Date September 2018
Approximate net recovery on cost
By The Numbers
- U.S. tariffs went into effect in August and September 2018 on over $200 billion worth of Chinese imports, including $29 billion of chemicals and plastics products
- Resin production and year-to-date sales of major plastic resins increased by 6.5 and 9.3 percent, respectively, through July 2018 as compared to the same period in 2017
- The industry is anticipated to grow at an annualized rate of 0.6% through 2023 due to the support of growing downstream markets; however, rising input prices could constrain growth
Resin prices mixed: Among the resins and plastics commonly used in industrial manufacturing operations are High Density Polyethylene (HDPE), Low Density Polyethylene (LDPE), Linear Low Density Polyethylene (LLDPE), and Polyethylene Terephthalate (PET). Based on information sourced from Plastics News, after record high PE production in July 2018, by the end of August resin pricing was down 3-cents per-pound for most grades of low and linear low density polyethylene and for film and other flexible grades of high density PE. Notwithstanding a non-market price correction implemented in February, this decline came at the end of a four-month period of relatively flat pricing for those grades. Alternatively, some buyers did not see decreases for injection molding and rotational molding grades of LLDPE, as well as some grades of HDPE, and PET bottle resin has steadily increased in price over the course of the year. Market analysts note that August declines in certain grades were supplier-driven. Crude oil, coal, and natural gas are used to produce the primary feedstocks for plastics: ethylene, propane, propylene, butadiene, benzene, and xylene. Feedstocks can comprise 60 to 70 percent of petrochemical manufacturing costs, making their cost a significant factor in resin pricing. During the past year, oil and natural gas have both posted price increases.
Tariffs in effect: After months of anticipation, U.S. tariffs went into effect in late August 2018 on approximately $16 billion worth of Chinese products, including over $4 billion of chemicals and plastics. The Chinese Ministry of Commerce quickly retaliated, announcing a 25 percent tariff on $16 billion worth of U.S. goods, including passenger cars and motorcycles as well as coal, grease, asphalt and plastic products. As reported by CNBC, the latest U.S. list brings the total worth of Chinese goods facing a 25 percent tariff to $50 billion. Another round of U.S. tariffs launched in September, relating to $200 billion in Chinese goods, includes $25 billion in chemicals and plastics products. The American Chemical Council (ACC) recently estimated that approximately $9 billion in U.S. chemicals and plastics exports to China would be impacted by tariffs if China retaliates on the latest U.S. threat. Per the ACC China imported 11% (representing $3.2 billion) of the plastic resins made in the U.S. in 2017.
Despite ongoing bilateral discussions attempting to stem a trade-war, it remains to be seen what materials will be targeted next. To the extent that the increased cost of goods could not be passed along to the end user, this would put pressure on manufacturers’ gross margins, which could negatively affect appraised values. This being said, most resins consumed in the states by U.S. plastics manufacturers are produced domestically as the U.S. is a low-cost producer of resin due to favorable natural gas prices. Most imported resins do not come from China, so the ongoing trade war will likely not impact resin producers from a supply chain perspective. Finished products may be impacted, however some customers’ products may end up benefiting from tariffs on competing Chinese products, so the outlook on the industry for trade and tariff-related issues is possibly favorable to neutral.
Industry forecast stable: The industrial production index, which measures manufacturing activity, is set to grow at an annualized rate of 0.8 percent over the next five years. As manufacturing activity improves, demand for plastic and resin inputs will increase. With this increase in industrial production and construction activity, plastic and resin manufacturers’ revenue growth is expected to increase slightly at an annualized rate of 0.6 percent to $96.0 billion.
Housing starts are expected to increase at an annualized rate of 2.8 percent over the next five years, according to research firm IBISWorld. As construction projects advance, demand for pipes, flooring, and other plastic-based materials will increase, stimulating demand for plastic and resin inputs. Demand from foreign buyers is also projected to increase, with exports forecasted to increase at an annualized rate of 0.9 percent to $38.1 billion, accounting for over 39 percent of industry revenue by 2023. Much of this demand is expected to come from Mexico and Canada. However, given the current trade talks around impending changes to the North American Free Trade Agreement, current terms may change. To the extent that trade terms with Canada and Mexico become less favorable, the U.S. may lose export volume, which could negatively impact domestic pricing and production.
Resin recoveries typically strong with exceptions: While resin inventories typically provide a strong recovery in liquidation, lenders must keep in mind several caveats. Uncolored resins, with no additives, are essentially commodity-like inventories that, in proper quantities, would be readily salable in liquidation at very low levels of discount off market pricing. This type of resin would need a short marketing period to sell. Once resin is colored, however, its utility to anyone other than the intended customer diminishes precipitously. Likewise, as various additives such as flow inhibitors, UV stabilizers, biocides, and other products are added to resins, the end-use and potential pool of buyers shrinks quickly. Resins such as these are readily marketable, but they may only generate scrap proceeds and would be sold as secondary surplus product to a formulator interested in blending the product with other resins to produce a particular product. Colored resins can typically be mixed to make darker colors but have little other color possibilities.
With the exception of thermoset resin, resin scrap is commonly reprocessed and used again. Many companies stock and reprocess scrap themselves in either flake or pelletized form. The value of these products and their recovery as a percentage of cost will vary tremendously by grade, color, and form. This recovery percentage would also be dependent on the costing methodology applied to these reprocessed inventory items. In addition, lenders should be aware that “resin” inventories may contain non-resin items such as colorants, performance additives, or other non-resin inventory. Thus, while the resin inventory category is something that should indicate a strong recovery on its surface, due care and diligence should be exercised before applying an advance rate for this type of inventory.
Inventory costing and mark-to-market reserves: When a company’s inventory contains commodity-type items, like resins, which are subject to frequent price fluctuations, it is imperative to understand the company’s inventory costing methodology. A standard cost approach includes updating inventory costs periodically and, depending on the frequency of the update, can result in the company’s reported cost varying from the market in an inflationary or deflationary environment. A rolling weighted cost approach utilizes an average weighted cost for each purchased item that equates to a rolling perpetual average. This methodology is useful for commodity-type items as a company’s reported cost will remain closer in line with the market, although it will still trail market prices by a set period. Given the volatility in the resin market, lenders should be aware of the target company’s costing methods and should consider incorporating a mark-to-market or lower of cost or market reserve. This type of reserve will adjust the cost basis to market and ensure that an advance rate based on a percentage of cost remains relevant even in a volatile market.