Central and Eastern Europe is finally starting to show its potential

The forgotten region

04 June 2008 17:32  [Source: ICB]

After years of hype and hysteria surrounding the Middle East and Asia, Central and Eastern Europe is finally emerging from the shadows

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Andy Brice/London

OVERLOOKED FOR decades, Central and Eastern Europe (CEE) is no longer a forgotten region.

The rapidly emerging economies of the Middle East and Asia continue to dominate the headlines, thanks largely to a proliferation of multimillion-dollar projects, the size and scale of which have never been seen before. But with soaring raw material, energy and transportation costs, CEE is starting look a little more inviting for investors.

As logistical costs climb and ethane availability comes under pressure, the Middle East is no longer as competitive as it was, and most of its feedstock advantage has been neutralized. This is even worse for Asian markets, where escalating feedstock costs are also having a noticeable impact.

"With expansion projects, restructuring, privatization and consolidation, we're now beginning to see a positive flow of investment in CEE, which is indicative of its potential," says Fred du Plessis, senior vice president of US management consultancy Kline & Co. "We've not seen enough external investment because attention has been focused on the Middle East and China, but I would be very surprised if we don't start to see a shift in the future."

A GROWING MARKET

Although GDP in the nascent CEE markets is comparatively smaller than the double-digit growth in China over the past few years, it is still well ahead of Western economies and the rapidly growing automotive, construction and energy segments are thriving.

Major players are even being drawn away from Western Europe, despite its established customer base and superior infrastructure.

"Markets in Western Europe are not growing if you want to grow, you have to move to these new markets," says Markku Immonen, president of Deco International - a division of Finnish paints and coatings firm Tikkurila. "To grow in Western Europe, you may have to acquire other businesses, but in the East, you can grow organically."

Immonen notes that more than 80% of Deco's turnover now comes from outside Finland, with Eastern Europe central to its development strategy. In May, Tikkurila announced a joint venture with Slovenia's JUB to increase its presence in Romania.

In Romania's paint market, for example, there has been exceptional growth of 20-30%/year over the past few years, compared with only 1-3%/year in Western Europe, he says.

"The manufacturing industry is starting to move from Western Europe to Central and Eastern Europe," he says. "The construction of buildings and infrastructure, the improved standard of living, and people renovating their homes will definitely mean strong growth for paints and coatings. The outlook is very, very positive."

To date, few global petrochemical majors have invested heavily in CEE other regions have appeared more lucrative, while mergers and acquisitions (M&A) in the region are risky and therefore rare. Many of the companies available are not in great condition, while those that are viable often bear an unrealistic valuation.

The lack of M&A has also been partly compounded by the reticence of CEE governments to approve acquisitions of local chemical companies. German producer PCC's failed acquisition of ZAK in Poland in 2006 is a case in point.

Most activity has been restricted to local producers, such as Poland's PKN Orlen, or Hungary's MOL and BorsodChem. The past decade has seen a wave of investment by these firms through M&A and consolidation, says du Plessis.

EU ACCESSION

The accession of Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, Slovenia and the Czech Republic to the EU in 2004 - and Bulgaria and Romania last year - flung open their borders to the rest of Europe and allowed these previously untapped markets to flourish.

US-based specialty chemical company Rohm and Haas is among those looking to increase their presence in the up-and-coming region.

Jean-Francois Mayer, director of CEE and Turkey, says these markets are far more profitable than India and China.

He expects CEE, plus Turkey, to see a 20% annual growth rate through to 2010. "The segments we serve are growing even faster than GDP, at around 10-15%, depending on the country. We are trying to target the fastest-growing markets."

"We have already established our name [in CEE]. We have our own human resources, finance and IT infrastructure there and we are building plants, clearly showing that we want to be closer to our customers," says Mayer. "This has been a significant change to the way we're approaching the market and the return on these investments is real."

Rohm and Haas is investing heavily in this vision. Its new acrylic emulsion plant near Moscow is due to start up in the second quarter (Q2) and will serve the paints, adhesives and detergents sectors in domestic and neighboring markets, including Belarus, Ukraine and Kazakhstan.

The company is also building a plastic additives plant in Gebze, Turkey, which is due to come on stream during Q4.

The 40,000 tonne/year unit would help meet strong demand in the construction sector, particularly for polyvinyl chloride (PVC) window profiles, he says.

"Our two plants in Russia and Turkey are going to be very significant breakthroughs that will trigger additional growth in our business," he says. "This is very important for us."

Looking ahead, the company is also considering plans to establish offices and gain a foothold in Ukraine and Romania.

A WINNING MOVE

The benefits of migrating to CEE are clear.

Labor costs are still extremely competitive in the region and although there are signs that wages are on the ascent, they can still offer considerable savings. Du Plessis says that while salaries are climbing in the new member states - with wage inflation that exceeds 5% - they are still at manageable levels.

Assuming a compound annual growth rate of 8-9%, it will take about five years for these salaries to double, and even then, they will still be below an established Western market such as Germany, he says.

Sourcing and retaining skilled employees is also easier. The labor shortage in the Middle East is well publicized, with players often trying to recruit from elsewhere. Conversely, China has plenty of workers available but the most qualified tend to be expensive and extremely mobile, tempted away by better pay and incentives from competitors. Even in Western Europe, companies still struggle to find chemists and engineers. In contrast, CEE boasts a plentiful supply of high-quality educated candidates.

Companies need no longer be hindered by the eclectic mix of languages and cultures in the region either. The end of communism and later, the opening of the borders, has encouraged migration throughout the continent. As a result, the younger generations are travelling more and studying abroad, and are starting to get a solid command of English, adds du Plessis, making communication far simpler.

Importantly, the financial support of the EU and its contribution to improving the transportation infrastructure has also been extremely beneficial.

Although the road network falls short of that to the West, significant investment means it is still more advanced than China's. Rail is also well developed, although there remain issues regarding the differing track gauges from country to country.

Waterways are another mixed bag, with some of the smaller rivers and tributaries unnavigable. Many ports in the region also fall below the required standards, and vary immensely.

Clearly, CEE is not without its hurdles, but it would be foolhardy to discount a region with so much promise.

With economies reeling from the global credit crunch, feedstock prices continuing their relentless upsurge and the increasing burden of rising transport costs, perhaps the potential of this forgotten region may soon be realized.

Keep up with CEE developments

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