Saturday, November 12, 2011

Thailand Floods Disrupt Supply Chains & Raise Inflationary Risks

04 November 2011
Thailand Floods Disrupt Supply Chains & Raise Inflationary Risks
By Simeon AngandOng Qiuying and Gerald Teo

The proverbial Noah’s Ark could do scarce when faced with a truly once in 50 years flooding event that has inundated a third of Thailand. Newly elected Prime Minister, Yingluck Shinawatra has been hard pressed since the saga begun nearly 3 months ago. Major flooding of the northern and north-eastern regions of Thailand began in late July when tropical storm Nock-ten made landfall. To date, over 400 lives and an estimated 400 billion baht ($13 billion) have been washed away by the floods.
Economically, the floods could not have come at a worse time. The country is still reeling from the effects of the 2009 Great Recession and has been struggling to mend political and social divisions. Thai Deputy Prime Minister and Commerce Minister, Kittirat Na Ranong, said that the floods could potentially shave off up to 1.7% from GDP growth. According to statistics released by the Bank of Thailand, the Thai economy had in previous quarters begun to lose momentum from its post recession recovery, registering a subdued 2.6% growth in 2Q11 year-on-year. Quarter-on-quarter, the Thai economy shrank 0.2%.

Elsewhere, the Thai National Shippers Council (TNSC) expects 3Q11 export volume growth to slow to 9.7% year-on-year compared to 19.2% growth in 2Q11. Export volume growth for 2011 is forecasted to come in at 16.4% compared to 2010’s 28.5%.

While it may be too early to estimate the true extent of damage rendered by the deluge, credit ratings agency, Fitch, feels that the current flood conditions will have a negative impact on its forecast 4% real GDP growth for Thailand. It opines the floods have disrupted the manufacturing industry as well as the overall economic activity in Bangkok, which is the economic hub of Thailand. Thailand’s manufacturing woes are not just centered around flooded areas, the disruption to the supply chain now extends to manufacturers in the eastern provinces and threatens to affect countries as far away as Singapore and Japan.

On the brighter side, Fitch remarked that while the floods will pose a significant detriment to GDP growth, Thailand’s credit worthiness is not expected to change as there is scope for public finances to absorb some deterioration at its current rating of ‘BBB’. It said that the government’s fiscal policy in the medium term as well as the maintenance of political stability would be more important rating drivers. Business sentiment was seen to be picking up in the prelude to the floods with the Business Sentiment Index (BSI) expected to hit 50.6 in the 3 months following September 2011 (Any figure above 50 indicates that business sentiment has improved). This remains to be seen when confronted by the deluge.

A Manufacturer’s Nightmare
Another credit ratings firm, Moody’s, also weighed in on the economic damage that the floods could cause Thailand. In contrast to Fitch, Moody’s slashed Thailand’s GDP growth to 2.8% for the year in light of the heavy floods affecting its seven industrial estates. According to the newspaper, The Australian, a total of 14,000 businesses will be affected, whereby, hardest hit are the five industrial estates in Ayutthaya including the Nava Nakorn Industrial Estate and Bangkadi in Pathum Thani where, some 1,000 factories have been inundated.

Automobile manufacturers are at the forefront as they get hit by factory closures, supply chain shortages, labour absences, transport roadblocks and other flood-related factors. Multi-national automobile manufacturers who are affected include Toyota, Honda, Mazda, Isuzu and Ford.

Toyota Motor Corporation (Toyota), which has its American Depository Receipts (ADR) traded on the Singapore Exchange, report that its plants in Thailand were shuttered mainly supply delay. The company expects the production halt to be in place until at least 5 November. The Thai floods have resulted in an output loss of 37,500 vehicles in the country itself since the shut down of its factories on 10 October.

To further compound matters, the production halt at its Thai facilities have had knock on effects on its other production facilities. Most recently, Toyota had released statements saying that it has scrapped overtime production hours in view of the supply chain disruption in Japan, United States, Canada, South Africa, Indonesia, the Philippines and Vietnam.

In the face of such closures and supply chain disruptions, Toyota had on 24 October, said that it would be reducing its output by 10% immediately. The company’s executives have not yet decided what to do about production from 29 October onwards, leaving the door open to further possible cuts.

The Flood’s Effect On Local Counters
Back home, several companies have announced the flood’s impact on their operations in Thailand. Most of the affected are manufacturers of electronics, metals, rubber and plastic products, including local counter STATS ChipPAC (see insert article below). Although companies claimed to have adequate insurance coverage, the direct or indirect loss of business in this disaster will undoubtedly influence their top and bottom lines negatively.

On 24 October, Elec & Eltek International Company announced that its two printed circuit board production plants in above mentioned industrial parks have temporarily ceased operations and the company is arranging to transfer some of its operations to other production facilities in China. As of 30 June 2011, the company’s Thailand production business contributed 11% to its overall revenue.

Meanwhile, precision engineering company Rokko Holdings said that three customers of its wholly-owned subsidiary Rokko Leadframes had halted their operations in Thailand. The company expects its newly acquired lead frame division to report a loss for the fourth quarter of the financial year ending 31 December 2011. Its counterpart Fischer Tech reported an operation halt to its factory located in Rojana Industrial Park, Ayutthaya. The company added that its other factory building at Pathum Thani is under serious threat.

Business disruption amongst the major industry players sent shockwaves to several companies within the global supply chains. Such is the case for Western Digital (WD), the world’s largest hard disk drive (HDD) manufacturers, which has suspended its operations at the Bang Pa-in and Nava Nakorn industrial parks. WD said that it would take at least four to six months to recover from the damage to its two plants in Thailand. Seagate, the second largest HDD manufacturing giant, said that the effects of the Thailand flood on the HDD industry are likely to be substantial and will extend over multiple quarters. Armstrong Industrial Corporation, Cheung Woh Technologies, Adampak and AEI Corporation are some of the companies expected to be hit with the supply shortage of HDD.

In the food and beverage industry, Thai Beverage reported flood impacts on their subsidiaries Wang Noi Brewery and Bang Baan Brewery, where most of its finished goods had been transferred to other warehouses in unaffected areas. Kamphaeng Phet Brewery, its other subsidiary, is still in full operation for beer production. Similarly, Fraser and Neave announced the cessation of its dairies product manufacturing facilities in Rojana Industrial Park under its wholly-owned subsidiary F&N Dairies (Thailand).
Do take note that definite figures will be revealed during the end of the year and in early 2012 when companies release their financial results.

Table 1: List of locally listed counters affected by Thai Floods based on announcements made on the SGX

Costlier Commodities Drive Up Local Inflation
Meanwhile, the manufacturing sector is not the only industry affected by the floods. Commodities, such as rice, were among the hardest hit by the flood that wiped out up to 14% of the world’s biggest exporter’s paddy fields. Apichart Jongskul, the secretary-general of the Office of Agricultural Economics, warned that the estimated losses may worsen once the water recedes.

Thailand’s rice export price (White Rice 100% Grade B) had already jumped 12% to US$622 a tonne year-to-date even as the prices of soybeans and wheat fell. Thailand’s main harvest, which represents about 70% of its annual output, was expected to expand 3.3% to a record 25.1 million tonnes and the US Department of Agriculture (USDA) had estimated Thailand to account for 31% of all rice exports this year before the floods.

With the flooding affecting up to 6% of crop area in the Philippines, 12% in Cambodia and 7.5% in Laos, according to the UN Food & Agriculture Organisation, Deutsche Bank noted that this could potentially drive up prices with the tighter supply and when farmers hoard stocks ahead of a government purchasing programme.

According to Sumeth Laomoraphorn, president of C.P. Intertrade, Thailand’s largest seller of packaged rice, the Thai export price of rice, also a global benchmark, may climb 21% to US$750 a metric tonne by December. Prices also face further upward pressure as the Thai government had earlier, started buying rice at above-market costs to boost farmer incomes.

Complicating the task to sustain economic growth hurt by the Eurozone debt crises, the costlier prices of commodities like rice could elevate inflation as it ripples into various domestic markets. In Singapore, food, which weighs about 22.1% in the local CPI, is likely to become a larger source of inflation.

Year-on-year, our local consumer price index (CPI) rose by 5.5% in September 2011 on higher costs of accommodation, private road transport and food, which has gone up by 3.1%. The September CPI fell 0.2% over August due to lower costs of transport, clothing and recreation that more than offset higher costs of food and accommodation. Food prices, in contrast, moved up 0.2%. For the rest of the year, Singapore’s inflation is expected to be around 5%, with core inflation at 2%. In 2012, the forecast for headline inflation is 2.5% to 3.5%, while core inflation is expected to come in at 1.5% to 2%.

Although Singapore’s food imports are not heavily reliant on Thailand and have a number of different sources, it could still experience the spillover effects of imported inflation with the higher costs of food, electronics and manufactured goods from Thailand.

The Ripple Effects
Parallels have started to form, matching the Thai floods with the Japanese earthquake and resultant tsunami. While it may be futile to compare the two natural disasters, we do appreciate the economic impacts that accompany such disasters. These effects can be felt throughout the world in today’s increasingly interdependant economies. The newly elected Thai government, at this point, is still unable to fully grasp the true extent of damage and its toll on human life as well as on economic beneficiaries.

Nevertheless, Fitch is already looking to next year’s growth and the impact of reconstruction on the Thai economy. It sees upside risks to its forecast of 4.5% expansion in 2012 and expects inflation to follow the up-trend. Philip McNicholas, director of Asia Pacific sovereigns in the company said that “once the flood waters recede, reconstruction spending will kick in, manufacturing production will rebound and the current flooding could cause a potential lift to prices of rice crops in early 2012”.

Though Singapore is unaffected and somewhat untouched by natural disasters, the financial and economic effects can spell dire consequences on the local economy. It is, thus, important that we seek to fully grasp such ramifications and brace ourselves for the ripple effects heading our way.

As with all natural disasters, our prayers and hopes go out to those affected by the Thai floods.

Electronics Woes: How Is STATS ChipPAC Holding Up?
Thailand is also home to one of the largest production grounds for electronics. It is the world’s second largest maker of hard disk drives (HDD) after China and makes up nearly half of the global output. Needless to say, the sector is hardly spared as the heavy floods battered the industrial sectors. According to market research firm IHS iSuppli, world output of HDD could fall as much as 30% in the last quarter of 2011.

STATS ChipPAC’s subsidiary, a leading semiconductor test and advanced packaging service provider, was ordered by the government’s flood relief operations centre to cease operations in all factories due to the continuous flooding in Pathum Thani, where it was based.

However, the Mainboard-listed counter could be considered one of the luckier companies in this disaster as its Thailand plant accounted for less than 10% of the firm’s revenue and its test and manufacturing centers are spread worldwide in China, Malaysia, Korea and Taiwan. While the full extent of damage and effect of the flood on the company is yet to be determined, it managed to report a positive third quarter performance recently.

Year-on-year, STATS ChipPAC’s revenue was marginally up by 1.9% to US$1,279.8 million while earnings plunged 51.1% to US$43.5 million for the nine months ended 25 September 2011 due to increase in interest expenses and overall operating costs. Revenue for 3Q11 increased by 3.8% to US$443.4 million over the prior quarter and was up 2.6% over 3Q10, at the higher end of its net revenue guidance report for net revenues to be a low to mid single-digit level increase from the 2Q11.

In a press release on 28 October, Tan Lay Koon, President and Chief Executive Officer of STATS ChipPAC, pointed out that the improvement in its third quarter revenue reflected higher demand in the communications market, which were partly offset by weakness in the consumer market.

With the need to manage inventory more aggressively in view of the uncertain macroeconomic outlook, Tan also expects net revenues in 4Q11 to be a single digit decrease from prior quarter, with adjusted EBITDA in the range of 20% to 25% of revenue based on the assumption that its Thailand plant operations will continue to be suspended until the beginning of December 2011.

Keeping A Lead In Technology
It is no mean feat that STATS ChipPAC has kept its market position as the outlook for the electronics sector takes a turn for the worse with the news of supply-chain disruptions. Furthermore, the volatility in this sector is well-known as the ever increasing pace of improving technology could make today’s product obsolete tomorrow.

Earlier in October, the company had rolled out its next-generation fan-out wafer level packaging (FO-WLP), which offers the technology to support a broad range of semiconductor markets including smartphones, media tablets and cloud computing applications. One of the key technologies in the FO-WLP technology platform is the embedded Wafer Level Ball Grid Array (eWLB), which has gained momentum as a technology enabler for semiconductor companies in the smartphone market. STATS ChipPAC has seen continuous strong growth in this market segment, having shipped over 150 million eWLB units.

Going forward, the demand for the integration of high performance and high bandwidth functionality in thin semiconductor packages will grow as telecommunications, information technology, consumer electronics and media solutions converge. Despite the Thai floods and global uncertainties, STATS ChipPAC seems well prepared to stay ahead in the game with its strong technology portfolio to meet customers’ needs.

Publish date:04/11/11

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