The turning tide of chemical products
But this golden age may be coming to an end. Some important indicators have changed in the past few years. Although the industry's performance in the past 15 years still looks good, a closer look at the past five years is not so favorable: since 2011, the TRS performance of the chemical products industry has not only lagged behind the overall stock market, but also the return on investment capital (ROIC) of the industry has tended to be flat, and the ROIC of some chemical segments has also declined.
The slowdown in financial performance reflects important changes in the fundamentals of the chemical industry. First, the industry finds it increasingly difficult to maintain the benefits of its productivity efforts. Paradoxically, this is happening at a time when advanced analytical and digital methods are creating a wave of new opportunities to accelerate productivity gains. Why are these difficulties in the industry? There are signs that one of the cornerstones of the industry's performance - the centralized industry structure - may be weakening. What does this show? In many areas, the level of competitiveness seems to be improving significantly, because the number of new entrants, mainly from China, is related to this. Overcapacity is increasingly becoming a challenge in many product areas.
The second factor is the slowdown in global demand growth. GDP growth in the vital Chinese market has fallen and is likely to fall further. More importantly, China's per capita chemical consumption is approaching the threshold of decoupling from GDP growth, and it is expected to lag behind GDP growth in the future. China has built infrastructure across the country from the investment stage, and most of its population has been equipped with their own new homes, consumer durables, cars and other properties - a more service and "upgrade" economy that provides less demand for chemical products. Middle class cars bought by Chinese buyers do not necessarily contain more polymer than entry-level models.
From a global perspective, we estimate that according to the assumption of regional GDP growth, the 3.6% growth rate of petrochemical products in the past 10 years may decrease by 0.5-2.0 percentage points in the next 10 years. This could be a huge shift for an industry that estimates annual capacity growth of 1% to 2%. Other sectors are likely to see similar declines in growth rates - although overall demand for chemicals will continue to grow faster than GDP. For example, in the case of agrochemicals, changes in diet and the potential to exploit the huge productivity reserves in the existing food chain may inhibit overall demand for chemicals.
There are also signs of long-term change. We believe that the professional model is increasingly under threat. A long-standing belief in the industry is that moving the portfolio downstream and to higher professional content is a reliable way to help address the challenges of growth and value creation. But we're more and more skeptical. The scope of expertise is not well defined, so it's hard to quantify, but we think it's getting smaller. It has become an "inch game" to develop new differentiated products through innovation. Apart from innovative crop protection technologies, it's hard to name any chemical blockbuster developed in the past decade. Even in the field of application development, the segment where consumers are willing to pay for cutting-edge solutions has not become larger because the fastest-growing markets (China and India) have limited appetite for high-end products. Expanding application development can only make up part of the profit loss of upstream core business.
Digital innovation may further accelerate this trend; e-commerce growth driven by distributors or platforms such as Alibaba may even accelerate the commercialization of products and services of professional companies. In some areas, such as agricultural chemicals with more B2C features, the Internet platform may be as destructive as we see in other consumer areas. Our research further reinforces our skepticism about expertise, suggesting that the profitability of a market segment seems to depend more on the industry structure (in fact, the number of participants) than on the technology content provided by the company. But with the addition of many new companies, especially Chinese ones, the industry structure is changing rapidly.