Managing Directors Business Review

Resins

Strong improvement in European performance

European market conditions for liquid resins were favourable throughout the year. A number of plant closures meant that capacity and demand were much better aligned, reducing the margin erosion that results from capacity overhang. In addition, Western Europe experienced genuine growth while Eastern Europe continued to expand, although from a low base. The business turned its attention to better quality, higher margin sales.

Ongoing rises in raw material costs were partially offset by the strong Euro and generally fully recovered through pricing. Increases in operational input costs were fully compensated by the benefits of restructuring and investment in efficiencies. There is a diminishing opportunity to continue to achieve this, with costs constantly rising, and margins will need ongoing attention to ensure these costs do not slowly erode performance gains.

Commissioning of sophisticated capacity for water-based resins allowed commercialisation of new products for such highly technical markets as automotive OEM and refinish, and wood coating. Further investment in high temperature plants reduced cycle times, increasing capacity and controlling costs. This increase in capacity facilitated the recovery of volumes lost as a consequence of the closure of the UK liquid resin plant.

Demand for powder resins was variable. It was very strong in the early part of the year when the operation was capacity constrained, and softened in mid year, particularly in the UK and Southern Europe. This coincided with the Silvertown capacity being commissioned, incorporating the Company’s most recent process technology. In spite of this, progress was made and sales built reasonably quickly to a broader customer and geographical base.

The focus for most research and development continued to be on resins capable of producing coatings that comply with upcoming 2010 European regulations. In many instances these products represent major technical challenges, with the need to maintain performance and yet minimise or even eliminate solvents which have been at the heart of resin technology for decades.

Traditional products have been honed over the years to achieve excellent film and application properties fully matched to modern performance standards and application methods. To equal this with such materially different resin and coating systems requires a significant uplift in technology sophistication. It is pleasing to see such a high level of success being achieved by the European technical team, and the business is well positioned to service the needs of the future market across a broad range of end uses. It is inevitable that the increasing sophistication of technology will be a catalyst to structural change within the industry, as less technically-able organisations are unlikely to be able to participate profitably in the long term.

Media, and financial press in particular, keep talking of the European slowdown. It is unlikely that Europe can remain immune to the credit-led financial disasters, but so far there has been little evidence of a sustained slowdown and the year ended strongly.

Increased earnings in the Americas

The Americas were a complete contrast. Closure of the Brazilian operations eliminated a significant loss-making unit and provided the basis for regional performance ahead of the prior year, in spite of difficult trading conditions.

Demand slowed dramatically in the US, especially in the second half. Competition increased with companies seeking volume in a shrinking market, creating difficult conditions under which to seek margin recovery. In addition, the soft US currency meant that raw material cost increases were well above the global average. This combination created an environment where full margin recovery was not possible.

However, there was also good news. Acquisition of the G-Cure® technology and business assets assisted, although performance was slightly below expectations due to market conditions. Recovery in the mid-term is expected. The acquisition added to existing acrylic technology, improving both knowledge and market diversity in this key business segment. Whereas traditional business had its principal focus on automotive markets, the strength of G-Cure® rested in the high durability industrial coating sector. It was also very heavily US-centric and the global reach of Nuplex operations suggests a buoyant and growing future for this product range.

The power of globalising available Group technologies continued, with the US gaining position in non-traditional markets using Australasian-developed products. Newly developed water-based resins for high-end applications were launched and are meeting US performance requirements. With the closure of Brazilian manufacturing facilities, key segments of the South American specialty resins markets have been serviced satisfactorily and profitably by US production units.

Concentration on specialty segments of the coating industry has provided some protection against the impact of the American recession. While not completely immune, it is pleasing that lower exposure to the construction segment – both in new building and refurbishment – has allowed the business to weather these difficult times.

Capital investment in the US has concentrated on capacity and upstream storage facilities to enable G-Cure® production to be brought in-house, and to support sales into new market segments. The need to requalify G-Cure® products used for critical applications and planned for manufacture in the Nuplex plant has delayed receiving full benefit from the acquisition. This work has now been completed.

Australasian earnings affected by soft demand

Market conditions within Australasia were generally weak, while strong currencies undermined export opportunities and created a favourable environment for competitive imports. Over-employment across the region made it difficult to find suitable applicants for a number of key positions, with little prospect of redress until the economic downturn frees up the employment market.

Good cost and margin control offset some of the impact of the slowdown in New Zealand. Market shrinkage was further exacerbated by a shift of manufacturing offshore to Australia and Asia, while a strong currency took its toll on both the textile and packaging adhesive segments.

Shrinkage also occurred in the composite market. Some sanitaryware manufacture was permanently lost to Asia and market sectors most exposed to discretionary spending, such as marine, had a dramatic slowdown in the second half. With demand down, an inevitable struggle for market share caused some margin erosion.

In Australia, demand from coatings manufacturers was stable, while composites saw a significant downturn in the second half. As would be expected, composite segments relying heavily on discretionary spending were the first to suffer. Margins were impacted by consolidation of several customers and by the effect of the strong dollar assisting importers of resins, coatings and coated products. Some share gains were made and penetration of top-end markets was achieved as a consequence of introducing a new product range developed within the European laboratories. Interestingly, offshore business was also gained as Nuplex’s superior technology position was recognised by customers focused on lifting their quality.

Composites in Australia had a trying year, with very difficult weather conditions impacting some major segments, although strong infrastructure expenditure provided some strength to the market. This part of the resins business has always been a good barometer of economic health, and movements in demand often give early indication of tough or great times ahead. Clearly, with a significant downturn in demand in the second half, Australia is in for a tight period, at least in the short term.

Expansion of Australian composite capacity at Wacol is progressing to plan. Stage 1 has been completed with good efficiency improvements already achieved. Stage 2 will be completed in October 2008 and the final capacity build stage is scheduled for commissioning in late January 2009 to meet peak demand. The construction of a large dangerous goods warehouse as the final part of the project will be completed in June 2009.

The Australasian paper manufacturers continued to struggle under the burden of strong currencies. Import competition kept pressure on domestic market share and margins, while virtually eliminating the traditional export market; exports are important in achieving mass to assist in operational efficiencies. Competition on the supply side, with a smaller market, made for a difficult environment. Results were steady on a year-to-year basis, a good result under the circumstances.

Strong demand continues in Asia

Continued growth was a high point for the Asian region. Improved living standards increased demand and also shifted quality expectations to a higher level in the decorative coatings market. All regional markets lifted sales over the prior year, and all but the Vietnam operation achieved a substantial improvement in profit.

Inflationary pressures became very evident throughout Asia. These were largely driven by two commodities: crude oil, where high prices are leading to high fuel costs; and basic food, where vegetable oils face steep price rises as an increasing percentage of available volume is diverted to production of biodiesel. Wages and salaries generally moved up in excess of 10 per cent as a consequence, but these costs were largely absorbed through plant and process efficiencies.

Conditions in Vietnam proved difficult as the fast-growing market continued to attract competition. Attempts by companies to build share to develop a base load prior to investment, coupled with increased interest in the market from regional producers, created difficult trading conditions. In spite of this, the business built sales volume substantially on a broader customer base. This confirmed the attraction of the product range and has provided a solid foundation upon which the company can work to return to previous profitability metrics.

In China, changes to VAT legislation, effectively a tax on exports, changed the manufacturing landscape. Export-focused industries such as furniture manufacture have started to move to lower cost countries – Vietnam for example. Companies established specifically to service such export-focused industries have suffered significant downturn in demand.

The primary role of Nuplex’s China operations is to service local demand. With spare capacity available, products were also being manufactured to service markets where the Company does not currently have manufacturing presence. Post changes to the VAT regulations, export margins became unattractive and production of this volume was switched to other plants in the region.

The focus in China was on quality domestic business with higher margins, rather than on volume and top-line growth. This programme was particularly effective and both China business units are now profitable. Assuming approval of regulatory authorities, there is confidence that further substantial investment in new capacity on the Suzhou site outside Shanghai will continue the success experienced to date.

Malaysian capacity was increased late in the year through plant modification and efficiency measures. By focusing on the best product mix for available capacity, the business delivered improved results. Indonesia gained over the prior year in what proved to be an unsettled market. A start was made on extending manufacturing capability to introduce composites resins to the site, with expected completion in the first half of 2008/09. Specialist technical and sales resources for composites have been situated in Asia to support this expansion plan for the region.