LUBRIZOL
Capital expenditures at Lubrizol Additives are likely to top
$300 million this year
and $250 million in 2013, says the com- pany's president.
Much of the money will go to construct an additives plant on
a greenfield site in China, for research lab- oratories in
Asia, and for upgrades to existing manufacturing facilities
in Texas and France.
After 2013, the additive company
expects to continue investing at the rate of around $200
million a year to improve its infrastructure, ensure supply
security, cre- ate and commercialize new technologies, and
add more capacity - largely in Asia.
Back in 2006, the Wickliffe, Ohio-based company could only
have dreamed of being in a position to make such reinvest-
ment, President Dan Sheets told the recent ICIS World Base
Oil & Lubricants Conference in London. That year, the entire
additives industry was on the
ropes. Supply and demand were unbal- anced, productivity had
been battered by hurricanes the year before, and emerging
markets like Asia, Eastern Europe and Brazil were crying for
attention. Plus, thanks to an earlier wave of mergers and
acquisitions, major customers in the lubricants industry had
grown to wield a substantial amount of buying power. Between
their purchasing clout and rising raw material costs,
additive company margins suffered.
"Lubricant and additive companies faced poor profitability in
2006," Sheets said on Feb. 24. "At that point, reinvest- ment
funds were not there."
The picture today is greatly altered, and
margins have improved. "Financial health
is improving," he said with evident relief, "and while global
growth remains at a modest 1 to 2 percent level, the future
looks cautiously optimistic."
Lubrizol was bought last year by Berkshire Hathaway Inc. and
folded into its portfolio of industrial holdings, so it no
longer publishes its financial results. However, the company
and one large
additives rival were publicly traded in both
2006 and 2011, and together their finances might be taken as
a bellwether for the additives industry, Sheets
suggested.
The two companies' average operating margins doubled from 10
percent in 2006 to hit 20 percent in 2010, he noted. (While
he did not name the other com- pany, only Newmarket Corp.'s
Afton Chemical business fits the description.) Meanwhile,
lubricant manufacturers, based again on a limited number of
pub- licly traded companies, saw their average returns nearly
triple in that same period. So together, the additives and
lubricant industries appear to have lifted them- selves to "a
pretty good place," he said.
Unique, Boutique
In terms of global volume sales, Lubrizol has seen about 1 or
2 percent compound annual growth since 2002, Sheets said.
"This is not a big, top-line growth kind of industry. It's a
very unique business though, and I don't know another one
like it. Additive companies are unique in this industry and
in the specialty chemi- cals industry. We have to provide not
only specialty chemicals and components,
but formulation technology and proof of
performance."
He estimated that the cost of replacing
Lubrizol's current infrastructure would be
$4.6 billion; it requires $180 million a year in capital
investment just to keep it run- ning. This is another reason
strong mar- gins are so critical, Sheets indicated.
Meanwhile, complexity is becoming the industry's biggest
challenge and is com- pounding its need for capital
investment.
"Lubricant technology, for example,
now sees continuous upgrades, with new engine oil
specifications coming along about every two years," he said.
"That adds complexity, because older specifica- tions don't
go away just because new ones are introduced."
Geographically, markets are shifting too, "with new customers
and new OEMs," Sheets told the ICIS gathering. "Security
of supply has become front-of-mind for many customers, who
now demand busi- ness continuity planning from suppliers like
Lubrizol."
R&D remains the heart of the business, and also demands
constant attention. Regulatory requirements to improve energy
efficiency and reduce emissions are one example; another is
the growing
number of base oil suppliers. "There are a lot of new base
oil players, and our cus- tomers want the broadest base oil
cover- age they can get for their formulations - and we have
to support that."
This shifting landscape requires a strong R&D pipeline,
Sheets said, and is why "Lubrizol evaluates 300 new essential
chemistries a year." The additives indus- try spends nearly
$250 million per year to perform industry-registered
drivetrain
and engine tests, Sheets pointed out, and
Technology and complexity are driving the additive company's investments, says Dan Sheets. (Photos: Lubrizol)
Presses for Profits
1 COPYRIGHT 2012, LUBES'N'GREASES MAGAZINE. REPRODUCED WITH PERMISSION FROM THE APRIL 2012 ISSUE.BY LISA TOCCI
COPYRIGHT 2012, LUBES'N'GREASES MAGAZINE. REPRODUCED WITH PERMISSION FROM THE APRIL 2012 ISSUE. 2
that price tag doesn't include all the development work that
precedes any engine testing. He estimated the total R&D spend
for the additive industry in
2011 topped $600 million, versus about
$430 million in 2006.
'What If?'
Another factor that's demanding more attention and creating more complexity is business continuity planning. Since the disastrous hurricane season of 2005, cus-
Drivetrain and engine oils require a strong R&D pipeline, says Lubrizol.
tomers have increasingly included contin- gency planning in
their contracts, and many enforce it by checking their
suppli- ers, Sheets said. Major customers expect additive
companies to show they have strategic relationships with
suppliers, keep qualified materials on hand, and have back-up
inventories available in case of disruptions.
"2005 set the tone for this," Sheets later elaborated to
Lubes'n'Greases. "Quite a few of our customers put real
teeth into their business con-
They want to have a back-up plan in
place themselves in case of disruptions in supply, and they
expect the same from their suppliers. So the addcos need
docu- mented back-up supply plans. These cus- tomers want to
see documentation too; we even had some 'mock drills'
with
some customers, where they threw simu- lated supply issues at
us, and we had to show how we'd manage it."
All of this is difficult and costly, espe- cially given the
2008-09 financial crisis, Sheets said, but Lubrizol is making
head- way towards the goal. In 2005, the com- pany held about
78 days of qualified products in inventory, valued at a
little over $400 million. In 2011, its inventory cushion had
grown to 102 days, and was valued at almost $1 billion. This
reflects both higher cost-of-goods and a deliber- ate
decision to carry redundant invento- ry, "which eats up a lot
of working capi- tal," Sheets emphasized.
More complexity also is seen in Lubrizol's manufacturing
metrics, he con- tinued. In 2002, the average batch size of
one of its additive blends was 120 metric tons and involved
10 components. Ten years on, the average batch is about 15
percent smaller, and it contains more components - up to 24
or 25 in the
case of some driveline products. In part this is due to the
proliferation of lubri- cant specifications, and customer
desires to field a range of differentiated products serving
multiple performance tiers. But the upshot, Sheets said, is
that the plants must make, manage and store more batches to
supply the same volumes.
These forces are similar to what the industry has seen in the
past, but more intense and complex, Sheets said. And despite
the need for large capital and R&D investments, only modest
overall
growth is expected, "so to continue, we need to keep having
the kind of return on investment that we've built up to now,"
he reiterated.
Planting in Asia Additive manufacturing and infrastructure also demand investment, especially as Asia
major consumers of lubricants. The number of vehicles in
China and India doubled from 2005 to 2009, with more to come,
Sheets said, so his company must put more supply capacity in
these markets.
Lubrizol is not alone in trying to rebal- ance its
manufacturing assets to be ready for growth in Asia. Sheets
noted that Afton Chemical is adding capacity in Singapore, as
are Infineum and Chevron Oronite. Lubrizol is building its
own new plant in the southern China city of Zhuhai, near
Macau, which will begin operating in 2013. Moneys also are
going to a new research laboratory in Zhuhai, and to an
existing lab in India.
"The Zhuhai plant will have a very care- ful, phased-in start
up," Sheets told the ICIS meeting. The company will begin by
base-loading some of its blending capaci- ty with additives
currently made at other Lubrizol plants. "Transferring some
busi- ness from other plants will let us quickly move closer
to customers in China and the Asia region," he said.
In his interview with Lubes'n'Greases, Sheets gave more
details about these plans, explaining, "Our plant in China is
mostly about security of supply. We need to have assets in
Asia to be close to customers."
Transfer of manufacturing to the Zhuhai plant will mostly
involve compo- nents and materials made at a plant in Deer
Park, Texas, he added. "Initially, additive components rather
than full packages will be shipped from Deer Park for
blending in Zhuhai, which will com- bine and blend the
components there.
"Deer Park will see no jobs lost or changed," he continued,
"and will have plenty to do, with no immediate big impact.
And with less pressure on capaci- ty, we'll be able to
improve our customer response time and better serve the
domestic and Americas markets.
"China in the first phase will make detergents, like
sulfonates and phenates. Then we'll look at the global supply
chain and future needs, and at those compo- nents where we're
most vulnerable.
Phase one is to come, and could include
viscosity modifier solubilization and
"In 2009, we said we'd make this invest- ment, and we're
doing it. We see the
need to demonstrate our commitment to
Asia. In 10 years more, the plant in Zhuhai will look more
like an integrated additive plant, although smaller than Deer
Park."
Life With Warren
Creating differentiated products, building new capacity and
fielding more additive packages - it's all worth doing if the
additive company receives a good return for its dollars,
Sheets remarked to Lubes'n'Greases. "It all adds complexity.
That's okay, we can deal with complexity
as long as it's worth dealing with. If it's just complexity
for the sake of complexity, if it doesn't add anything, then
it may not be worth investing in. On the other hand,
complexity can be a good thing in some cases, where it's
possible to achieve a competitive advantage.
"The reality is, if the lubricants indus- try wants the
addcos to be viable, we have to get the returns to support
the capital and technology investments that it requires us to
make. I'll point to what our CEO James Hambrick has said:
'It's less about prices than profitability; what's really
important is the outcome on your margins.'"
What kind of margins would those be? Sheets declined to say,
noting that his
ICIS presentation gave a rare glimpse into Lubrizol's life
under Berkshire Hathaway. He said the acquisition made it
possible for Lubrizol to fund growth independent- ly, rather
than selling itself to a larger chemical company or borrow
against assets to raise capital.
All the SEC filings and published reports now have been
replaced with quarterly financial summaries, delivered by
Hambrick to Berkshire Chairman and CEO Warren Buffett and CFO
Marc Hamburg. Daily internal governance is handled by a
management advisory committee which includes Sheets as a
member.
"Life under Berkshire is a joy," he said. "It's streamlined,
it's simpler, we have faster decisions on capital, and more
flexi- bility." As for future investment, Sheets
repeated, "if we see a gap or need for new
tinuity planning after that.
Dan Sheets
and the Middle East become
industrial lube additive packages.
capacity, it's likely to be built in Asia."