At the Global Gypsum Conference & Exhibition in Paris, France, in 2010, Bob Bruce presented a paper about how the global gypsum industry was likely to be affected by the underlying trends shaping the world today. One year ago business in Western Europe and North America was suffering and everyone was hoping that conditions would improve soon. Meanwhile, much of the rest of the world was enjoying a growing market. So what has changed in a year?
On the face of it, not much has changed since the Global Gypsum Conference & Exhibition in Paris in October 2010. The USA was recovering, but now is facing a potential 'double-dip' recession and is pulling into its shell. Western Europe has been rocked by the debt issues in Greece and elsewhere. Japan has suffered a devastating earthquake/tsunami/radiation disaster.
But while these major economic centres were struggling, the developing countries continue to grow, especially in gypsum. At Innogyps we receive calls almost every week from someone wanting to get into the gypsum business somewhere in the world. So perhaps the gypsum business is not so bad after all.
Lafarge heads for the exit
On the other hand, one of the three global players in gypsum, Lafarge, has decided to exit the business. This is big news. Why would a major player decide to leave a business that has shown so much potential? The answer to this question is simple, but the activities around this can tell us a lot about the future of the gypsum industry.
Lafarge owed Euro19bn and had promised its shareholders that it would reduce its debt. Gypsum was a valuable asset to sell, so that is what happened. The interesting part of the story is to look at who is buying... and why?
Lafarge had divided the gypsum business into four regions: North America, South America, Europe and Middle East/Africa/Asia/Australasia. All regions were growing and profitable, except North America. Etex, Lafarge's partner in South America, now has all of the South American and European plants. Boral bought out Lafarge's interest in their joint venture in South East Asia and Knauf bought the Australian division. Meanwhile Lafarge's interests in North America remain for sale. Each action makes good business sense. It is also useful to see how this fits into the overall pattern of how the gypsum industry is likely to evolve.
The gypsum industry in 2011
I will take a few words to describe how the gypsum industry has grown. The gypsum industry started thousands of years ago when it was found that gypsum rock could be turned into plaster and used for interior finishing. Over a century ago gypsum board was invented and has grown to be the primary use of gypsum in developed countries, but in many parts of the world today gypsum board is still a brand new product just coming to market.
Evolution of local gypsum markets
When gypsum board is introduced, it is used to replace conventional plaster construction, or may be introduced as part of new construction practices imported to developing regions, one example being fire rated construction for resort hotels. Building systems using gypsum board evolve over time to enhance sound, fire, impact, abuse and others and eventually achieve widespread use in interior walls and ceilings. To a lesser extent this also happens in floors, roofs and exterior wall systems.
Over time, these structures need renovation or repair and product is sold into this new market sector. To get the product to market requires a distribution network, which offers the gypsum manufacturer the opportunity to increase both revenue and influence on pricing through vertical integration in the market channel.
This can even extend to the end customer by having the manufacturer's products installed using preferred contractors. Over time there is a natural evolution down this path, although sometimes there are barriers to this evolution.
When you look at the gypsum industry around the world, it is possible to divide the various countries/regions into three categories:
- Mature: Those with well-developed gypsum board systems already in place.
- Growing: Those that are just introducing gypsum board in place of gypsum or cement plasters.
- Future: Those that are not ready yet.
Figure 1 shows a map of the world in which the three regions are highlighted; those with mature gypsum board systems in purple, those just growing gypsum board in green and those not yet ready (future) with no colour.
Mature markets
The purple regions in Figure 1 have well developed products and building systems. The companies operating in these markets generally have the technology to build high-capacity, low-cost wallboard manufacturing plants. They operate in very competitive environments and need to develop innovative products and continue to reduce costs to survive. This requires investment in overhead costs which are best spread over large sales volumes. There is also considerable advantage if strategies can be developed to gain some improved control over price and market channel dynamics. In these mature markets there will be global players with representation in many markets, regional players with plants throughout the country/region and local players with one or two plants in one area only.
There is a constant push for local and regional players to expand their market area. The global players must strive for consolidation in mature markets while they push into growing markets.
Growing markets
The green regions in Figure 1 have good growth potential. They need access to technology and funding to expand efficiently. They also need access to more sophisticated products and building systems at minimal development cost. The growing regions can clearly benefit from applying knowledge from the mature markets. In these growing regions, local independent companies, often with good connections to the end customer, will tend to enter the market challenging the larger regional and global companies that are also attempting to invest in these areas.
Future markets
The uncoloured areas in Figure 1 represent future markets. At some future date the economic activity in the region will grow to the point where personal income levels and labour rates will support the demand for wallboard systems. These regions need economic development, along with many other things, before gypsum board based building systems will become commonplace.
Back to Lafarge
Going back to Lafarge; The Etex deal gave South America access to European systems and gave Europe more volume to cover European overheads. The Boral deal allowed Boral to more easily push their 'market focus' management style into the growing South East Asian market. Knauf was simply moving into an area where it was not yet represented.
Gypsum in North America
But what about North America? The Lafarge's North America assets are first class, but it is difficult to see how to make an early return on this investment. This needs a more detailed review.
The North American gypsum board business is often described as having three sectors; new residential construction, new commercial construction and renovation/repair. New residential construction is often measured by housing starts, which are currently at the lowest level in 50 years. Unemployment levels are very high, people are worried and foreclosures continue to impact demand.
In recent financial results presentations USG has projected that excess housing units will be depleted by 2012 at which time normal economic forces will take over. While this sounds positive, if 'normal' economic conditions consist of high unemployment, high debt load and low confidence for the 'baby boomer echo' generation then recovery will be slow. Housing starts at peak 2006 levels may take 10 years, with a normal level of 1.5 million USA starts not occurring until 2014.
New commercial construction requires companies to be making money and has a long lead time from decision to spend. The recovery through to early 2011 was showing promise, but risk of a double-dip will now postpone this rebound in spending until 2015 or later.
Renovation shows some promise. Often consumers will feel that if they cannot buy new then they can make do by fixing up what they have. Home Depot is a good example of an outlet focussed on repair and renovation. Home Depot was affected by the recent downturn, but revenues only dropped about 10% and are almost fully recovered. In comparison, the gypsum industry is still at less than 60% of peak demand volumes with significant price reductions on top of this. USG's introduction of UltraLight and its exclusive arrangement with Home Depot was likely driven in part by a desire to increase USG's market share in the renovation sector.
The downside of relying on this sector is the inability of manufacturers to push price increases through the channel. These types of outlets buy significant volume and demand competitive pricing. They are quick to force prices down when times are difficult, but very slow to react to price increases when business starts to improve.
Gypsum board at Home Depot near my home in Canada is being sold at about the same price as when gypsum activity was at its peak, even though the price from the manufacturer has dropped by 40%. It should be noted as well that another distributor near Home Depot is offering a competitive lightweight board to USG UltraLight, at the same price as regular board! Of course I have also seen gypsum board in Home Depot in other parts of North America at very low prices as well. Obviously competitive forces are fully in play in this market today.
Price, capacity and utilisation trends
It is interesting to look at the price for gypsum board compared to volumes for the past 10 years. About 10 years ago large quantities of inexpensive flue gas desulphurisation (FGD) gypsum became available. Gypsum companies were quick to build new capacity to take advantage of this high-quality low-cost raw material, as well as take advantage of the cost savings that a new efficient plant can bring.
With new capacity and reduced manufacturing costs, there was much competition to fill these new plants and prices dropped to less than half in about 18 months. Figure 2 shows the USG price and volume as reported for USG in their quarterly public financial reports. Note that during 1999-2000 prices continued to drop even as sales grew. Obviously it was not falling volumes that caused the price to drop.
Figure 3 shows how capacity has compared to shipments in North America over the past 30 years. Note that in 1999-2000 shipments remained strong, but capacity grew much faster than demand.
Price versus capacity utilisation
A comparison of price to capacity utilisation shows the true cause and effect relationship. Figure 4 shows industry volume compared to capacity utilisation over the past 10 years.
When industry utilisation drops below 85-90%, prices start to drop and continue to do so until the supply-demand curve comes back into balance. Normally the price will drop and force capacity closures until the plant utilisation rate approaches 85-90%.
Both USG and Eagle Materials have addressed this point in recent financial presentations. USG states that supply and demand will get into balance as soon as we get back to 'normal' business levels and we have a further 10% reduction in capacity from 2010 levels. Eagle shows that the overcapacity is worse east of the Mississippi than in the west and that prices will not recover to peak levels in some regions for over 10 years. This does not paint a very rosy picture for the industry.
In North America there are two fundamental problems; the supply-demand imbalance and the inability of manufacturers to obtain market support for 'announced' price increases.
Certainly there have been plant closures, but the housing bubble in 2006 followed by the current recession gives us demand figures that are unusually low, outside the normal cycle dynamics typical of the North American gypsum market. Certainly there have been closures in the past two years, but when prices drop and manufacturers are no longer competitive then sometimes the only way to avoid losing market share is to build new low-cost capacity. Several companies talk of the capacity reductions in the USA but may not mention the new capacity that has become available in Mexico and Canada that also competes with previous supply points in the USA.
In addition, some of the closed capacity is only mothballed, ready to be brought back into service if needed - See the red triangles in Figure 4. Closures need to continue until capacity drops to what is needed for 2013-14, a further reduction of 3-4 million msf - See green squares in Figure 4.
Must-have products
Influence over price is a much more difficult problem to solve, especially in a slow market with several supply options in every local market. Conventional tactics are introduction of unique, must-have products and taking more control of distribution.
In keeping with this strategy, USG introduced UltraLight but competitive products soon appeared. USG also has been in distribution, but USG Building Products Distribution is losing money as well and is being cut back. On the other hand, Saint Gobain continues to expand its Building Distribution sector in Europe, offering a full range of company products through these outlets. It is enjoying good growth and profitability.
Perhaps this strategy will work if done on a large enough scale.
Consolidation in North America?
Perhaps the preferred solution here is significant industry consolidation, which would naturally bring about both plant closures and increased market channel control. Moving from 11 suppliers to five in North America would certainly strengthen the position of the manufacturers in the market channel and also allow both speedy and well controlled matching of capacity with current and future demand. The following activities make the potential for consolidation particularly attractive now:
- Lafarge North American business unit for sale;
- Purchase of Temple Inland by International Paper;
- Overall reduction in share price of publicly traded gypsum companies (USG and Eagle);
- Difficulty for Georgia-Pacific Gypsum to line up with Koch Industries' priorities;
- Fragility of small independent high cost supply points;
- Attractiveness of independent low cost supply points;
- Huge long-term oversupply in some market areas;
- Ability to leverage mature-market personnel and expertise into growing markets.
Recommendations
The forecast data suggests that there is considerable work yet to be done for the North American gypsum industry to recover and that just waiting for the market to improve will be insufficient. Consolidation will likely take place to some degree in the upcoming months, but to improve profitability and be a survivor of consolidation activities each company/plant must:
- Have every plant do everything possible to reduce delivered cash cost while maintaining quality and service.
- Run plants with more production days or not at all. Running short weeks is fine in the short term, but plant overheads must eventually be covered and in a long term market this means low cost plants running at least five days per week.
- Compete on price only if others plants in the local market region have higher delivered costs.
- Compete on innovative products and service wherever possible but ensure that extra development costs are covered by price or volume improvements. Leverage these added costs over the widest possible markets as fast as possible.
- Find new ways to take more control of the market channel dynamics in order to support supply chain stability and ward off customers' demands for lower prices.
- Take advantage of international growth markets to leverage valuable expertise and reduce the impact of regional cycles.
- Be quick to recognise and respond to competitive situations brought about by those looking for growth and to new entrants with preferred connections to customers.
Conclusions
In summary, it is not just the growing markets that have potential. Those operating in the more mature markets have considerable talent and financial resources that can help to open up the growing markets.
Industry consolidation in difficult mature markets will almost certainly improve profitability as well as provide a strong base for expansion into growing markets. The larger global players have been doing this for some time but only recently have more regional companies started to look outside their home markets.
Taking an even longer term view, the future markets also have good potential and any assistance the mature or growing markets can offer with economic and social development will be followed by growth in gypsum business activity.
Yes ... the world is full of change and the global gypsum industry is evolving. As in nature the survivors in evolution are those that can best use their resources to adapt to the changing environment. It will be interesting to see who rises to this challenge in the global gypsum industry over the next five years.
