View from the Trenches: North American Distributors

22 November 2004 00:01  [Source: ICB Americas]

Hopes for continued recovery in US manufacturing, managing product and cost volatility and the looming role of China are some of the issues topping the agenda of North American distributors. Patricia Van Arnum moderates.

2004 has been a year of recovery for the top North American distributors. Like the chemical industry as a whole, distributors are benefiting from the improved fortunes of the US manufacturing sector. As demand improves, however, margins remain squeezed by higher product prices at the manufacturers’ level and escalating energy costs.

To get some perspective on the situation, CMR’s executive editor Patricia Van Arnum discussed the state of the industry with several major North American distributors. Participating in the roundtable were Hank Waters, president of Ashland Distribution Company; Stephen Clark, president and CEO of Brenntag North America; John Yanney, president and CEO of Chemcentral; Mark Laehn, vice president and general manager, Hydrite Chemical Co.; and John Sammons, senior vice president and chief administrative officer, Univar.

CMR: How is the market performing in 2004 relative to 2003? Have you seen an improvement in demand? In margins? What has been the impact of cost pressures for commodities such as energy/gasoline and steel?

Brenntag’s Steve Clark: 2004 has been a welcome relief following three difficult years in the US manufacturing sector—our customer base. Overall demand has picked up significantly, causing a number of product lines to be in short supply. With some products on allocation, many customers have turned their concerns from pricing issues to those of ensuring product availability. With dramatic increases in prices resulting from both increased demand and higher feedstock costs at the producer level, gross margins have taken a slight hit as the full extent of price increases has not been able to be passed on concurrently.

There are other factors, such as the escalating costs for diesel fuel, as well as higher costs for containers. As we operate a large private fleet, we have been adversely impacted by fuel costs. For some time now, we have been charging a fuel surcharge which fluctuates with the rise and fall of diesel costs. However, the surcharge has not been sufficient to completely recapture our increased delivery expense from the end users. Other commodity increases such as steel drum costs have much the same affect as rising feedstock costs as each has been a component of increasing total costs, which have forced us to raise our prices to our customers.

Univar’s John Sammons: Generally speaking, 2004 has been better than 2003, particularly in the second half, as a result of the improvement in the economy and in the manufacturing sector. We do see margin pressure from the continuing competitive environment. We also see increased costs of between 10 to 15 percent from steel drums, all of which affect the cost of doing business.

Chemcentral’s John Yanney: We have seen double-digit increases in 2004 over 2003. Of this growth, approximately 40 percent has been inflation or increased selling price and 60 percent has been unit growth. Our percentage margin has remained the same, while dollars have increased. These higher costs have impacted our bottom line for employee costs, primarily medical, fuel costs for our fleet, and the increased cost of drums have been the most significant drivers. We have passed on fuel cost increases through fuel surcharges to our customers, and we have worked diligently in being more efficient in our operations to offset some of the increases on drum cost. We will be initiating some health care changes in 2005.

Ashland’s Hank Waters: This year has been substantially better. The chemical industry as a whole is performing better, and sales volumes are up. Demand is strong, and certain parts of the market are facing product shortages. Although product pricing is up, there are issues that continue to impact margins. The escalating cost of energy is obviously having a double impact—the cost for raw materials and the cost of diesel fuel. The escalation in diesel fuel costs is a huge cost component of our business. Higher energy costs further impacts energy-intensive industries such as steel, and we are seeing rising costs for steel drums—as much as 25 percent to 35 percent—that has to be factored into the cost of doing business.

Hydrite Chemical’s Mark Laehn: We have seen economic improvement as well as improvement in demand by volume. This is across all sectors in the large volume commodity and industrial chemicals. However, although sales are up and volumes are up, margins have not improved, primarily because of higher costs for raw materials and for packaging such as steel drums. Also, rising diesel fuel costs, which have gone up as much as 25 percent in the past few months, here in the Midwest, have further crimped into margins.

CMR: Some economists are pointing to a slowdown in manufacturing activity in the fourth quarter. Are you beginning to see evidence of that for the markets you serve?

Chemcentral’s John Yanney: We have not seen a slowdown. October continued to be very strong, and the first two weeks of November show[ed] no sign of business slowing down. We anticipate, as in previous years, that we will see some changes during the holiday season.

Brenntag’s Steve Clark: While we have seen the forecast data indicating a manufacturing slowdown, our numbers indicate demand continuing to strengthen. September and October indicate strengthening volume growth versus the prior year. We continue to plan on increased volumes for 2005.

Hydrite Chemical’s Mark Laehn: Although it has been widely discussed that the US manufacturing sector may be slowing, we have not seen evidence of it yet. Manufacturing activity as a whole continues to perform fairly well, although there are some concerns of activity beginning to slow in parts of the Midwest.

Ashland’s Hank Waters: Although we are familiar with reports US manufacturing is slowing, we do not see a slowdown yet. One possible reason for this is that end-market users may be still working down their backlog of orders, so the slowdown has not moved through the value chain. One possible cause for a slowdown in manufacturing activity could be a response to product shortages; there is simply not enough product to satisfy demand. However, we anticipate the manufacturing sector to continue to be strong. We see the demand fundamentals holding up over the next two to three quarters—at least through mid-2005.

Univar’s John Sammons: For now, we do not see signs of the manufacturing sector slowing.

CMR: On the transportation front, what would you identify as the most significant issue facing chemical distributors, such as in recent proposed regulations for rail and trucking?

Brenntag’s Steve Clark: The single most important long-term issue for chemical distribution continues to be the exodus of manufacturing from North America. While demand has picked up recently, the long-term pressure from low cost countries continues to be negative.

However, as our customers continue to consolidate to achieve economies of scale, this presents a significant opportunity for us, as we can help reduce their costs and serve their needs through our strong geographic coverage and wide product line offering. In addition, chemical manufacturers continues to outsource their smaller customer relationships to distributors in an effort to improve their cost structure. This again will continue to be an excellent avenue for distributor growth.

While the recent on-again, off-again drivers’ hours of service regulation have caused decreased freight capacity, dislocation in freight movements and increases in our costs, they have also brought us opportunities. We have been able to provide additional services to both our customers and suppliers as we have been able to avail them of our significant private fleet. This additional business has helped offset a portion of our increased cost.

Ashland’s Hank Waters: Security continues to be a number one issue for the industry. I feel that the industry and government have come together to provide for the safe transport of goods, whether it is modifying rail service or adjusting trucking regulations. These are all changes that we adapt in the interest of safety.

Hydrite Chemical’s Mark Laehn: On the transportation front, a key issue continues to be a lack of quality drivers. Another issue is the rising costs of diesel fuel, which impacts not only your own fleet, but it is also a cost that is passed on from common carriers, which have been charging significant fuel surcharges of up to 15 to 20 percent. These surcharges have really spiked in the second half of this year, and we do not see any relief in site.

CMR: Looking forward, what would you identify as the five most critical issues impacting the business of chemical distribution in the North America?

Ashland’s Hank Waters: Probably the most critical issue is the rising cost of energy and its impact on the global and US economy. Eventually, high energy costs will have a dampening effect on economic growth. The second critical issue is the margin squeeze. Margins are better today than they were in 2003, but they are not back to historical levels. We continue to face higher producers’ costs, but have difficulty in passing costs onto customers because in their end-markets they are facing very low price-growth. Consumer inflation has been very modest. This creates a further problem because it can put small to medium-sized customers at risk, which has an effect down the value chain as demand for goods and services decline.

The third critical issue relates to managing energy costs, which has resulted in an unprecedented number of price increases from chemical manufacturers. Just the task of implementing and managing those pricing increases across different customer bases is a large administrative task.

Another issue is consolidation in the supplier community. Mergers and acquisitions create change, and that change can be disruptive. The chemical industry as a whole continues to see companies reposition themselves in the market. Another concern is the emergence of China and the shifting of manufacturing assets. As the manufacturing base moves to low-cost producing regions, such as China, the US-centric based business model for manufacturing and distribution will have to change as well.

Hydrite Chemical’s Mark Laehn: There are several critical issues facing distributors. First, as we discussed before are rising energy costs, which not only affect transportation costs but also product pricing as result of higher raw material costs. A second issue is product supply. We are seeing tightness and allocation issues across many sectors in industrial chemicals, including the vinyls chain and the benzene chain. With these conditions, the third issue that is of critical importance is what I call “margin management” issues—balancing cost pressures and growth concerns. Also, rising health care costs are a concern. The business of distribution by its very nature is a people-oriented business in many facets—from transportation, to warehousing to customer service—and so escalating health care costs have a direct impact on the cost of doing business.

And lastly is the difficulty in concluding acquisitions. As a company, we have a specific strategy of growing both organically and via acquisitions, and it has been difficult to find good candidates for acquisitions. There are several factors that can come into play that make a potential acquisition target less than desirable. It may be as simple as that the target is overvalued or that the company is positioned in market that faces little growth. There is also the environmental risk—costs that have to be factored into a potential acquisition if certain facilities need environmental remediation. With all these factors coming into play, it can be a struggle to conclude an acquisition.

Univar’s John Sammons: In the short term, product shortages and the resulting influence on pricing continues to be an issue. This is a fairly broad-based problem. The other key concern going forward is political stability in the Middle East, which has an influence on energy pricing.

Within the industry itself, we see continued pressure for consolidation among chemical distributors as the competitive environment challenges receiving a fair return on investment.

Also, China is certainly an issue. Even though there are concerns of a shifting manufacturing base to China, the potential market in China dwarfs outward migration that may occur there.

Chemcentral’s John Yanney: There are several important issues: balancing supply and demand; lack of producers investing in their assets in North America; corporations moving production to China and Southeast Asia; continual consolidation; and optimizing utilization of assets in our industry.

Brenntag’s Steve Clark: First is the continued decline in the manufacturing sector of our domestic economy. Second is the failure to enact tort reform. And third is the ability to find qualified employees as our labor market continues to tighten.

However, in general, distributors continue to be in the enviable position of being right in the middle of the supply chain. As such, we are the only option to reduce certain types of these costs for both chemical producers and end users. Distributors should continue to grow at a pace above manufacturing output.

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