In this periodic report, ARC Advisory Group looks at different process and hybrid manufacturing industries to identify trends in capital expenditures (CapEx) and their drivers. (A future report covers the discrete manufacturing industries.) We calculate our CapEx index using the same rigorous methodology we use for the ARC Automation Index, which is based on publicly available data provided by major companies (in this case, end user companies, rather than suppliers).
Capital expenditures are a leading indicator for automation markets. When confidence in vertical industry markets decline, a decline in investments often follows.
Past experience shows that it takes around eight to nine years following a financial crisis to experience a global upswing. For example, following the global crisis in 2008, the upswing started in 2017, with 2018 being another strong year and a return to a normal business cycle movement. We are seeing the current political uncertainty and trade tensions (such as the US-China trade war and Brexit) dampening growth and affecting long-run investments in particular. While many of the discrete industries have already reduced their CapEx, many process industries are still expanding and we expect the turning point to be in 2020 and 2021.
In addition, the growth engines of the past decade are slowing down. South Africa, Turkey, Brazil, and Russia, all show weaker growth, but it is predominantly China that has an impact on the global economy.
When it comes to technology trends, digitalization is certainly the most important, as it triggers investments in many other areas from field devices, to MES, to IT/OT convergence. The concept of the digital twin is reducing engineering times and helping improve the performance and availability of installed assets. Artificial intelligence (AI) is still an unknown variable in many areas, but we are starting to see advanced analytics and both predictive and prescriptive maintenance approaches gaining traction.
Over the long run, modular production concepts and open process automation are also gaining traction and will likely change the global landscape of the process industries. Some takeaways from our research include:
Food & beverage continues to grow pushed by megatrends, such as urbanization and a rising middle class. It appears that investments in packaging are growing faster than primary production.
Pharmaceutical investment is driven by long-term demographic trends (e.g., ageing populations) and, the rising incidence of chronic diseases, and new biopharmaceuticals.
Chemicals investments lost momentum in the EU and China but is still increasing in North America and the Middle East.
Metals manufacturers are lowering CapEx spending by focusing on smaller projects with a faster ROI.
Mining industry has consolidated, resulting in continued flat CapEx investments. ARC expects a small recovery in 2019, but not a return to pre-consolidation values.
Oil & gas experienced ups and downs in the last few years and is strongly affected by geopolitical developments. Investments expanded in 2018 and we expect a further increase in 2019, followed by a slowdown in investment activities. We are not likely to see a return to the high CapEx volumes of 2012-14 within the next five years.
Power industry is increasing investments in renewable energy generation and associated infrastructure.
Pulp & paper industry is struggling to achieve profitability (despite current shortages of pulp), making it increasingly difficult to authorize capital spending.
More detailed discussions of the above industries follow.
In 2018, economic development continued to lose momentum. While the global domestic product (GDP) still grew by 0.6 percent, the differences in economic dynamics between the various countries increased.
Even though global industrial production continued to grow, exceeding the previous year’s levels, the condition of the global chemical industry is not ideal and hasn’t been so for years. Europe’s chemical industry position has weakened significantly, and things are no longer running smoothly in all parts of Asia. Industrial production shrank in Japan. In China, growth also clearly slowed. Overall, prospects are becoming less favorable for the development of the industry.
Global chemical production lost speed due to less momentum in important customer industries. The industry grew slower compared to the previous year. While we saw continued year-over-year growth, production slowed, particularly in the EU and China.
In the period under review, most customer industries expanded their production. However, production in one of the chemical industry’s major customer sectors – automotive – fell worldwide. Due to the associated demand for chemical products, global chemical production also lost momentum, particularly in the EU and China.
The pace of global expansion is likely to slow further in the coming months. It is thought that the peak of growth dynamics was seen in 2017. However, the robust employment trend (with historically low unemployment rates) continues to support growth in private consumption. Furthermore, monetary and fiscal policies remain geared to expansion. But in many countries the upswing is already well-advanced and, considering the stronger price and wage dynamics, the major national economies in particular will potentially have lower growth rates.
Overall, the risks are high. The trade conflict between the US and China could escalate - with negative impacts on the world trade system and, due to the strong integration of value chains, with higher production costs almost everywhere. Trade policy tensions between the US and EU have not yet been resolved, either. Also, because of their possible effects on other emerging markets, the crises in Turkey and Argentina could potentially slow down global growth. Moreover, in Europe there are home-grown risks such as Brexit and a new debt trap.
Most trends show a negative development. The short-term trends, EBIT/CapEx and CapEx/Revenue, recovered in 2018, but the long-term trend remains negative. This suggests that investments will only be made if a timely ROI can be expected. Fortunately, the indicators for EBIT/Revenue and EBIT/Asset turned positive in 2018, enabling the chemical industry to strengthen its competitiveness.
In general, there’s been a trend for global bulk and specialty chemicals manufacturers to shift production from well-established production centers in Europe, Japan, and (to a somewhat lesser degree) North America; to cost-advantaged China and India and feedstock-advantaged Saudi Arabia, which has been making a major push to increase the value of its exports to help diversify its previously oil-dependent economy. ARC is seeing investments in state-of-the-art, world-scale chemical production facilities in all these countries.
Increased global competition drives the need for greater efficiencies and cost reductions across the industry. While the scale and complexity of bulk chemical manufacturing appears to be increasing; specialty chemicals manufacturers, particularly in Europe, are exploring increased modularization of production assets. This includes development of new modular production sites that can be easily located close to either feedstocks or end customers to reduce logistics costs.
In addition to growing pressures to reduce both project-related and operations-related costs and expenditures, chemical manufacturers face increased governmental regulation. This includes mandates to increase safety and reduce potentially harmful emissions. In general, the entire chemical industry is seeing a move toward increased automation to reduce costs and compensate for the growing skills shortage. Increased digitalization across the value chain is another clear trend.
Due to the essential nature of many products produced, the food & beverage industry is less affected by global economic conditions and trends than other industries. However, it is sensitive in the mid- and long-terms to government regulations that determine how products are manufactured and where they can be sold.
The structure of the food & beverage industry is both global and local. A handful of global conglomerates produces a huge variety of branded foods sold around the world, but consumer preferences in recent years have shifted away from packaged and processed foods and toward fresh food and local producers, resulting in stagnant or shrinking sales for “Big Food.” Fresh goods can be more profitable, driving supermarkets to allocate more shelf space for these products, while reducing space for packaged and processed foods. ARC’s CapEx index reflects the economic performance primarily of publicly traded large producers. This fact may mask some market dynamics and miss those related to smaller suppliers.
Demand and investment in the food & beverage industry follow the business cycle like other industries, but there tend to be fewer extremes. People eat and drink independently of economic ups and downs, and some armchair-economists even argue that people drink more during tough times. In any case, population-related megatrends influence industry development the most, such as the increasing urbanization of the populace and growing average incomes in developing economies. This is especially true in large, rapidly growing markets like China.
Long term, growth in the food & beverage industry will mostly follow population trends but we expect technology to play a role as well. The industry has invested heavily in IT infrastructure in recent years to keep up with the level of technology necessary to remain competitive. IT systems support the processing of information needed to maintain quality standards, improve compliance, address food safety issues, and track product information. In the next few years, producers will invest more in their IT systems, driven by the acceptance of and need for digitalization, but will expect a payback from these investments.
The digitalization of industry is both a broad topic and represents a long journey for industry players. The convergence of OT and IT means that industrial companies now can take advantage of digital tools that are already widely used in other sectors. Both products and production assets will benefit from the “digital twin,” a software replica that speeds up product design with simulation and allows new product lines and entire factories to be laid out in the optimum way before construction even begins. Increasing use of artificial intelligence in the coming years should further benefit these processes.
In existing plants, end users are learning how to get more out of existing production assets through data analytics that can be implemented at many different levels and no longer require the special skills of outside data sciences. Many of these solutions will be implemented in the cloud, so spending will shift from hardware and software purchases to service-driven business models. The market for computer hardware and software will continue to boom, but new business models will allow these products to be used more efficiently and they will be operated by service providers rather than end users.
Important trends and technology drivers in food & beverage are the demand for more transparency and sustainability. For producers, this translates to an evolution of culture regarding labels. Consumers want more and easier-to- understand information about ingredients. Purchases are increasingly motivated by “free from” labels that list things NOT in the product, such as sweeteners, dyes, and other artificial ingredients. On top of this, consumers want labels to contain more information about where ingredients come from and their purchasing decisions are increasingly being influenced by the product’s sustainability and the environmental friendliness of the packaging.
We assume that food & beverage investments in equipment go into factories that process and package food & beverage products. However, automation and robotics are increasingly being used in food distribution, from brick-and-mortar stores to online grocery stores, and yes, even in semi-automated restaurants. Food preparation equipment traditionally used in manufacturing processes is finding its way into large restaurants to address personnel costs and labor shortages.
Another development impacting the food & beverage industry is “precision farming,” a technology employed in farming to optimize efficiency and maximize return on assets. Precision farming uses precise satellite navigation together with sensors mounted on farm equipment and even drones to observe key parameters such as crop yield, topography, organic matter content, and levels of moisture and certain nutrients. These data are mapped across farmland to detect variations, allowing farmers to optimize controllable parameters, from irrigation to seed distribution.
Companies in ARC’s CapEx index saw a dip in profitability versus other indicators in the past few years, mostly due to higher commodity prices. But the trend flattened in 2017 and picked up slightly in 2018. While this slide in profitability may look alarming, it is most likely cyclical and not evidence of a long-term trend.
In any case, investment levels (CapEx) versus revenue have remained flat since 2015, a trait that is typical of the stable food & beverage industry.
The great challenge facing the food & beverage industry is technology. Like all traditional manufacturing industries, food & beverage producers must embrace new technologies for two reasons: as order qualifiers to keep up with competition and general industry trends, and as order winners to differentiate their offerings from those of competitors, and to increase efficiency to gain a cost advantage.
Most producers have invested in software tools for product design, and many integrators now use CAD design and simulation tools to layout production processes. But few have truly embraced the full concept of the digital twin and taken advantage of its benefits from product and process design to the “performance” (operations) phase. In an industry that derives profits from economies of scale rather than high margins, expect such technologies to soon play an increasingly influential role in CapEx investments.
In addition to these challenges, industry executives believe that new product development, more autonomous operations, and efficiency improvements in logistics will drive growth and help improve profitability in this sector.
The global metals industry is comprised primarily of steel, aluminum, and copper production. The steel and copper segments of the market continue to suffer from declining demand, price erosion, and excess production capacity. In contrast, aluminum is experiencing a surge in demand from the automotive and aerospace & defense sectors, driving investments in plant and equipment in these segments.
Since 1999, China has progressively expanded the production capacity of steel plants such that this region now accounts for over 50 percent of the global steel production and is responsible for about 46 percent of the global overcapacity. The metals industry in China expanded to accommodate domestic demand for building and infrastructure materials. The production buildout had an impact on a global scale whereby Chinese metal producers are one of the primary causes for lower profitability, declining prices, and general instability in this industry. The Chinese government is planning to close 110 million to 165 million tons of steel capacity by 2020 to assuage the excess capacity in the market.
Companies in the metals industry depend on the automotive, construction, oil & gas, and aerospace & defense industries for growth. Specifically, the aluminum sub-segment, which remains a virtual oligopoly with its vertically integrated businesses, will benefit from the rise in consumer demand for cars, housing, and air transport. However, the remainder of the metals industry, which is focused largely on steel, is adjusting to new pricing levels and increasing competitiveness. The focus in the steel and copper industry has shifted to rationalizing underperforming assets, idling capacity, and undertaking corporate reorganization to help lower costs and improve margins.
From 2012 to 2013, capital expenditures grew significantly faster than revenues – creating excess capacities. In 2014, following the sharp decline in domestic demand, Chinese metal producers started focusing on the export market, driving down prices globally. US steel producers filed anti-dumping suits against China and several other nations. In 2018, the US imposed tariffs of 25 percent on steel and 10 percent on aluminum primarily targeting China’s dumping of steel. This has created a more positive environment for North America-based steel companies to continue to make capital investments in plant and equipment.
The EU instituted anti-dumping measures on Chinese imports of seamless pipes and tubes of stainless steel for another five years. The duties, ranging from 48.3 to 71.9 percent, were initially imposed in 2011 and continue today.
Despite these protectionist measures, excess supply of metals and raw materials, along with excess capacity for downstream steel and aluminum production, has caused a decline in large capital expansion projects in this industry. This will have a significant impact on CapEx development over the forecast period as metals manufacturers will likely focus on smaller projects that have a faster and often more measurable return on investment.
The automotive, aerospace, oil & gas, and construction industries account for over 75 percent of steel and aluminum consumption. Both automotive and aerospace have experienced sequential year-over-year growth since 2012, but this has not been enough to offset the tremendous oversupply in the market. Prior to the downturn in the oil & gas industry, shipments of metal products into the oil & gas sector represented over 10 percent of the revenues in the metal industry. However, the decline in oil prices resulted in a significant reduction in capital expenditures of tubular goods, mobile machinery, and other equipment. There are signs that this trend may be reversing.
Construction has remained strong in North America, but a significant de-cline in China has disrupted the market. The previous hyper growth in construction and infrastructure driven by government investments in China has declined precipitously. While metal producers in China create a challenging business environment, the decline in domestic demand for metals in China has a significant impact on businesses in this industry globally.
Overall, the expectation is that capital expenditures in the metals industry will be concentrated primarily in two areas of the market. Steel manufacturers in the US, now under the protection of tariffs, will increase capital expenditures to improve operational performance. However, the US only represents about 5 percent of the total production output, so this will not have a major impact on the global CapEx in the industry. Globally, the major aluminum producers will continue to increase CapEx investments as the increasing use of aluminum in automotive, building & construction, aerospace & defense, and food packaging materials will drive investments.
Most EBIT measures have increased over the last few years, mainly due to improved production efficiency in the industry. North American and European firms struggled through this challenging low-price environment (at multi-year lows in 2015 and 2016) where firms restructured and put more emphasis on return on invested capital, productivity, and product specialization. Increased productivity means today's steel mills don't need as many workers. In North America for example, steel is made at super-efficient mini mills, which use electric arc furnaces to turn scrap metal into steel. Traditional integrated steel mills make steel from scratch, feeding iron ore and coking coal into blast furnaces. In the 1980s, steelmakers needed over 10 man-hours to produce a ton of steel; now they need 1.5 man-hours. Mini-mills, the state-of-the-art in the industry, need just 0.5 man-hours to produce a ton of steel.
Investment activities slumped between 2014 to 2017 when the oil price shock and China’s slowdown in infrastructure spending placed a strain on the market. Overcapacities are now being removed and modernization is taking place in regions that have implemented protectionist measures. Looking at the long run, CapEx/revenues will demonstrate a slightly upward trend beginning in 2018, a long-run trend of around 4 percent.
Manufacturers in the metals industry will need to undergo a digital trans-formation and implement smart manufacturing principles to emerge as globally competitive players. They’ll need to transform the way raw materials are sourced and manufactured as well as become increasingly more customer- focused. This change is not a one-step process as there are obvious challenges of trust and data security to overcome between diverse parties in the supply chain. Early adopters within the metals industry will gain a sustainable competitive advantage by shifting the focus to adding value with customized products while improving operational efficiencies in logistics, product quality, predictive maintenance, and process control and safety.
Table of Contents
- Executive Overview
- Food & Beverage
- Oil & Gas
- Pulp & Paper
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