mathematically that cannot be reached in any scenario”. The simple fact is that information released by China will most likely have been massaged to feed an official narrative.
From my perspective, the coatings and adhesive market in China will see a tepid pace of activity for the remainder of 2020. China relies on a strong and vibrant export market as its domestic market is still evolving. The coronavirus has essentially shrunk the single largest source of economic growth for the Chinese and that won’t change in the near term.
In addition to the lack of domestic and global market demand, you now have countries like the U.S. confronting China about the manner in which they handled the Coronavirus outbreak. We have seen and will see more political posturing on all sides combined with a lot of finger pointing.
In the U.S., there is a bipartisan push to craft bills that will decrease U.S. reliance on China-made products. The medical supply chain and defense related goods are top of the list of products to move back to the U.S. to produce. There is talk in Washington to provide financial incentives (up front relocation cost or tax breaks) for any company who wishes to shut down in China and return to the U.S. It is a bit unfortunate that some high-level Chinese officials apparently threatened to withhold medical drug shipments to the U.S. That action is being used to justify this latest “produce in the U.S.” campaign.
I consider most of this back and forth to merely be sabre rattling by both sides. There is a bigger question to address, “what happens to the trade deal between China and the U.S.”?
Coatings World: How has the Covid 19 situation impacted investors?
Considering all the comments in this note, I think some investors will be a bit more cautious about further investments in China. Of course, as history has shown many times before, long term the Chinese economy will improve as will the U.S. and Europe. China has weathered several major economic upheavals and most likely will emerge from this one in good shape.
For the “long term investor” China represents the only coatings/adhesive market that is truly growing. If you are a major paint producer (Industrial or Architectural coatings) you have to be inside China and inside the APAC region. The coronavirus may make an immediate decision a bit more difficult but long term, if China was your target pre-virus, it should remain a target post virus.
Coatings World: Dan, how does Blairgowrie see the M&A picture look for companies considering business expansion their business in the region?
Somewhat similar to the business sector, M&A activity in APAC hit a major decline as a result of the coronavirus. Asia dealmakers report a 7-year slump in M&A activity. (a decline of 20% in Q1).
Deal value across APAC, at $177.4 billion, was down 20% in the first three months of 2020 versus the same period a year earlier. Deals involving China, where the virus was first reported at the end of last year, dropped 16% and remain sluggish.
Bankers and other advisers, fearing a prolonged hiatus in headline mergers and acquisitions (M&As), are turning to other forms of activity as governments worldwide restrict movement to curb the spread of the virus, making travel and face-to-face meetings near-impossible. This trend is likely going to persist for the greater part of 2020. Based on feedback from various sources, there are numerous “bargains” available in APAC and especially inside China. However, few deals are being completed as potential buyers are concerned as whether or not today’s value if the right value to consider for a potential acquisition.
Some buyers are contemplating triggering material adverse change (MAC) clauses in deal agreements that can allow them to walk away, renegotiate or delay as prices fall, while others eyeing assets may want to have epidemic – or pandemic-related clauses added to contracts.
In APAC, one of the more aggressive buyers happens to be “CHINA”. Even as the Virus situation still exist in the region China is making overtures to acquire vulnerable assets around the region, especially in India.
Although not dead, the APAC will require a lot of time to return to any level of “normal,” in regard to Mergers and Acquisitions. For investors who are committed to be in APAC this will become a major stumbling block to their plans. Given the current “poor” relationship between the U.S./Europe with China, it is likely to curtail significant acquisition work inside China in the near term.
My opinion is that there may be a few acquisitions in the region/China in 2020 but serious return to pre-2020 levels will not happen until later.
Coatings World: Looking on the bright side, what do you see going forward for China’ chemical industry?
Despite these hurdles, some of the biggest players in the chemical industry are continuing their investments in the country with some mammoth projects. Table 2 highlight several examples of recent investment by offshore companies in China.
China has dominated the global chemical industry for the past two decades and this trend is expected to continue soon. Despite the many challenges which this country has faced, China remains a driving force in the world market.
Does this mean that the glory days are over for China and that investors should be more cautious when considering China as a growth objective and a site for future investment? Difficult to say at this point. It is clear that the U.S. will be taking a hard view at continuing to allow China to be the sole source of critical items such as pharmaceuticals, medical equipment, etc. I don’t think the attempt by Chinese leadership to blackmail the U.S. into silence was received very well by most U.S. citizens. You might say, the next move is sort of up to China, what they say and do will set the future tone and composition of any relationship that the U.S. and China might have.
Table 2: Examples of Recent Investment Activity in China
- In November 2019, BASF launched its ‘Smart Verbund’ project in Zhanjiang, China. The $10 billion dollar complex, scheduled to be completed in 2030, this plant is expected to be the third largest BASF site worldwide after Germany and Belgium.
- Towards the end of last year, Sinopec Sabic Tianjin Petrochemical, a 50/50 joint venture of China Petroleum & Chemical Corporation and Saudi Arabia Basic Industries Corporation (Sabic), announced plans to expand production from 1 to 1.3mm tons/yr., at their Tianjin Province plant.
- Exxon Mobil recently announced the construction of a petrochemical complex in Huizhou, Guangdong Province. The $10 billion-dollar complex is anticipated to produce 1.6 million tons of ethylene per year. The project is claimed to be one of the few major petrochemical projects in China to be wholly owned by a foreign investor
China doesn’t want to lose that position, but the coronavirus has weakened them in the eyes of the world.