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March 1, 2004

15 Min Read
Capital Investment: Planning strategies for 2004

Financing in a recovery

All of the economic indicators suggest that the plastics industry is on a path to recovery. Maybe so. In any case, the landscape we grew to know and love in the late 1990s has changed dramatically. Winning plastics professionals are evolving, getting leaner and smarter. And when it comes to capital investment and financing, your options are changing also. MP looks at the state of the finance market and offers some strategies for the coming year.

The last few years have been hard ones for the plastics industry. It seems no one escaped the double-hit processors sustained: A recession accompanied by the flight of manufacturing to Asia. For the men and women in this industry who hold the purse strings, the pain was no less felt. With overcapacity rampant, and as companies shuttered their doors, used injection, extrusion, blowmolding, and thermoforming machinery flooded the market. Purchase of new equipment, by 1990s standards, was unknown.

But if the economic storm is passing, it''s time to look to the future. Plastics professionals who want to reassert themselves in 2004 will need to do so with the most current and most efficient equipment.

"The plastics universe has shrunk and boiled down to its core," contends Thomas Blaige, CEO and managing partner of Thomas Blaige & Co., a Chicago-based investment and M&A specialist serving the plastics industry. "There''s a flight to quality, and the only processors who have a need for capacity are the ones who have a proactive strategy."

So, is the industry ready to expand again? If so, the finance community is ready, but there are some new hurdles for processors to clear.

Defaults plentiful, money scarce

The challenges facing the finance community right now are painfully obvious. Plastics professionals for the last three years have watched revenue decline, facilities close, and customers leave. Financiers have watched loan defaults skyrocket.

Sam Smith is VP division manager of the Plastics and Packaging Group for Wells Fargo, based in Portsmouth, NH. He''s been on the finance side of the equation for 20 years and grew up in the industry (his father was president of Van Dorn for 20 years). He says the finance market has changed dramatically. "For the last three years we''ve had a weeding out of ''mom and pops,''" he says. "This is not news to anyone. Companies have had to get smarter."

The problem, he says, is that borrowing, in the meantime, has become more difficult. Lenders want greater assurance that they will get a return on their investment, and proving that is not an easy proposition. "When the used market was flooded, values just weren''t there for investors," Smith says. "Residual equipment values are dropping. Machinery just doesn''t have the value to a plastics processing operation that it used to."

Chris Lyle, customer finance manager for machine tool supplier Makino (Mason, OH), sees similar challenges. He says Makino finances about 30% of all the machines it sells, and it''s Lyle''s job to walk customers through the process.

After two to three years of steady losses, he says one of his primary jobs is repeat-business support. "I help our customers buy equipment, but I also help them be around to buy more in the future," he says. "The challenge is proving funding for a capacity increase." He says many customers today come in with little equity, two years of declining revenues, and a strong desire to add capital to their operations.

The decision: lease vs. buy

So, if you are ready to add equipment, and you need financing help, what do you do? Do you lease that new injection molding machine, or buy it outright? The answer, of course, depends on what your equipment strategy is.

Smith, at Wells Fargo, is a strong proponent of operating leases (also see sidebar, "Operating leases head east"). More specifically, he''s a strong proponent of leasing through vendor financing. Most every major machinery supplier today offers some sort of vendor-sponsored financing service, typically backed by a Wells Fargo or similar institution. The advantages of vendor financing, says Smith, are several.

First, because the vendor is "fronting" the deal, paperwork and the usual requirements are minimized. Second, the vendor is naturally incentivized to offer financing plans that will enhance his relationship with his lender and his customer. ("The vendor will not sponsor something that will hurt his position," says Smith.) Third, all of the "acid tests" that a lender requires of a borrower are presumed passed in a vendor-sponsored deal.

Smith also says that an operating lease keeps your cash outlay off the balance sheet; this means that your leverage ratio is untouched by the exchange.

Lyle, at Makino, offers a slightly different perspective. More often than not, he says, he can prove to a customer that an outright buy of the equipment can, in the long run, be more cost-effective. Lyle''s concern is that too often—particularly with leases—customers focus on interest rates and monthly payments to the exclusion of all other details. He identifies "hidden" upfront payments, skip payments, and unfair buy-out options as chronic problems in poorly written leases. "Interest rate and monthly payment are not the sole determinants," he says.

Further, in buy scenarios, he contends that the cash outlay is usually more favorable, as are the depreciation and write-off options. In any case, Lyle recommends processors do two things: Get multiple quotes on financing and do an apples-to-apples comparison of the quotes. The latter is best done, he says, by comparing amortization schedules. "If you have an amortization schedule, it puts in print your deal," he says. "This is the best way to check your purchase price, all costs, rates, and your capital outlay. If there are warts in your deal, the amortization schedule will show them."

If you do decide to lease, Lyle and Smith say that there are a few things to watch out for. "My biggest concern on an operating lease is that the borrower really understand what their options are at the end of that lease term," reports Smith. At the end of a lease term, you can, typically, either opt out, buy the equipment at a set value (determined at time of signing), or renew the lease. Where processors get burned, say Smith and Lyle, is on the buy option. The amount of the buy option—called fair market value—if you''re not attentive, can be excessive or unfair, thereby diminishing or negating the value of the whole lease.

Smith recommends borrowers be sure to get a fixed term on the fair market value cap. That, combined with the multiple quotes, should help ensure a fair deal. And when in doubt, says Lyle, "Ask lots and lots of questions. If it seems too good to be true, it probably is."

Jeff Sloan [email protected]

Improve your credit rating before you ask for a loan

A plan to decrease volatility in world financial markets could create headaches for some processors, but opportunities for others. The Basel II accord, which takes effect in 2007 but is already being partially implemented at many financial institutions, will force banks and other lenders to perform a more detailed analysis of the credit-worthiness of potential borrowers.

In the past, banks often loaned money at a set rate, with the result that firms with a superior credit rating probably paid too much for their loans, while those with poor credit ratings did not pay enough. Banks also had to have capital reserves available amounting to a fixed percentage of their total credit amount. Basel II changes that. Under it, that fixed percentage will be replaced with a floating one directly linked to the combined creditworthiness of all borrowers, forcing banks that loan to high-risk creditors to maintain more non-working capital. Lenders must also obtain more information from the firms to which they extend credit.

On a macro scale, say some financial gurus, Basel II may lead to an increase in banks'' capital reserves and a reduction in the amount of total credit available, likely increasing the negative affects of any economic downturns. Closer to home for plastics processors, now is the time to ensure your financial house is in order, say experts, so that if the amount of available credit is indeed crunched, your firm will make the short list.

Strategies

In light of the stricter lending standards, Schaefer''s firm works to improve SMEs'' odds of accessing funding at better-than-market rates. Preparation includes at least the following:

  • Where are you now? An analysis of the current situation at the processor is required, and persons from outside the firm help this assessment remain neutral. This assessment highlights strengths and weaknesses and looks at chances and risks. It includes consideration of financial statements and projected results. Schaefer says identifying strengths and weaknesses is critical since fixing the weaknesses (or having a plan to fix them), and highlighting the strengths, is central in any talks with potential lenders.

  • How do you improve your rating? The evaluation of past financial and projected financial results identifies any potential roadblocks in the path to a loan. Some of these may be simple fixes, but some, such as developing a working succession plan, require more time. During this step, the consultant also helps a firm improve its system of information management so that this is more transparent to potential lenders. This also means continuously updating a company''s financial position; improving systems for accounting, risk management, and risk recognition; and preparing for meetings with potential lenders by gathering all necessary quantitative (e.g., profit margin) and qualitative (e.g., expected market growth) data.

Gabriele Schaefer, partner at consulting firm KWPS (Cologne, Germany) notes that many SMEs could use a better managed debtor/creditor system to keep accounts receivables low and paid on time. She also recommends restructuring debt from short- to long-term and considering leasing agreements instead of cash purchases to optimize cash flow.

She also says that a progressive balance sheet policy can place a firm in a more positive light and lead to lower rates from lenders. Under a progressive balance sheet policy, quantitative data such as debts and credits are accented with qualitative measures the firm is using to improve its competitive position. These can include steps to improve customer loyalty, to reduce employee fluctuation, or plans to implement lean management techniques to better use available resources.

Finally, monitor how changes have improved the firm''s credit rating. Schaefer says that while most lenders ask for similar information, processors should obtain in advance lending agreements from those lenders they intend to approach, so that they can hone their presentations to include lender-specific requests.

Matthew Defosse [email protected]

Finance in the Far East

In China, injection machine suppliers see capital investment continuing strongly this year, although as one of the few major global growth markets, equipment suppliers are competing fiercely for a slice of this pie. With little leasing conducted in Asia and many processors struggling to secure bank financing, some suppliers are reportedly offering extremely attractive purchase terms.

For example, several Asian machinery suppliers reportedly offer terms of no payment for one year, with the balance spread over the following two years. Others see this as a dangerous practice. "How can you guarantee that a processor will be in business two years down the track?" asks one Japanese supplier.

An emerging trend in China, according to all-electric injection machine supplier Fanuc, is for resin trading companies to buy machines directly from suppliers and sell them on to processors under attractive terms. This ensures an outlet for the trader''s resins.

Life in Japan

While much of the focus in Asia is on China, all is not lost in mature economies such as Japan. Toshimasa Ota, president of auxiliary equipment supplier Kawata Mfg. Co. (Osaka) says that despite the impression that all types of manufacturing are declining in Japan, there are some bright spots.

"While a lot of investment by Japanese automakers and their suppliers is in China, increased use of electronics in vehicles is resulting in investment in small, sub-20-tonne machines in Japan for molding precision connectors," he says. Ota estimates that about 70% of injection machines shipped in Japan are now small (50 tonnes or less).

Small machines are also being purchased in Japan for camera and pickup lens molding, digital camera components, and other IT components—particularly components for LCD displays. Ota sees food packaging and medical as other markets that will hold up in Japan.

Ota adds that despite the rising Japanese yen, they are pressuring their suppliers to come up with cost cuts, and prices have not risen significantly. "A lot of our suppliers are increasing procurement overseas," he says. He predicts 5% appreciation of the yuan this year as the peg with the U.S. dollar is loosened.

On the auto side, one major user of processing equipment is adopting an innovative strategy. Faced with competition from low-cost manufacturers in Asia, Toyota Motor (Aichi) is embarking on an ambitious project to reduce plastic part production costs to one-third their current level. Reports from Japan say Toyota has developed a process to enable the molding of parts on an 800-tonne machine that would normally require a 4000-tonne machine, and that it plans to make the processing machinery in-house.

Low-cost strategies

Peter Hibel, national sales and marketing manager for Haitian Australia (Brookvale), says there has never been a better time for Australian molders to purchase U.S. dollar-dominated machinery. "Interest rates are low and the Aussie dollar is at a six-and-a-half-year high."

Hibel also believes that Australian processors are beginning to appreciate that made-in-China machines can deliver quality.

"We already have users in white goods and automotive in Australia," he reports. "Some processors had been using 30-year-old presses before they upgraded to Haitian, and they understand that quality can be got with Haitian injection machines that employ the latest European and Japanese components and are manufactured using Japanese and European machining centers."

Haruo Taga, CEO of used machinery dealer Business International Ltd. (Takaishi, Japan), says a lot of near-new used machinery is available in Japan and Southeast Asia at present.

"A lot of the 70% to 80% of the machines we acquire [in Japan] are then exported via Hong Kong to China," Taga says. Sometimes, the key reason behind a used machine purchase can be delivery times, especially for larger machines, he notes. "Currently, machine suppliers have so many orders that for larger machines in particular, delivery times can be six to 12 months. Buying a near-new machine at 70% of the price of a new one then starts to make a lot of sense," Taga concludes.

Stephen Moore [email protected]

In Asia, a healthy environment

Preliminary data for injection machine shipments in Japan indicate that almost 19,000 were shipped in 2003, making it the best year ever in unit terms. An estimated 5678 were delivered to Japanese processors and 13,150 were exported. This compares to 4894 and 9211, respectively for 2002. Japanese suppliers are confident that if there is no major disruption this year such as a reoccurrence of SARS or a bird flu pandemic, shipments in 2004 should be on a par, which means another solid year of capital investment.

The appreciating Japanese yen has pushed up machine prices, but with the euro appreciating even more, Japanese manufacturers believe they are still competitive.

Operating leases migrate east

In the U.K., operating leases—a form of rental agreement popular in the U.S. and transplanted to Europe—are becoming more widely used because they are off the balance sheet, notes Engel U.K. Managing Director Graeme Healihy. These are also known as FMV (fair market value) agreements. They make it easier for a processor to cost a particular job, since they can lease the machine for the length of a job, and then give it back to the machinery supplier.

Engel is about to launch a new product in collaboration with insurance company Abbey, which provides a form of extended warranty covering breakdown and accidental damage. "Companies are tending to budget things differently now," he says. "People are buying application-specific equipment, so they want to fund them through an operating lease over the period of the application. They are no longer just buying capacity."

Peter Mapleston [email protected]

Machinery makers often a good source of advice

Machinery manufacturers often prove wise to the ways of financing new equipment—no surprise since it is in their best interests to ensure processors have access to funding for new equipment. At extruder manufacturer Boston Matthews (Diglis, Worcester, U.K.), marketing manager Richard Brookes says the firm asks potential customers to complete a short form to speed the process.

The form touches on a number of aspects of a processor''s business. First, how long has the processor been in business? Firms three years old or younger have harder access to funding, notes Brookes.

He says the firm also talks through the costs of initial deposit, length of loan, and repayments. "It''s no good for a company looking at an £80,000 extrusion line that will cost them in excess of £2000 per month if their cash flow cannot stand it," he explains.

Standard deals are based on a minimum 10% deposit over a two- to five-year period. The firm recommends processors phone potential lenders to get an estimate of the rental costs before they even begin shopping for new equipment. Have an idea of what you want to pay, including deposit, and the period you require, he advises.

Brookes notes that with interest rates in the U.K. and other countries at post-WWII lows, many processors are benefiting from hire-purchase arrangements on fixed-term agreements, which allow buyers to budget more accurately. He argues that leasing is not proving as tax-advantageous as it once was, and that hire-purchase plans give the customer clear title to the goods upon settlement or final payment. He reckons that presently about 90% of customers are using these fixed-term hire-purchase arrangements.

Matt Defosse [email protected]

Contact information

Boston Matthews   

KWPS   

Makino   

Wells Fargo   

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