Reach legislation, rising production costs, and manufacturing's shift to the east puts Europe's paint industry under pressure

18 May 2007 17:32  [Source: ICB]

PAINT AND coatings producers have had little breathing space over the past year, what with ever-toughening legislation, the high price of raw materials, and the shift of manufacturing away from western Europe. Environmental and legislative issues continue to push innovation, while, for many, the focus remains on reaching lucrative growth markets in eastern Europe and China.

The most pressing issue is Reach, the EU legislation covering registration, evaluation and authorisation of chemicals. This has already taken up a vast amount of time and resources and will remain a key issue.

The legislation comes into force on 1 June and the paint and coatings industry has been preparing to meet the regulatory deadlines. Uncertainty over the ultimate effect of Reach has been worrying the market. Downstream users are concerned about the future availability of raw materials, for instance.

The European Council of the Paint, Printing Ink and Artists' Colours Industry (CEPE) has been heavily involved in lobbying the European Parliament to ensure that the regulations are workable for the industry as a whole. Now CEPE's focus is on preparing for the legislation and putting together the technical guidance documents that companies will be working with.

CEPE managing director Jan van der Meulen says the issue for many will be what raw materials will still be available. This has potentially far-reaching implications upon product formulations.

Terry Knowles, business manager at consultancy IRL, voices one of the difficulties likely to be faced by the industry. "Companies need advanced warning if a product will no longer be available if it is found to be non-compliant. Companies will have to reformulate and rethink their products." He admits, however, that in many cases, this is less than certain to be the case.

The European paints industry is calling for more support from raw material suppliers in the run-up to Reach. "The industry is desperate for more support and increased cooperation. They want a greater insight into what raw materials producers are doing," says Knowles. He calls for more raw materials companies to share their information and expertise with paint companies - especially the smaller ones that have limited or no research and development.

The aim of Reach - to add a new degree of transparency along the whole supply chain - will not come about without a significant administrative burden for both suppliers and some downstream users. This could conceivably add to downstream price pressure, as suppliers consider the increased costs involved in the administration process.

It is also plain that the legislation issue is not going to go away. As Tikkurila president, business area coatings, Visa Pekkarinen, comments: "The Reach discussion has not yet had a direct impact on the market. We don't know exactly what that impact will be, but it may have the effect of changing raw materials. The industry will clearly survive, but some changes will have to occur."

The second regulatory issue looming over the industry is the EU's solvents emissions directive, which is bringing with it a set of more stringent regulations due to come into effect in 2010. Pekkarinen points out that the industry will continue to see a shift in the type of materials it uses. "By 2010, when more strict regulations will be enforced, there will be a further decline of solvent-borne products and an increase in water-borne coatings," he notes.

Moira McMillan, CEO of the British Coatings Federation, stresses the need for discussion between the industry and the authorities to ensure the smooth running of new regulatory developments in the future. "We need to talk to government about how far technology can allow the regulations to go when the solvent emission thresholds are reviewed again in 2010," she says.

Pricing pressures

Legislation aside, there have been further headaches for the industry in the form of high production costs. Producers have had to pay a high price for their raw materials during the past year or so, and this has proved hard to swallow for some. Energy costs have also seen dramatic increases and paints and coatings manufactures have therefore been hit on both sides.

"Energy costs became a major issue [for manufacturers] for the first time last year," says McMillan. "The coatings industry suffered the double effect of oil and energy prices pushing up the cost of its raw materials, plus the high increase in its own process energy costs. We have yet to see the benefit of more recent energy price reductions."

Knowles also points out the problems paints and coatings companies have faced with the shortages of certain metals. The marine paint sector, for example, uses copper, and with the world market so short, production has been affected.

Pekkarinen takes a pragmatic view, however: "We try to fight against price increases and be more effective in our operations." However, it has proved hard to pass on feedstock price increases to end-users and this has forced paint companies accept lower margins in some cases.

Price pressure in the retail sector has been an ongoing problem in Europe. A spokesman for Akzo Nobel, Europe's largest paints maker, points out: "Price competition has also prevented value growth. Despite rising raw material costs, unit prices have seen little increase due to retail competition in architectural DIY, and competition with end-user industries in Asia and eastern Europe."

SigmaKalon, the second-largest decorative supplier in Europe, has around 500 specialist trade centres across Europe through which it sells its products directly to the trade, along with about 3,000 independent wholesalers. This has proved an effective way of keeping down costs while maintaining margins. SigmaKalon intends to build up this network, which it says gives it an advantage over competitors, as it can retain close contact with the needs of the market and provide added-value service.

Growth prospects

Leaving behind these areas of concern, the prospects for growth are important in taking the business forward. Faced with a mature west European market, growing at an estimated average of only 1-2%/year, paints and coatings manufacturers are interested in branching out into markets that offer much greater growth potential.

Eastern Europe is an obvious candidate for expansion. While the average paint consumption per capita in west European countries stands at 16kg/year, according to IRL's figures, eastern Europe's is significantly lower at 9-10kg/year, and Russia's lower still at an average 7.5kg/year. IRL estimates the Chinese population's consumption at approximately 3.4kg/year, based on a population of 1.3bn and an estimated market size of 4.5m tonnes.

Along with many players, Akzo Nobel sees a positive outlook for the east European market. "There is still plenty of room for development in this region and EU membership is expected to lead to up-market, more sophisticated and therefore higher unit price products entering central Europe," said the company. On the other hand, EU membership could end up hampering growth as production and labour costs go up, reducing the competitive edge that had previously attracted companies to these countries.

Pekkarinen points out the importance of these developing markets. "Eastern Europe and Asia are areas of growth, [but they] are also taking some core industries which we serve with them, such as metal and furniture." These are moving particularly to China and south Asia and so Tikkurila has to follow its customers, he explains, adding, "we are actively looking at the Chinese market".

The trend for manufacturing operations to move their production bases out of western Europe has forced paints and coatings producers to look further afield too. Looking further forward, van der Meulen expects to see, "shifting growth to more middle or east European EU member states, while the west European market sees consolidation and shifts in technology".

According to Akzo Nobel, both the Russian and Ukrainian markets are underdeveloped, but growth is often restricted by outdated equipment. "However, increasing consumer confidence in line with economic improvement, housing construction and some development in industry as international companies start to cautiously invest in the region are stimulating demand," says a spokesman, who identifies architectural paints as the most important sector in the region.

Some positive news came from the German market last year, as its paints and coatings association, VDL, reported a decent year for German manufacturers in terms of production figures. They recorded a 2.7% increase in 2006, which represents the highest level of production growth since 2000. Exports, predominantly to other European countries, rose by 7%.

Still, Akzo Nobel notes that the west European market recorded declining sales of paints and coatings in 2006, reflecting the maturity of the market. "While all market sectors recorded [a] decline, the most buoyant was architectural. Increased levels of housing construction in key markets such as Spain and the UK boosted sales here," says the spokesman. The protective coatings and aerospace sectors also had a good year, he says, following a stagnant period of several years that saw zero growth.

M&A rolls on

Strengthening market positions and expanding into new areas are vital to keep the industry in shape. The top players continue to see mergers and acquisition (M&A) activity as a very real option in order to consolidate their market positions and enhance their portfolios.

The past 12 months have seen a fair amount of activity as a whole within Europe, but one sector has been particularly active: the protective coatings industry. This had been slow to start the process of consolidation, but this year there has been no stopping players. "These companies have collectively been adding technology to their portfolios and some specialist businesses in the last six months. It's been long overdue," says Knowles.

The wave of activity was spurred by PPG Industries' acquisition of US producer Ameron in June 2006, and since then, there have been six further moves. Akzo Nobel purchased Ceilcote (US) from Germany's KCH Group, PPG acquired Champion Coatings in the US, 3M in Europe acquired E Wood Holdings in the UK, Hempel bought Germany's Lacor Protective Coatings, and Walter Maeder bought Sika's German bituminous pipe coatings business.

The final episode so far has been the sale of DuPont's German protective coatings business to Sika, but it looks likely that more acquisitions could follow in the coming months. The protective coatings sector is by its nature very fragmented, and Knowles believes that the niche businesses could prove interesting for prospective purchasers in the future.

Akzo Nobel identifies the cost of EU legislation on environmental issues as being a potential catalyst for a shift in the market dynamic. "The cost of compliance is increasingly a problem for smaller manufacturers, and it is likely that some may get squeezed out of the market or otherwise sell out to their larger competitors," says the spokesman.

In the automotive sector, BASF has been taking over a number of operations in Europe, which are effectively reinforcing its position in the automotive refinishing market. These are French companies Michel DERIS and Chateau-Arnoux Peinture, Norway's Billakksenteret, and Austrian Autolacke Handel.

Tikkurila has been looking towards the Russian market, with recent purchases giving it a strong position within the decorative coatings market there. In addition, the Finns are contemplating the industrial coatings business, which is a much more fragmented affair than the decorative sector. Pekkarinen says: "We have six plants in Russia, which puts us in a good position for our goal to be leader in the marketplace."

Speculation about possible moves by various companies to acquire ICI's business has also been circulating recently. "If ICI were acquired, any paint company could find themselves with the No 2 position in China and the No 4 position in India, and this would look very attractive," comments Knowles.

Looking towards the future, green issues take centre stage. Unsurprisingly, considering the raft of legislation and the focus on the environment, the outlook for water-based products appears to be very positive. Van der Meulen expects technical water-borne powder coatings and UV-curable materials to gain in prominence in the future within the field of industrial coatings. In the decorative market, he predicts further increases in the use of water-based paints.

McMillan also identifies the need for ever-evolving new product ideas. "I can't see the amount of regulation reducing, so the industry will have to continue to come up with some more innovative ideas."

At a very challenging period in its history, the paints industry is holding its own, producing innovative products, and reformulating old ones. There are pockets of growth and pockets of stagnation, and geographical shifts in focus, as new revenue streams open up. Before long, the real effects of EU-wide legislation will become more apparent, but until then, there is a shadow of uncertainty across the market which concerns paints and coatings companies both upstream and downstream.

M&A activity in the European coatings sector, January 2006 to April 2007

Acquirer	Business acquired/from	Field/activity
Akzo Nobel	Balakom (Czech Republic)	Decorative paints and powder coatings
	Graf Lack (Switzerland)	Automotive refinish distribution
BASF	Degussa (Germany)	Construction chemicals business for €2.7bn ($3.7bn)
BASF Coatings	Autolacke Handel from Ludwig Christ Group (Austria)	Automotive refinish sales
	Billakksenteret (Norway)	Automotive refinish sales
	Chateau-Arnoux Peinture (France)	Automotive refinish sales
	Michel DERIS (France)	Automotive refinish sales
Bunker Hill Capital	Cookson (UK)	SCS specialty coatings operations
CIN	Proitesa (Tenerife)	Decorative paints
European Capital	Farrow and Ball (UK)	Premium decorative paints and wallcoverings 72% stake bought for £80m ($158m, €117m)
Helios	Odilak (Russia)	82% stake in a diversified producer
Hempel	Lacor (Germany)	Protective coatings and industrial paints
Materis Peintures	Vernis Claessens (Switzerland)	Premium decorative paints
Oresa Ventures	Guzu Chim (Romania)	Bought 49% of business now known as Fabryo Corp
Protech	Flanders Powder (Belgium)	Powder coatings
RPM	Tor Coatings (UK)	Specialty paints
	Watco Group (UK)	Concrete floor coatings
SigmaKalon	Bollig & Kemper (Germany)	Coil coatings activities
	HCH (Slovakia)	Distributor with five depots and five paint shops
	OP.ARM (Slovakia)	Distributor with one depot and one paint shop bought 60% stake in firm
Sika	DuPont (Germany)	Protective coatings business
Sniezka	Belpol (Belarus)	Raised stake in operation to 80%
Tikkurila	Finncolor (Czech Rpublic)	Acquired all of the local importer
	Kolorit Paints (Ukraine)	Remaining 49% of business from LGU
	Gamma (Russia)	Metal finishes bought 70% stake in firm
	Ohtinski Zavod Poroshkovyh Krasok (Russia)	Powder coatings bought 70% stake in firm
Walter Maeder	Sika (Switzerland)	Germany-based bituminous pipe coatings operations
Yasar Holding	Dyo Romania (Romania)	47% of venture held with local distributor
3M	E Wood Holdings (UK)	Protective coatings, bought for £40m ($79m, €58m)SOURCE: IRL CUBE ARCHIVE

IRL's latest profile of the west European paint industry is now available, priced €3,200 ($4,300). For more information go to: www.informationresearch.co.uk

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