Grounds for optimism in 2010

While further weakness is expected, there are also some encouraging signs indicating a better year ahead for Australian manufacturing in 2010.

In the full throws of a global economic downturn, as expected, 2009 was a rough ride for many Australian manufacturers.

A collapse in global demand, combined with a recession in trade, placed strong pressure on profitability and employment in a sector already burdened by challenging market conditions due to a high Australian dollar and intense overseas competition.

Australia’s manufacturing sector’s performance in 2009 reflected these pressures, with the Australian PMI revealing sharp declines in activity in the first part of 2009, with manufacturing profits before income tax falling to a seven-year low of $17.1bn in 2008-09.

Frank Gelber, Chief Economist & Director with BIS Shrapnel, says along with the collapse in demand both overseas and in Australia, it is the strong Australian dollar – which soared past US90c in October and is predicted to reach parity with the US dollar early next year – that is really damaging manufacturing’s competitiveness.

“While the Australian dollar remains high, the tradeable side of manufacturing will remain affected,” Gelber explains.

“All the short term signs are indicating the dollar will remain high for the short term. We need a dollar of US70/75c to be competitive.

“A lot of manufacturing that has been trade exposed has gone already, and if it (A$) remains strong, we’ll lose even more offshore,” he told Manufacturers’ Monthly.

While much of manufacturing in Australia is dedicated to servicing the domestic industry and to a point is sheltered from the currency, Gelber says the slowdown of investment triggered by the financial crisis will continue to hurt the sector and believes the Reserve Bank’s latest interest rate rises have been “premature”.

Heather Ridout echoes Gelber’s reservations about the interest rate rise and says while conditions still appear healthy for some businesses, a solid recovery remains some way off.

“Low interest rates, a boost to the First Home Buyers Grant, cash payments to taxpayers and a lift in public infrastructure investment have benefited some sectors including food and beverage, and construction materials.

“However, despite the signs of a return to economic growth, conditions remain tentative and driven largely by government and fiscal stimulus measures,” Ridout told Manufacturers’ Monthly.

Gelber is equally cautious, but says while he expects to see another year of weakness in the Australian economy, it will pick up.

“And when it does, it will pick up strongly, so we are looking at a recovery in 2011 with growth of 3-4% for the next three years, and this will stimulate the manufacturing sector,” he said.

However with adversity, comes opportunity, and even though it has undoubtedly been a tough year for Australian manufacturers, companies in this sector are not only demonstrating resilience, but are remaining positive and focused on recovery.

Ridout points to Ai Group research, which showed that over 85% of companies have reviewed or are reviewing their business plans, with a focus on boosting sales of current products, developing new markets, introducing new products and reducing operational costs were the key strategic responses to the downturn.

“Looking ahead, the development of new products and process innovation are the strategies which firms are focusing on to take advantage of recovery in the economy,” she said.

“Recent experiences of significant skills shortages have encouraged many employers to attempt to hold on as long as possible to skilled workers to avoid the skill shortages which are likely to re-emerge as the economy returns to growth.

“This has been important in helping the economy to avoid the sharp loss of employment experienced in other economies and has helped to shore up incomes and consumer confidence,” Ridout said.

Industry Minister, Senator Kim Carr is equally encouraged by the manufacturing industry’s response to market challenges, but says while the Government’s $77bn stimulus strategy had helped shield Australia from the brunt of the global recession, he stresses that “innovation is the key to accelerating recovery and opening up new pathways to prosperity”.

“Companies have responded to these issues in various ways, by restructuring and cutting costs. In many cases, workers and managers have developed flexible arrangements – such as reducing hours and bringing forward leave – to avoid job loses and keep businesses operating.

“This spirit of cooperation and innovation must be extended to every aspect of the industry’s work if Australian manufacturers are to make the most of the new opportunities recovery will bring,” he told Manufacturers’ Monthly.

“We are already seeing encouraging signs. Australia has come through the global recession better than just about any advanced country. The manufacturing sector is expanding again after a year and half of contraction.

“The international recovery is still fragile, and it is too early to sound the all-clear, but there is good reason to be optimistic about the future of Australian manufacturing,” he said.

Ridout agrees but questions how self sustaining the recovery will be without continued policy stimulus.

“On top of this there is a risk that conditions may be weaker than expected globally and that rising domestic employment may discourage consumer spending,” she cautions.

“A lot depends on the Reserve Bank and Federal Government’s actions over the next few months,” she said.

Machinery & Equipment

Traditionally regarded as the linchpin of Australian manufacturing, it’s a well known fact the machinery and equipment sector in Australia has been under pressure for some time.

While it certainly has been a challenging year for the automotive sector, with a slow domestic market and a dramatic decrease in export share, there have been some positive signs amidst the doom and gloom.

Official VFACTS data released by the Federal Chamber of Automotive Industries (FCAI) showed a stronger than expected result for September, with 78,131 passenger cars, SUVs and commercial vehicles sold.

Andrew McKellar, FCAI Chief Executive, says while the September results are down 3.5% (2,807 vehicles) compared to September last year, there were increases in some segments, demonstrating signs of consolidation in the new vehicle market.

“The Government’s response has sent a very important signal to the parent companies that there is strong desire to continue to attract investment in the next generation of passenger cars to be built in Australia.

“Toyota’s decision to proceed with an Australian-produced Hybrid Camry; the announcement by Ford to invest a further $230m to produce three new engine technologies for Falcon and Territory; and Holden’s production of a new small car to be built in Adelaide, are key indicators of growing confidence in the local auto sector.

“Significantly, the production of Holden’s new small car was a decision that was approved by GM at the height of the financial crisis and it is an important vote of confidence in the company’s operation here in Australia,” he said.

“Not withstanding the current challenging backdrop, I think there are grounds for optimism for the local vehicle manufacturers in that they have still been able to attract renewed investment on the part of their parent companies,” McKellar told Manufacturers’ Monthly.

Looking ahead to 2010, McKellar says he hopes to see further signs of consolidation in terms of the broader economic outlook.

“It also needs to be acknowledged that the various stimulus measures that have been put in place have helped to sustain the Australian economy through 2009.

“In particular the automotive industry has been a significant beneficiary of the business tax break which saw a very strong boost for sales particularly in the middle of the year and this is expected to continue before the end of this year,” he said.

Non-Metallic & Mineral Products

The volatility and uncertainty experienced in housing and construction sector during 2008 has continued well into the financial year ending 2009.

With a significant slowdown in construction growth throughout the year and a contraction forecast for 2010, firms already facing intense competition for available work and tighter profit margins, are bracing for a tough year ahead, with mining, civil and heavy industrial resource-based projects most under pressure.

Engineering and commercial construction work is forecast to fall sharply to a 2.3% growth rate in 2009 and then fall by 2.4% in 2010.

Reflecting tight credit conditions and weak investor sentiment across the property market, private sector commercial construction is predicted to contract in 2009 and 2010 by 5.1% and 15.4% respectively.

However, assistance from Federal and State Government infrastructure plans including the Building Australia Fund and the fast tracking of investment into education and hospital/heath infrastructure projects is expected to continue to stimulate construction opportunities and offset a significant market decline in 2010.

Building materials company Boral’s performance over the past year reflected the challenging business conditions which had a significant impact on the company’s US, Australian and Asian markets.

With the exception of the Australian infrastructure segment which remained strong, Boral’s major markets deteriorated during the year.

Boral’s reported sales revenue of $4.9bn for FY2009 was 6% lower than last year. Boral’s underlying profit after tax (PAT) of $131m, before significant items, was 47% below last year’s underlying PAT of $247m.

Despite this, Rod Pearse, Boral’s outgoing CEO and MD, says the company remains confident about the long term strength of its markets, but says a comprehensive response was necessary to lift performance in the short-term and to position the company well for an inevitable recovery and for long-term growth.

“Our response to the significant synchronised downturns in Boral’s markets has been to substantially decrease production to match sales and to manage inventories, together with a disciplined approach to pricing, widespread and rigorous cost reduction initiatives, a focus on improving cash flow and substantial constraints on capital expenditure,” Pearse explained.

Some positives for the sector include lower interest rates combined with improvements to the First Home Owners Grant which significantly improved affordability and flow through is expected from the social and defence housing component of the Federal Government Stimulus Package. Finance approvals for new dwelling construction have risen which will eventually flow through to building activity.

Pearse says the company’s production levels will lift to match sales increases as they eventuate and says he expects Boral’s Australian Building Products earnings to lift in 2009/10 on the back of stronger volumes and improved pricing.

“Despite the challenging times, and the need to reduce costs, we have not cut expenditure on our sustainability programs.

“The company is well positioned to deliver further performance improvements, particularly in the areas of reducing greenhouse gas emissions and other environmental impacts, sustainable product development, responsible supply chain management and safety management,” Pearse said.

Food, Beverage & Tobacco

While other sectors have struggled in the face of the economic downturn, conversely Australia’s $100bn food, grocery and beverage sector has not only weathered the global storm better than other industries, but has in fact, experienced growth.

Touted as ‘the new mining’, recent figures suggest the agri-foods industry played a major role in keeping Australia out of recession.

According to the Australian Food Statistics 2008 report released in October, the sector grew 3% between June 2008 and June 2009, with food manufacturing increasing by 5.4% over the same period.

AFGC Chief Executive Kate Carnell says these figures demonstrate that agribusiness is emerging as a key growth industry for Australia.

“The food and grocery sector turns over as much as mining and about four times as much as the automotive sector and it is a significant exporter to a wide range of global markets.

“Also over the past year we have seen quite a significant change in eating habits which is offering a real boost to industry.

“With the global recession, more people are eating at home, whereas 12 months ago eating out was the flavour of the month,” Carnell said.

However while sales are good, Carnell told Manufacturers’ Monthly the proliferation of private label products in supermarkets is putting increasing pressure on margins.

“While it is certainly true that some of these products are manufactured in Australia, a significant amount are imported, so while sales are good for many local manufacturers, this is not necessarily reflected in their margins,” she said.

Another key challenge for the food and beverage sector will be the introduction of the Carbon Pollution Reduction Scheme (CPRS), which Carnell says will add more pressure on a sector already mitigating water shortages and a rapidly growing population.

“A huge challenge for the local food processing manufacturing space is the ability to produce food for growing local and global populations.

“In Australia we are already at around 22 million people, with recent figures we have the highest population growth in the world, with a projected population growth of 34 million by 2050.

“Therefore a big focus for industry, particularly for companies in the food processing sector, is on things like water reuse, energy management, cogeneration,” she said.

Moving forward to 2010, Carnell says with the passing of the RET (renewable energy target) legislation, the industry will feel the impacts of the resulting hike in power prices.

“We are predicting we will see the cost of electricity rising 20-40% over the next few years and this is a huge new incost for food processing companies, many of whom are not eligible to receive any carbon credits,” she said.

Despite these challenges, Carnell says there are many positives for the industry and the sector is expected to continue growing as the population increases.

“We are really keen and very positive about the Government’s new Brand Australia approach to increase the knowledge of Australian products around the world and we believe Australia is in a great position to be able to cater for growing markets in Asia,” she said.

Metal Products

Given the wide use of steel in a number of industries and applications, the performance of the steel manufacturing sector tends to be a good indicator of the health of the global economy.

Unfortunately, companies’ performances in this sector mirror many of the tumultuous operating conditions experienced by other parts of manufacturing.

While the first part of 2009 started strongly, the second quarter brought a dramatic decline in demand.

Key industry player BlueScope Steel’s results for FY2009 reflected the experiences of many companies in this sector, with the steel company reporting a Net Loss After Tax (NLAT) of $66m and an underlying Net Profit After Tax (NPAT) of $56m, a decrease of 93% on the previous year.

Speaking at the release of BlueScope Steel’s FY2009 results in August, MD and CEO Paul O’Malley, declared that it had been “one of the most challenging years BlueScope Steel had faced”.

“The year started strongly on the tail-end of very buoyant business conditions, with regional benchmark hot rolled coil (HRC) prices exceeding US$1,000/t.

“However, coming into the second quarter, with a marked decline in economic and financial conditions in the developed world, export demand fell heavily, followed by domestic demand.

“The decline in sales volumes and prices continued until after the first quarter of the 2009 calendar year when both stabilised, but at low levels.

“The regional HRC price had reached a low of US$400/t around this time,” O’Malley said.

However O’Malley says there are some encouraging signs following a tough year and that the company is beginning to see the results of decisive action taken in the second quarter which included a number of cost saving and capital restructuring initiatives.

“This decisive action now sees BlueScope Steel with a very strong foundation – gearing reduced to 11.8%, no material refinancing obligations due until July 2011 and a strong liquidity position,” he said.

While there are encouraging signs of improvement in some markets and movement in steel prices globally, O’Malley remains cautious on the outlook for next year, saying the company expects to deliver a small reported net loss after tax in the first half of FY2010.

“We are yet to see the full flow-on effect of various Government stimulus packages, especially in the United States and Australia. We are seeing the benefits of China’s economic stimulus package and we have an increasingly positive view of our prime market, Australia,” O’Malley said.

Paper & Wood Products

It has been a tough year for companies in this sector, with the full impact of the global downturn hitting hard towards the middle of 2009, resulting in some significant casualties and restructures.

While earnings for the 2009 year were down 2.3% from $369.1m to $360.5m (after tax), key industry player Amcor put in a solid performance for 2009 given the particularly difficult economic conditions.

In August this year, Amcor announced its interest in acquiring parts of Alcan Packaging, creating a portfolio with approximately 80% of total sales in the flexible packaging, folding cartons for tobacco and custom PET containers divisions.

Following the acquisition of Alcan Packaging’s businesses, sales for the new Amcor are expected to increase by 50% to $14.3bn, and better enable Amcor to penetrate nominated strategic growth markets including flexible packaging, folding cartons for tobacco packaging, value-add custom PET containers and beverage packaging.

Amcor MD Ken McKenzie said the key advantage of combining the Alcan Packaging businesses with Amcor’s existing operations is the ability to substantially improve the value proposition to customers.

“The acquisition of parts of Alcan Packaging’s operations specifically targets these chosen growth areas, creating leading global positions. Amcor will be one of the global leaders in folding carton packaging for tobacco and flexible packaging.

“This is an exciting opportunity that significantly enhances future growth opportunities,” he said.

However, Amcor’s Australian businesses on the other hand, had a particularly difficult year, with earnings down 39.9% to $113.2m.

As well as slowing economic conditions which adversely impacted across most parts of the business, other negative factors included loses from the export of old corrugated cartons (OCC) and recycled papers.

Looking to the year 2009/10, Nigel Garrard MD of Amcor Australia says due to the company’s proactive response across all aspects of business to the current economic downturn, the full benefit of it is expected to come in 2009/10.

Petroleum, Coal & Chemical Products

The operating backdrop which has characterised the Australian pharmaceuticals product manufacturing industry has changed dramatically over the past decade, with further changes now expected as the industry seeks to transform itself in order to ensure its continued survival.

The latest IBISWorld data forecasts industry revenue will increase from an estimated $9bn in 2008-09 to $10.5bn in 2013-14, representing an average growth rate of 3.1% per annum.

However it also revealed a forecast growth rate for 2009-10 of only 1.5% as the industry negotiates a slowing domestic and international economy in line with the current global economic recession.

These conditions impacted heavily on exporters, with figures released from the Department of Innovation, Industry, Science and Research suggesting industry exports may fall back down to $2.8bn by 2010 in line with the process of consolidation currently occurring within the industry.

These operating conditions have been driving a trend for stricter capital efficiency, resulting in a number of plant closures and consolidation in the market.

Global pharmaceutical manufacturer Pfizer is expected to cut the number of its manufacturing plants from 100 in 2003 to 43 by year end 2009 while at the same time its reliance on outsourcing is to increase from the current proportion of 18% to 30%.

In October this year, Pfizer also announced the acquisition of Wyeth, which Jeff Kindler, Pfizer Chairman and CEO said will result in a strengthened and diversified global product portfolio for the company.

“We are pleased with our results this quarter and in our ability to once again deliver solid operational performance in an environment that continues to be challenging,” he said.