Low demand, rising capacity threaten decades of prosperity for PPC.
JOHANNESBURG - For a century PPC (JSE:PPC) has been one of SA’s best performing companies but dark clouds have gathered over the Prolific Profit Company since its bleak trading update last week.
Therein it warned that cement demand in the first quarter fell 5% - after a 22% fall since the heady days of 2007.
Concurrently Murray & Roberts (M&R) (JSE:MUR) and WG Wearne (JSE:WEA) announced impending losses, underlining serious distress in PPC’s feeder, the building and construction industries.
After supposed dissolution of the cement cartel between PPC, Lafarge and AfriSam, the industry is also under a competition cumulo-nimbus. To minimise potential fines, PPC is co-operating with the commission. With most companies that has turned out to be an admission of guilt.
In its annual report PPC was proud to report that it has given shareholders an annual average compounded return of 13.3% for 100 years. Had you invested R100 when the company listed in1910 and reinvested dividends, you would now have R26m. (What was my grandfather thinking?)
SA has sunk many mines, built millions of houses, factories, shops, bridges and roads in the past century. PPC has led the sector since the beginning. The track record from the 1970s to the early 2000s was particularly impressive. Such was the benefit of a cartel! Cartel-like behaviour dies hard, hence the current investigations into construction and cement by the Competition Commission.
Until recently, cement prices have risen once or twice a year largely in spite of stagnant demand. PPC raised prices 5.5% last year and is about to publish another increase. Rising energy and railage costs pretty well oblige price increases.
PPC has stagnated for the past three years with operating profit, cash generated and dividends paid stuck in a band (see table). Now we have the prospect of a sharp reverse.
PPC the vital numbers:
| 2010 | 2009 | 2008 | |
| Revenue (Rm) | 6807 | 6783 | 6248 |
| Op profit (Rm) | 2115 | 2418 | 2323 |
| Cash generated (Rm) | 2442 | 2602 | 2546 |
| Dividends paid | 1062 | 1195 | 1401 |
The spectre of tougher competition in the near future is something for investors to ponder.
The graph from PPC’s last results presentation shows that the industry’s capacity already far exceeds demand. Capacity rose from 7mt to 13mt between 1970-1986. After that there was a slow rise to 14mt by 2007. PPC reckons capacity now is 17mtpa while demand is around 12mt. The new players will push capacity to 20mtpa, which implies huge over capacity soon.
I asked Pieter Fourie, who heads Sephaku Cement, why he believes profits are to be made with a new 2.2mt facility costing R3bn.
“We disagree with current capacity figures. The industry’s biggest problem is that plants are antiquated. The average age is 38 years and some are more than 50 years old. The average power consumption of existing plants in SA is 145 kwh per ton. Our new plant will use only 95kwh/t.”
Fourie says the new plant will be more efficient because it will comprise two sites – one in Lichtenburg and the other in Delmas. Trains will take coal to Lichtenburg and return with clinker. Fly ash from the Kendall power station will be added at Delmas and the mixture ground to the finished product. This could give Sephaku a 30% cost advantage.
Fourie says Sephaku Cement will be funded as to 60% debt, 40% equity. The equity is already in the bank and negotiations are going on with the banks for the rest of the funding. Loans will be guaranteed by Dangote Industries of Nigeria, Africa’s biggest cement producer.
Sephaku is busy converting into a pure cement play, selling or unbundling other assets. It received R80m for gold assets and wants R20m for its nickel assets. Its own financials make for daunting reading but now Dangote has a 56% stake perhaps it can set its sights long term on the sort of rating enjoyed by PPC. The share hit a high of 384c in August 2010 but has subsequently come back to 335c.
According to Fourie, AfriSam, formerly named Holcim and before that Anglo-Alpha, is in an awkward situation. He says the deal by which the PIC and BEE interests acquired the company from Holcim of Switzerland was not exactly favourable.
“They paid R16bn for 4mt of old capacity. We are paying R3bn for 2.2mt of new capacity. Those numbers speak for themselves. The PIC picked up R10bn of debt so they are not in a strong position to engage in a price war if one does break out.”
Not that Fourie believes there will be such a war because cement demand is price inelastic. But he adds: “It would be naïve to assume that prices will be unaffected in a more competitive environment.”
AfriSam’s Victor Bouguenon says at the time of the deal with the Swiss, cement was booming. He also points out that a going concern with long-held customers is more valuable than a start-up. He says the competitive dynamics are complex but he does concede that the shareholders’ debt can affect the trading company which effectively has to service that debt.
Jannie Stockenström, who is running the Wiphold-Conticem-Jidong project at Brits, says all is well. Initially the new plant will have capacity of only 700 000tpa at a capital cost of R1.65bn. He says capacity can quite easily be trebled but this consortium is proceeding cautiously.
Kevin Odendaal of PPC concedes that a number of existing plants are antiquated. The least efficient are in mothballs and were last used during the boom of 2008, yet are still in their capacity figures. PPC is upgrading certain plants, most notably those in the Western Cape. He agrees that new plants are more efficient. PPC’s Dwaalboom, for instance is 30% more energy efficient.
Odendaal points out that electricity is only 7% of PPC’s cost. Coal is 12%. Coal emissions are an industry worry but he says most emissions in cement making come from burning limestone.
If PPC’s capacity is so antiquated, the question arises, why did it pay dividends of R2.6bn and buy back shares worth R740m in the past three years? Dividend cover has fallen to 1.25.
Should PPC not rather have built new more efficient capacity? The big dividends and share buybacks have reduced shareholders equity to the point that PPC earned 125% on equity last year – up from 77.9% the previous year.
Until now, like any industry with capital intensive plants working at high capacity, PPC has been a cash cow. The question in the new environment: is this level of payout sustainable?
While the share price of M&R has fallen by two thirds since the boom years, that of PPC has been pretty resilient. At just over R30, it is down only 14% from the one-year high of R35.
Gloom in the industry is far from complete. The new capacity will come on stream only in 2013. The great hope is that government’s promised R850bn infrastructure programme will be rolling more convincingly by then – and who knows, perhaps confidence will revive so that people build houses, flats, shops, offices and factories again?
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