Not forgotten: New investments are continuing to flow into the sector

The Philippines’ manufacturing sector is gradually strengthening but it continues to lag behind as services, construction and remittances remain as the key drivers of the country’s rapid economic growth. Hampered by high energy costs, expensive logistics and low infrastructure investment, the manufacturing sector’s share of GDP has been declining since 2002 in what the Asian Development Bank has warned could be a premature shift away from industrialisation.

The government has, however, been increasing its efforts to attract investment and accelerate manufacturing growth, resulting in the country earning an investment grade rating from the three major global credit ratings agencies during 2013. Despite these improvements, volatile global markets have held back foreign investment, and a sustained acceleration of manufacturing growth continues to remain elusive.

SECTOR SIZE & STRUCTURE: Compared to its Asian peers, the Philippines has a relatively small manufacturing sector, which is dominated by food processing and other, mostly low-value-added, production for the domestic market. There are also significant export-oriented electronics and automotive parts industries, driven mainly by US and Japanese foreign investment, but manufacturing export’s share of GDP, at 20.8% in 2012, is far below that of most emerging Asian economies.

Manufacturing grew at an average rate of 4.2% in 2002-12 in terms of real value added, according to National Statistical Coordination Board (NCSB) data. However, this wasn’t enough to keep up with faster growth and inflation in the services and construction sectors in an economy increasingly driven by outsourcing and remittances-fuelled consumption. The manufacturing sector’s share of GDP fell from 24.7% in 2002 to 20.8% in 2012 and 20.2% in the first half of 2013, according to NCSB data. This is compared to an 18.9% manufacturing share of GDP in Vietnam in 2012, 23.9% in Indonesia and 34% in Thailand.

In terms of total GDP, the manufacturing sector’s contribution has grown from P1.04trn ($24.98bn) in 2002 to P2.17trn ($52.32bn) in 2012. Dividing the sector’s value added by the national population yields a figure of $541 of manufacturing output per capita in 2012. That compares to $302 in Vietnam in 2012, $852 in Indonesia and $1862 in Thailand, according to those countries’ official data.

PRODUCT BREAKDOWN: By far the largest manufacturing segment is food processing, beverages and tobacco products, which accounted for 49.7% of manufacturing sector GDP in 2012, according to NCSB data. Other major segments are oil processing and chemicals, accounting for 13.4%; electronics, 13%; textiles, leather and apparel, 6.6%; metal and other mineral products (mostly construction materials), 5.4%; and machinery and electrical equipment (including automobiles and parts), accounting for 5%.

Among exported manufactured goods, electronics dominate, accounting for $18.9bn or 36.3% of total exports in 2012, National Statistics Office (NSO) data shows. Other segments with major exports, according to Department of Trade and Industry (DTI) data, include: automobile and motorcycle parts, with $4bn of exports in 2012 (including some overlap with electronics); electrical equipment (other than vehicle parts), with $3.5bn; oil products and chemicals, with $2.7bn; construction materials, with $2.5bn; and garments, textiles and fashion accessories, with $2.1bn.

FOOD PROCESSING: The Philippines is a textbook example of an emerging market where rising incomes are leading to more expensive diets. The food processing segment has recently been growing slightly faster than the overall economy, registering 7.6% growth of real value added in 2012 and 8% year-on-year (y-o-y) in the first half of 2013, according to NCSB data. The sector’s total output (without netting inputs) grew by 14.3% in volume terms and 21.7% in value terms, according to NSO data, reflecting rapid food price inflation. Beverage producers, however, have struggled amid tough price competition, registering 2.7% growth in real value added in 2012 and a 3.4% y-o-y contraction in the first half of 2013, according to NCSB data. “A major factor in the Philippines soft drink market is price; therefore in order to be competitive and attract the largest number of clients, found at the bottom of the economic pyramid, drinks would need to cost less than P10 ($0.24),” Partho Chakrabarti, president of Pepsi-Cola Products Philippines, told OBG. Despite the slower production, some market factors continue to support the sales of bottled beverages. Antonio Panajon, director of Asiawide Refreshments Corporation, told OBG, “A major problem affecting the country, but benefitting the industry, is the lack of accessibility to potable water. Although in Metro Manila the population does not face serious issues in this respect, in many provincial areas potable water is not accessible, making people opt for carbonated drinks as an alternative.”

GLOBAL CONNECTIONS: The Philippines has a long tradition of multinational investment in its food, beverages and tobacco industries. Subsidiaries of PepsiCo, Coca-Cola, Dole, Mondelez International (a Kraft spin-off), Nestlé, Unilever, Cargill and Philip Morris are among the country’s largest companies. By far the largest domestic player is San Miguel, originally a brewer of beer that also holds a leading position in the packaged foods segment under its Pure Foods division. After a more recent expansion into other sectors, San Miguel is also the Philippines’ largest company with sales of P699bn ($16.8bn) in 2012.

The Philippines is the world’s leading grower of pineapples and coconuts, and its processed food and beverage exports mostly consist of these products. Coconut oil, for example, is enjoying rising popularity in US and European kitchens and as a component of biofuels. Cargill has been heavily involved in the coconut business for decades and operates a coconut oil mill. The domestic bottled coconut oil segment is dominated by the Coconut Industry Investment Fund Oil Mills Group and its Minola brand.

In pineapple products, local firm NutriAsia has emerged as the strongest player. Originally a producer of sauces, in 2005 NutriAsia took over Del Monte Pacific Limited (DMPL), a Philippines company that had been sold by the US company Del Monte Foods in 1991. Boasting “the world’s largest fully integrated pineapple operation” with an annual processing capacity of 700,000 tonnes, DMPL under NutriAsia is targeting global expansion. In October 2013 DMPL announced plans to acquire Del Monte Foods, its erstwhile US parent, for $1.7bn. This is move is not unprecedented, as DMPL previously bought the Indian company that owned the rights for the Del Monte brand in India.

STRUGGLING SEMICONDUCTORS: Integrated circuits (ICs) and circuit boards – including the fabrication of semiconductor “microchips,” the packaging of them with ceramic housing and metal connectors, and the production of the plastic printed circuit boards on which microchips are fitted – have long been the core product of the Philippines electronics industry. Even amid a third consecutive year of weak performance, ICs and circuit boards still accounted for 76% of electronics exports in the first nine months of 2013. Among the major global semiconductor industry players active in the Philippines are Samsung, Texas Instruments, Rohm, Toshiba, STM icroelectronics, NXP Semiconductors, ON Semiconductor, Amkor Technology and Fairchild Semiconductor. However, difficult logistics, high power prices and the lack of domestic raw materials has led semiconductor manufacturers to shift production to China and other locations, highlighted by the withdrawal of Intel in 2009. After peaking in 2010 at $23.8bn, IC and circuit board exports dropped by 26% in 2011 to $17.8bn, slid another 1.8% in 2012 to $17.5bn, and were down another 10.7% y-o-y in the first three quarters of 2013, according to NSO data.

Even steeper declines have hit the Philippines data storage segment, which includes hard drives, optical drives and solid-state drives. The segment’s exports declined from a peak of $6.2bn in 2004 to $3bn in 2012 and were down another 16.6% y-o-y in the first nine months of 2013. Industry watchers say IC, circuit board and data storage producers suffered such steep drops in 2013 because they were focused on desktop and laptop computer components while demand shifted to tablets and smartphones.

Ryan Patrick Evangelista, deputy secretary general of the Philippine Chamber of Commerce and Industry (PCCI) told OBG, “Electronics are one industry where the issues are well known: high electricity costs, high logistics costs and labour costs that, relative to productivity, tend to be higher than most ASEAN countries. Most electronics is export-driven and not really high value added.” On the other side of the coin, Edwin Coseteng, president of the First Philippine Industrial Park, told OBG that the Philippines’ lack of energy subsidies is likely to prove a key advantage.

Coseteng’s company operates a 349-ha industrial site in Santa Tomas, Batangas, one of many locations around the country that have been designated for tax and other incentives by the Philippine Economic Zone Authority, which are highly favoured by electronics and other investors. The park is part of the First Philippines Holdings (FPH), one of the country’s largest producers and distributors of electric power.

Coseteng told OBG, “I think the whole mindset has changed because of what’s been happening over in Europe the past few years. Sovereign credibility isn’t what it used to be. Governments that run large deficits to support large energy subsidies will eventually find themselves on the doorstep of a crisis.”

FPH learned that lesson with a recent investment into production of photovoltaic cells, the core component of solar power panels. The project was delayed as solar panels turned unprofitable after too many producers piled in just before European governments cut subsidies. “Solar power is another example of how government policy has to be sustainable,” Coseteng said.

ELECTRONICS GROWTH AREAS: While chips, circuit boards and storage are waning, new growth segments in the electronics industry are emerging. Chief among these is the production of office and desktop printers, both of which are included in the “office equipment” segment in Philippine statistics. Driven by ongoing investments by major Japanese printer manufacturers, the segment saw explosive growth in 2012 with exports leaping to $533m from $225m in 2011, an increase of 137%, according to NSO data. The boost came largely from an $110m Epson inkjet printer and projector plant completed in December 2011.

The office segment is expected to continue ramping up output thanks to ongoing investments by two other major Japanese printer manufacturers. Brother completed a $54m inkjet printer cartridge plant in August 2013 and was planning to complete a $62m inkjet printer and printer-copier-scanner plant in 2015. Canon also announced in 2012 that it would spend $220m on a laser printer plant, tentatively scheduled to open in 2013. Brother and Canon are both locating in the First Philippine Industrial Park.

SEGMENT EXPORTS: Overall, electronics exports were down 10% y-o-y up to the third quarter of 2013, signalling further contraction for an industry whose total exports dropped from a peak of $31.1bn in 2007 to $22.6bn in 2012, according to NSO data. However, the NCSB’s GDP data told a very different story, showing the electronics industry – divided into “office, accounting and computing machinery” and “radio, television and communication equipment” – increasing its value added by 3% y-o-y in the nine months of 2013 in peso terms and by 10.5% in real terms.

That latter figure helped boost reported manufacturing real growth to 9.8% in the first three quarters of 2013, a figure that was widely, but probably prematurely, hailed as a sign of accelerating manufacturing growth. The clashing export and GDP figures could hypothetically be partly explained by strong volumes amid weak prices, rising domestic sales and/or increased transfer pricing, but evidence for those was thin to nil. Given generally weak results for the electronics industry globally in the first half of 2013, the weak export revenue figures probably better reflected actual business conditions for the Philippines electronics sector.

STEADYING AUTO PARTS: The automobile and motorcycle parts industry registered a modest 4.2% growth of its export revenues in 2012, which reached $3.95bn, up from $3.79bn in 2011, according to DTI figures. Mainly supplying the Japanese automobile and motorcycle industry, the segment’s growth in previous years followed a “V”-shaped course of emerging market manufacturers, booming in 2004-08, contracting sharply in 2009 and then rebounding strongly in 2010-11.

As for 2013, the partial data available for particular segments of the automotive parts industry were positive. Exports of wiring harnesses, which accounted for 37% of automotive and motorcycle parts exports in 2012, were up 31.2% y-o-y in the first nine months of 2013. Exports of automotive electronics (also included in electronics industry data) rebounded strongly over the same period to $364m after a very weak year in 2012, but looked unlikely to match the 2011 annual peak of $800m. Automotive electronics products include car stereos, anti-skid brake systems and car body electronics, with Continental, Fujitsu, Muramoto and Clarion among the main producers.

Toyota is by far the biggest auto parts player, accounting for about a quarter of the segment’s output with $963m of exports in 2012. Toyota produces manual transmissions and constant-velocity joints, mainly for export to Toyota plants elsewhere in South-east Asia.

Among the largest current investments in the auto parts sector is a $620m project announced in 2011 by Yokohama to add 10m units of annual capacity to its tire production facility by 2017. The extra capacity, which will come on-line in stages beginning in 2013, is aimed at the fast-growing domestic tire market.

AUTO ASSEMBLY IN QUESTION: The Philippines also has a small automobile assembly industry, using the “complete knock-down” model in which cars are imported complete but disassembled. In what was intended to be a first step towards the creation of a full-fledged automotive manufacturing industry, the Philippines government encouraged Toyota, Nissan, Honda, Mitsubishi, Isuzu and Ford to set up assembly plants by placing high tariffs on imports of fully assembled cars and restricting imports of used cars.

Despite these advantages, assemblers found themselves competing with a large grey market and, since 2003, with fully assembled imports subject to lower or zero tariffs thanks to ASEAN and other free trade agreements. Maricar Cristobal-Parco, president of BMW importer Asian Carmakers Corporation, told OBG, “Cebu is showing significant potential for growth in the premium segment; however, competition against the grey market remains the biggest challenge. Smuggling of cars into Cebu is far greater than Manila due to higher numbers of ports and accessibility to them, thereby creating a lot of competition for the authorised dealerships.”

Sales of domestically assembled automobiles fell from a peak of more than 145,000 units in 1996 to less than 55,000 in 2006, according to the Philippine Automotive Competitiveness Council (PACCI), a lobby group founded by Japanese auto assemblers.

A crackdown on grey-market imports spurred a recovery of domestically assembled automobiles to more than 80,000 units in 2010, according to figures from PACCI and the ASEAN Automotive Federation. Since then, however, output has wavered, falling to about 65,000 units in 2011, recovering to about 75,000 in 2012, and increasing 1% y-o-y in the first nine months of 2013 to just over 58,000 units. That was just 1.8% of ASEAN automobile production, which is dominated by Thailand, Indonesia and Malaysia.

The Philippines auto assemblers’ output held steady in 2013 despite a reduction in their number by one, as Ford closed its assembly plant in December 2012 soon after completing a new automobile manufacturing plant in Thailand. Other assemblers have survived by focusing on commercial vehicles, which accounted for nearly three-quarters of their output in 2012. PACCI continues to maintain an aggressively optimistic position, detailed in a “Vision 2022” strategy paper published in 2012, that calls for domestic assemblers to recover to and maintain a 70% share of the domestic new automobile market while annual sales grow at an average rate of more than 12% a year to reach 500,000 units by 2022. Domestic assemblers had a 48% share of around 156,000 official new car sales in 2012.

OTHER MODES OF TRANSPORT: The Philippines motorcycle assembly industry has been more successful, capturing nearly all of the domestic market. Although the industry has recently suffered from declining sales, which fell to just over 700,000 units in 2012 from nearly 760,000 in 2010 according to the ASEAN Automotive Federation, sales rebounded in 2013 and looked poised to exceed the 2010 peak. The industry is dominated by Suzuki, Kawasaki, Honda and China’s Haojue, which is assembled by the local company Norkis Trading. Suzuki completed a new plant in November 2012 that doubled its annual capacity to 200,000 units.

Shipbuilding has witnessed the quickest growth among heavy industrial manufacturers, with exports up 59% in 2012 to $1.1bn. The industry has grown exponentially from just $55m of exports in 2007, driven mainly by shipyards operated by Japan’s Tsuneishi Heavy Industries and Korea’s Hanjin Shipping. Australia’s Austal and Singapore’s Keppel also operate shipyards.

Evangelista told OBG, “It’s a major challenge finding the industries where we can perform well, without subsidies – where we have a comparative advantage that will support other sectors and deepen complementarity with our neighbours. Our shipbuilders have been getting a lot of really good Korean and Japanese contracts. Automobile assembly probably isn’t our competitive advantage, because we’re not an automotive hub.”

PUSH FOR PETROCHEMICALS: A growing petrochemicals industry is helping to revive investment in oil refining in order to secure cheaper supplies of crucial feedstock for the production of petroleum-based plastics, used especially in consumer goods packaging and plastic bags. That’s the story behind two major investments due to come on-line in 2014: a P74.78bn ($1.8bn) upgrade of the Petron Corporation’s Bataan oil refinery, the country’s largest, and a new $800m naphtha steam cracker being built by JG Summit Holdings.

Both projects will produce gasoline and petrochemicals. JG Summit already operates two petroleum-based plastics plants that have been chronically short of feedstock. The investments should also help reverse a recent trend of growing oil-products imports as oil processing stagnated. The oil processing segment’s real value added declined by 4% in 2012 and was down 15.4% yo-y in the first half of 2013, according to NCSB data. Meanwhile the chemicals sector boosted its real value added by 4.2% in 2012 and by 46.4% y-o-y in the first six months of 2013. The chemicals sector also includes pharmaceuticals, paints, fertilisers, coconut-based oleochemicals and many other products.

OUTLOOK: Manufacturing is likely to continue to grow at a decent overall pace while lagging somewhat behind the booming services sectors. On the positive side, the government clearly understands the importance of manufacturing to developing economies. As Eries Cagatan, director of the Board of Investment’s Infrastructure and Services Department, told OBG: “Our thrust is to revive the industrial manufacturing sector of the economy, which has been propelled more by the service sector. For this reason economists have criticised us, observing that our economy is not walking with both legs. What we really want is a sustained acceleration of manufacturing growth. The job creation that manufacturing brings is very important.”

Also on the positive side, some reasons for relatively slow manufacturing growth are accidents or detrimental conditions that could be fixed, including even the seemingly intractable problem of logistics. Logistics are slow and expensive mainly due to the fact that infrastructure is underdeveloped and in some cases poorly managed. The Aquino administration has now begun to address the country’s infrastructure deficit.

Other reasons for slow growth, such as high energy prices, can’t easily be fixed. Many of the Philippines’ neighbours are oil and gas producers that subsidise energy prices to stimulate investment in industry and share oil and gas wealth with the population. However, any energy subsidies in the Philippines would have to be funded directly from taxes and could risk a reversal of the recent progress in cleaning up corruption. But if the Philippines can foster the development of a more energy-efficient manufacturing base than its peers, it will likely come out ahead over the longer run.

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The Report: The Philippines 2014

Industry & Retail chapter from The Report: The Philippines 2014

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