By Jenny Ruth
Thursday 27th March 2008
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Resins manufacturer Nuplex surprised the market with its better-than expected near tripling of first-half net profit to $24.6 million compared with the previous first half. The result reflected restructuring as the company further integrates recent acquisitions. Among the most recent purchases were the G-Cure resins business in the US in November last year, the unsaturated polyester business of Huntsman Chemicals in Australia and the $208 million purchase of the Akzo Nobel Coating Resins business in January 2005. The company now operates globally in countries including Britain, the Netherlands, Vietnam and China as well as in Australia and New Zealand.
Sharechat: Can Nuplex continue to grow dividends at the average compound rate of 16% achieved over the past five years?
Managing director John Hirst: I think it's probably unlikely to sustain that level of increase, that's for sure. Clearly, the board has provided the challenge to management to continue to grow dividends at significantly above CPI so that we can give shareholders a genuinely improved cashflow result from dividend payouts on an annual basis. That in itself is a sufficient challenge, rather than setting a 16% per annum benchmark. It just wouldn't be sustainable. We have changed the amount of operating profit we distribute. Traditionally, we used to distribute roughly half the operating profit. If you look back over the last few periods, you will find we're now up more in the 70% region of profit being distributed. We are required to manage the business so we can provide well above CPI dividend growth to shareholders. That implies two things: profit increases and also appropriate cash management.
SC: Are there further efficiencies and profitability improvements to come from the Akzo Nobel Coating Resins purchase?
JH: The answer, clearly, is yes. We're still in the relatively early stages of doing some of these things. All the management decisions have been made and all the plans now being executed. We're starting to get some results from efficiencies and improvements coming through. We've spent three years working on turning these businesses around and we're starting to get the results we want from them. Let me just go through the individual areas. In the UK, where we came from a substantial loss, we're in positive territory at the EBITDA (earnings before interest, tax, depreciation and amortisation) level as at the end of the last half. It's a question now of utilising the new capacity we've built for powder resins - which, of course, are environmentally friendly resins. As we take advantage of that capacity, and continue to penetrate new markets, the performance from that operation will increase quite dramatically. All the profit improvement is moving straight to the bottom line. On the European stage, we're getting the advantage of work we've done in improving margins and we've also installed additional capacity there on two fronts: one, the traditional solvent-based area, by de-bottlenecking primarily, and one the second stage, we've built quite substantial capacity for water-based resins. Moving forward, we've probably got most of the additions in place in Europe now. It really is about a margin and volume play from here. In the Americas, we've closed down Brazil. There's still a little bit of a hangover from that in the first half. That will be cleaned up and won't impact the future. In the US, we've done quite a bit of efficiency improvement. We've created capacity at relatively low investment cost. We've specifically focused on increasing capacity and capability in the water-based production area. That will give us the opportunity to expand the product range and market segments that we service. The main play in the US is clearly a volume play. It would be fair to say that our current overhead cost structure in the US is high and it would be better suited to a larger operation. We're taking the position of leaving that in place with a view to building the US to a larger operation as we're currently under-represented in that market. In Asia, it really is about volume growth. We've invested to de-bottleneck plant and to improve processing technology. We will be investing additional hardware to take advantage of volume opportunities there.
SC: What's happening to solvent-based resin capacity in Europe? I thought you'd said there had been capacity closures?
JH: I was talking specifically about our Netherlands operation. We had in fact eliminated some solvent-based resin capacity out of our UK operation. There has been a material reduction in capacity in Europe where a number of people are closing down operations. That's tightened up the supply side of things which has created an environment more conducive to better margins. Because the market is changing in terms of it's demand for different resin types, what I expect to see is, in the medium term, further closures of solvent-based resin capacity that's currently operated in-house by paint manufacturers. That's fairly typical of what's happened elsewhere. As a result of that, the merchant market, which is the market we operate in, tends to be steady or even perhaps growing in the medium term through the closure of in-house capacity. If you look longer-term, we would expect that to be moderately stable.
SC: What's happening to demand for environmentally-friendly resins in Europe?
JH: The demand for environmentally-friendly resins in Europe is certainly growing. It will be taking almost all of the growth in the market in the first instance and, in the second instance, in a number of areas it will be replacing more conventional products. It's being driven in the first instance by regulation that came into play in 2007 and will be further strengthened by new legislation in 2010. It really specifically focuses on those coatings that are used and exposed to the atmosphere. We can't control the emissions it the air of some solvents. The decorative paint market and the light industrial market are the markets most affected by the regulatory changes. From a Nuplex perspective, they're the markets we're least exposed to. In a sense, the changes in legislation perhaps have far less of an impact on us than they have on some of our competitors. The high-level, sophisticated industrial applications for resins such as automotive and packaging coatings resins, plastic coatings, highly durable material coatings, these tend to be applied in a factory format. We can control the emissions - burn them or recover them, as the case may be. Therefore, such products aren't covered by the regulations. There are significant movements in some segments of the market and it's slower in other parts of the market.
SC: Are there opportunities for these products outside of Europe?
JH: Yes, there are. In many cases, other markets are quite differently shaped. If you take the New Zealand and Australian markets, what's happened in Europe in the decorative paint segment happened in Australia and New Zealand years ago. It's predominantly a water-based market and a relatively low solvent-based market for decorative paints. Having said that, solvent-based paints that are sold in Australia and New Zealand wouldn't be accepted in Europe post 2010. There are some differences in the market. Other products are being developed specifically in Europe to meet the demands of the European regulations. These products are perhaps different and, in some cases, more advanced products than offered elsewhere in the world. Naturally, as they become available for marketing in the rest of the world, there may be opportunities for growth as a result.
SC: Why are you spending so much on increasing capacity at the moment?
JH: There are three particular elements I would like to highlight. Firstly, we consider certainty of supply to be the absolute number one test for us, as a buyer or as a seller. We're manufacturing materials that are inputs to other companies' manufacturing processes. Therefore, we must be able to give them as much comfort as possible that we're not going to disrupt supply to them. From a capacity perspective, we can't afford to have our capacity inhibit growth. We've got to put capacity in place prior to the demand. Also, in parts of Akzo Nobel, we've changed the focus in the market from their previous view, which was a relatively narrow view of the coating industry. We're changing that to a broader view of the coating industry and some other allied industries. These are markets where traditionally Nuplex has had very large market positions in Asia-Pacific. We're increasing capacity and also changing capability in terms of the products that are able to be produced to enable us to focus on a broader market front. Thirdly, the coatings industry continues to grow internationally at better than GDP so, clearly, we must make sure we've got capacity in place in the right places.
SC: Re the G-Cure purchase: although small, why buy that business when the US economy looks headed for recession?
JH: The two things we achieved with G-Cure was one, technology and two, a current business, the manufacture and supply of products to customers who are 95% US-based. However, we can take the technology to a global market, not just the US market. In the technology area represented by G-Cure, we already have a strong position. This strengthens that position. It gives us a view of a different approach to the technology. We've found some surprising things there - some surprising things good and some surprising things not good. In any event, sure, the US economy looks to be headed for recession, if it's not there already, but at some stage or other it's going to come out of recession. We see momentum coming back into that market in the second half of 2009.
SC: You say volume in China was constrained by new VAT regulations - what is the outlook there?
JH: What we've done is we really got stuck in and said, let's full the damn thing up. We found maybe common sense hadn't prevailed. Some of the business we acquired was probably costing us money to sell. We changed strategy on that in the last 12 months and said, let's concentrate on quality business. We've done that. We now have quite a reasonable amount of capacity still available and yet we've improved our profitability. It was further forced down that route by the VAT change. It just doesn't make sense to export out of China these days. There's been quite a change there. We have a better quality business than what we had before.
SC: Is the industry in Australia fully rationalised now?
JH: On the resins side of the business, that's fair comment. I think it is. We're now left with not a lot of manufacturers or resins in Australia and New Zealand. Anyone of any substance is really a subsidiary of an international player. To my way of thinking, there's unlikely to be any significant acquisitions resulting from the current structure. There may be some other action but I'm not aware of that. I think Australia, for all intents and purposes, can be considered fully rationalised in the resins business.
SC: Why is your composites business growing so strongly - does that simply reflect the Huntsman purchase?
JH: It is growing strongly. It was both the Huntsman purchase and there are also some market segments growing strongly. Overall, that's been quite a dramatic change to the business.
SC: How long do you expect the Seven Hills sales process to take and is $40 million still a realistic sale price?
JH: We expect both the Seven Hills and the Avondale site in Auckland - we're planning on having them sold by the end of calendar 2008. We're expecting somewhere in the vicinity of $40 million for the lot - it will depend very much on the state of the real estate market over the next few months. They will be industrial use. We're remediating them to industrial standard. Both properties are absolutely ideally situated.
SC: Are you seeing any signs of raw materials costs stabilising?
JH: A couple of things have happened. Oil prices have continued to strengthen and are now consistently over $US100 a barrel. That's going to push petrochemical prices at some stage as a result of input costs. The second major thing has been the impact of bio-diesel production from vegetable oils. There's now huge competition in the bio-diesel market for everything from tallow through to palm and soya bean oils. We now find bio-diesel is in competition with traditional industrial applications for these products and food which I find quite insane. There are major price movements - I'm talking huge movements in those vegetable oils and tallows. On the petrochemical side of things, there's been an awful lot of capacity built so there's less pressure from the normal supply and demand scenario. All the pressure's coming from increase crude and vegetable oils so I'm afraid we're still facing increased raw materials prices.
SC: Can you continue passing price increases through to customers?
JH: We just have to. We're not in a position to absorb raw materials costs. We just can't. If we can't pass raw materials costs through, there isn't a business. At some stage everything will reach an ultimate resistance point. We see it very clearly at the petrol pump. No matter how much they increase the petrol price, we still fill our cars up. If we take that as being indicative, I think we're still a long way short of finding the ultimate resistance point.
SC: What's your view of the economic outlook and how do you expect Nuplex will be affected - your saying that EBITDA guidance of $120 million will be at the lower end of expectations suggests you're reasonably optimistic?
JH: Clearly, in the US we've seen slowing growth in those segments of the market that interface the housing industry. There are two areas where resins are used, decorative paints and wood coating - typical of that would be coatings of kitchen cabinets and so on. Clearly, they're not building too many of them at the moment. The other parts of the market are still quite stable. It hasn't been quite to the extent that one would expect from reading the newspapers and doom and gloom. Elsewhere in the world, maybe New Zealand is a little slow. Australia's probably not too much different. Asia's still going well and Europe is still going well, but we are alert. As I said at the first half results release, providing we stay as we are, this is the result we expect, but there's no guarantee things will stay as they are. You ask whether I'm optimistic. I prefer to call myself realistic. I'm basing that on current information. I'm quite comfortable saying, so far, so good, but you only need two bad months to spoil it.
SC: Do you expect the environment to throw up opportunities for Nuplex and will the company be able to take advantage of them?
JH: The current credit crunch makes life interesting. There's good news and bad. On the one hand, clearly, if there are assets out there that are not valued by their owner - I'm particularly thinking about private equity - and that don't have a long-term strategy, then the environment may be good for shaking them out and making them available. But on the other hand, to actually pay for them, we've got under-valued equity and expensive new credit. On balance, it's probably neutral, just different.
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