Tuesday, April 29, 2014

SOUTH AFRICA: Imports, supply glut pressure cement sector

THE domestic cement industry is facing tough conditions in the short term, with excess supply expected to keep margins under pressure. As a result, any further investments are likely to be channelled into upgrading dated and inefficient plants.

Supply gains have come from new entrant Sephaku Cement, as well as an increase in imports, which surged 44% last year to 1.1-million tonnes. There is talk in the industry of lobbying for protection from cheap imports.

But the spokesman for the International Trade Administration Commission of South Africa (Itac), Thembinkosi Gamlashe, says the commission has not received an application from the industry.

Sephaku entered the market in January and brings 2.5-million tonnes of annual capacity to the industry. Though figures vary, analysts say this takes industry-wide capacity to between 18-million and 19-million tonnes a year. Domestic sales totalled just 12.2-million tonnes last year, 5.3% better than 2012’s volumes.

But Sephaku believes supply capacity figures are overstated due to double counting, and says some excess capacity is needed to cater for spikes in demand.

Gavin Wood, chief investment officer at Kagiso Asset Management, believes the South African cement market "is facing a challenging coming few years".

Amidst the increase in supply, Mr Wood says cement demand "is likely to be weak".

Weighing on demand will be the slow roll-out of the government’s infrastructure programme, and less private sector corporate construction following a reasonably strong few years. This is in addition to expectations for subdued residential construction activity, "particularly in the low-income market where unsecured credit conditions are much tighter".

Meanwhile, Mr Wood says the energy-intensive industry is now dealing with energy prices which are materially higher than before, while the implementation of carbon taxes will affect the "heavy carbon emission industry".

"Cement producer margins are likely to suffer as the various cement producers battle it out for market share," he says. But he is more positive about the prospects north of South Africa’s borders.

He says PPC’s growth plans for the rest of Africa "are very exciting and are likely to generate strong returns for shareholders".

Cement demand in Africa outside South Africa will be buoyed by increased construction activity as Africa’s collective economy sustains strong growth rates, while PPC will benefit from the lack of existing cement production facilities in Africa.

PPC is in a drive to get 40% of its sales from the rest of Africa by 2017, from about 22% now. The successful completion of four projects will get the group to that goal.

The projects include a joint-venture plan for a 2-million-tonnes-a-year plant in Algeria, announced in February, while PPC is also building cement plants in Ethiopia, Rwanda and the Democratic Republic of Congo.

Mr Wood says the new projects all have "attractive funding and strong local partners".

"There is competition in Africa, but it is likely to be rational and not concentrated in areas where existing cement plants provide adequate supply," he says.

Imara SP Reid analyst Sibonginkosi Nyanga believes recent investments in South Africa were guided "by elevated profit margins during the 2000-07 construction boom".

Mr Nyanga says while margins will be affected by overcapacity and competition in the short term, "we do not anticipate any price war as Sephaku has indicated that it is not intending to rock the boat".

But while cement demand has gone through a number of cycles, "there is expectation that another boom cycle better than the 2000-07 cycle is on the horizon".

As cement demand is largely driven by economic and population growth, Mr Nyanga says "for the next few years we are not expecting a massive improvement in cement demand, unless government infrastructure spend kicks in".

He expects average cement sales volume growth of at least the same rate as real economic growth, which is expected to be between 2% and 4% in the near term.

Supporting demand is government’s social housing projects and various development projects across the country.

Mr Nyanga says South Africa’s per-capita consumption of cement, at 222kg, is still low compared with a world average of 500kg — indicating "that there is still scope for growth".

As cement is expensive to transport, competition in the industry is segmented into geographic areas. "It’s all about logistics — the company with better logistics arrangements will compete well in this environment," Mr Nyanga says. "It’s usually uneconomical to transport cement for long distances, especially by road.

"I think the issue of logistics also comes into play in Africa as well — what counts is how strategically the plants are located."

He believes plant upgrades in South Africa are necessary due to the age and inefficiency of most plants, and to remain competitive.

In the rest of Africa, Mr Nyanga says cement prices are often high due to supply deficits and logistical difficulties, "so I think African competition is manageable for now".

PPC CE Ketso Gordhan said in a recent interview that Sephaku’s entrance would further delay any new major expansion plans in South Africa.

Mr Gordhan said PPC’s domestic capital investment plans would be limited to upgrading its old Port Elizabeth plant and expanding one of its inland plants in order to prepare for higher demand in a few years’ time.

On a positive note, the excess capacity of the local market meant the industry would be well placed to respond quickly to a materialisation of government’s infrastructure programme, he said.

While PPC does not usually export product as local players cannot compete on price with low-cost producers from the likes of Pakistan, Mr Gordhan said PPC would export a relatively small amount for its own purposes into Congo, where it is building a plant.

"We are going to use some of our own cement building our plant, and we are also going to start using some of our own cement to begin to build the brand," he said.

Mr Gordhan said Congo would remain an undersupplied market even after PPC’s entrance.

Meanwhile, he said PPC had "a pretty downbeat view on the South African cement market for this year", though the outlook for demand would gradually improve after the elections. "So we are slightly more optimistic about the 2015-16 financial year."

PPC recently told investors that in the five months to the end of March, its local cement volumes were down due to weak economic conditions, and flooding in some regions which had hurt demand.

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