A winding road: M&A, economic uncertainty change the game for distributors

13:18 PM | October 28, 2019 | Vincent Valk

Chemical distributors are facing an increasingly shaky economy and more demands from both customers and suppliers. Meanwhile, consolidation has picked up speed—and produced an ever-shifting competitive landscape.

Distributors are feeling the effects of an economic slowdown, but say that fundamental growth drivers remain in place. Chemical makers continue to outsource more of their business—and more aspects of their business—to distribution partners, leading to growth that outpaces the industry as a whole. “The overall market for distribution is growing faster than the general market,” says Terry Hill, CEO of Maroon Group (Avon, Ohio). “This has been a trend for years and years.”

Still, the slowing economy is a key concern. “Demand seems to be weaker,” says Frank Bergonzi, CEO/Americas at Azelis. “I don’t think it’s declining tremendously, but it’s a bit softer than it has been over the past few years.” Azelis, however, is still “growing in accordance with our forecasts,” Bergonzi says.

There is a widespread notion that a slowdown is on the way, although little talk of an outright recession. This aligns with macroeconomic forecasts, which call for slowing growth. IHS Markit expects US GDP to grow by 1.6% in the third quarter, after posting 2.0% growth in the second quarter. Globally, GDP is expected to grow by 2.6% this year and 2.5% next year.

“The US economy still is still pretty strong right now, but our members are preparing for a potential dip or a slowdown at some point,” says Eric Byer, president of the National Association of Chemical Distributors (NACD; Washington).

Trade talks

Part of the reason for pessimism on the economy is trade, particularly the US–China trade dispute. The conflict has disrupted global trade flow and is widely perceived to be a major cause of lower business confidence and greater uncertainty.

Chemical distributors are not immune to these impacts, and in some cases they are quite keenly felt, though this varies by company. “Trade is a big part of the industry,” Byer says. The actual costs of tariffs can be a big hit, especially for smaller distributors, but the administrative burden is also high, he notes. That burden includes sorting through new, and often-shifting, lists of products subject to tariffs, and filing paperwork and requests for exemptions. “We are doing what we can on education and compliance to help members out,” Byer says.

BERGONZI: Suppliers are growing increasingly selective
and “looking for more self-sufficiency.”

All elements of the chemicals supply chain —distributors, manufacturers, and customers —are now trying to figure out how to contend with tariffs for major products. “There are some chemistries … for which China is the only producer,” Hill says. “So [customers] still have to buy those products and the tariffs are really creating uncertainty.” As the number of products subject to tariffs increases and the tariffs themselves also increase—from 10% to 25% in many cases—companies have begun searching for alternatives. “Earlier in the year we saw some customers buying up ahead of the tariffs,” Hill says. “But what’s started to happen is buyers look at this and see so much volatility happening around tariffs, and they can’t budget or plan. So they start looking for functional equivalents.”

That search for functional equivalents presents both opportunities and challenges for chemical distributors. Maroon Group, for example, has aimed to source products, or functional equivalents, from the US or Europe, and worked with some customers on reformulation efforts. “We’ll try to give our customers multiple options,” Hill says. “We’ll shop the globe for products on customers’ behalf, or look for functional or chemical equivalents [that are made outside of China]. We see a churn, with customers looking for alternatives, looking to reformulate.”

The ability to reformulate can help showcase the value of capabilities that many distributors have built up. “We might use a slightly different chemistry to get the same qualities” that a customer relied on in a product sourced from China, according to Hill. “It’s an opportunity to open up formularies and use our technical capabilities.”

While NACD is focused on compliance and education, lobbying efforts around trade appear unlikely to yield a substantial result. “I’m concerned with the duration and increasing nature of the tariffs, but we are doing what we can to help our members through education, compliance resources, and policy advocacy,” Byer says. The group has joined and written letters to the United States Trade Representative (USTR), the Commerce Department, and other parts of the administration. But lobbying has its limits. “This is happening at such a high level that, advocacy-wise, there is very little that we can do,” Byer says. “It’s a personal priority for the President … and no one really knows what to expect [from Trump]. I am hopeful that they will find a way to scale back the tariffs but I couldn’t really say if it will happen.”

More capabilities, more service

The ongoing trade spat is not the only reason for distributors to build up their formulation capabilities, a trend that stretches back years and appears to be growing in intensity. “A big shift in distribution…has been in adding more value for our customers beyond just logistics or transportation,” says Tom Corcoran, vice president/food and nutrition at Brenntag and current NACD board chair. “That means more technical support capabilities, more work with regard to sustainability, and being an integral part of the total supply chain.”

Capabilities around regulatory compliance and environment, health, and safety (EH&S) are critical, as well. Suppliers and customers increasingly insist that distributors be able to provide such services, along with technical support and formulation capabilities. “Suppliers are becoming more selective and looking for more self-sufficiency from their distribution partners,” Bergonzi says.

“Customers and suppliers expect more in terms of safety, security, regulatory compliance, digital tools, specialization, transparency and growth from their distribution partners,” says Mark Fisher, president/USA business at Univar Solutions. “It starts with suppliers wanting a trusted distribution partner that can reduce their cost and deliver growth. Customers want a distributor that can provide safe and reliable service, while helping to reduce total cost and grow their business through improved formulations and comprehensive solutions.”

The growth aspect of that equation is often just as critical as the services a distributor can provide. “If you’re not showing sustainable, organic growth then suppliers will look elsewhere,” Bergonzi says. “Suppliers look at us as a channel of growth. They believe that the distribution channel should grow at higher rates than the direct [sales] business, because there are a lot of smaller customers that we can access and increase their market share.”

Consolidation: push and pull

Consolidation has long been a key feature of the distribution industry, and this trend shows no sign of abating. Azelis has announced five acquisitions in 2019 alone, according to CW data. Maroon Group has completed ten acquisitions since 2014, according to Hill. Brenntag and IMCD have also lately figured among the industry’s most active acquirers.

Small deals predominate, but larger M&A transactions have made a splash. In March, Univar closed on a $2-billion acquisition of Nexeo Solutions, bringing together two of the top distributors in North America by revenue. Univar expects $10 million in synergies from the deal this year, and the company has expanded or solidified its position in a number of markets by adding Nexeo. “Due to the merger, we’ve been able to stand up new specialty end-market commercial teams focused on lubricants and metalworking, and homecare and industrial cleaning,” Fisher says. Univar has also added technical sellers, marketers, product managers, customers, and suppliers, he notes.

BYER: Trade war is a key
concern for distributors.

But it’s worth nothing that distribution isn’t the only part of the chemicals supply chain that is consolidating. A major round of consolidation has swept the chemical industry more broadly in the past several years—and this has had a big impact on their distributors.

“When there is consolidation among the large manufacturers, it definitely has an effect on chemicals distribution,” Bergonzi says. “It can be positive and it can be negative. If you don’t have a relationship with the buying entity and they have their own network, you could be on the outside looking in.”

Big mergers usually mean that manufacturers review their distribution networks, with the ultimate aim of doing business with fewer distributors. “Most of the M&A amongst producers will ultimately result in [distribution] channel consolidation projects,” Bergonzi says. “It usually results in fewer distribution partners.”

Consolidation among suppliers presents opportunities too, as bigger companies will move more business to the distribution channel. Newly merged suppliers may also outsource more activities, such as supply chain management, logistics, or technical service, to distribution partners. “[Suppliers] might have had six technical sales people in one market, and they’ll cut that down to three and transfer some of that cost and that market to distributors,” Hill says. “They’ll also streamline warehouses and logistics and outsource some of that to distributors, at least for a certain tier of customers. So the share of the business that goes to the distribution channel grows, but the number of distributors that they work with shrinks.”

This dynamic can reinforce consolidation among distributors. “Suppliers are looking to consolidate their networks,” Bergonzi says. “They have larger relationships with fewer distributors and they are choosing the larger entities that have been active in M&A.” As suppliers make more demands on distribution partners, the advantages of scale for distributors rise. And when suppliers merge and cut down their distribution networks, large distributors with scale, reach, and the ability to offer services around technical support, formulation, and regulatory compliance are often at an advantage. “Suppliers understand that with a bigger company, such as Azelis, they’ll get the same process and compliance across regions,” Bergonzi adds. “They also want access to application labs. Whether or not you have labs can be a determining factor [in winning business].”

Pressures are rising to increase scale, even independent of consolidation among suppliers. “We have a personal care lab, we have a coatings lab,” Hill says. “As you get bigger, it’s easier to invest in that. The customers want it, and the suppliers do, too.” Hill also notes that customers often like to work with distributors that can provide different formulations to solve different technical problems. “A distributor can give you a solution that is chemistry-agnostic,” he says.

Of course, fragmentation still plays a big role in the ongoing consolidation among chemical distributors. Small, regional, often family-owned distributors may be finding it increasingly difficult to compete, but many still exist, and acquiring them has been a key facet of growth for larger players like Brenntag, Azelis, Univar, Maroon Group, and others. “You see this litany of family-owned, regional distributors that either don’t have a succession plan or the next generation doesn’t want to take control of the business,” Hill says.

Consolidation is also going global. Azelis, for example, is headquartered in Belgium and entered the American market with the acquisition of Koda in 2015. Brenntag and Univar are both global and have acquired competitors throughout the world. Within North America, Maroon Group recently completed a major acquisition in Canada.

Asia could be the next frontier, according to Hill. “The biggest market for chemical distribution is Asia … but there haven’t really been global Asian distributors,” he notes. Asian companies could begin looking at moving into other parts of the world via acquisition, in much the same way as Azelis entered the North American market with a major deal, according to Hill. The industry is evolving, and more big companies—often backed by private equity firms—are taking shape. “Almost every distributor started as a regional, family-owned business,” Hill says. “In some instances that has remained the case, and in some instances they grew regionally and nationally. The next step in the evolution form there is global distribution.”