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Wednesday, 22 April 2020

Cement looks set for another tough year in 2020

Cement looks set for another tough year in 2020: As covid-19 continues to ravage economies and pummels once-healthy sectors such as tourism, it’s hard not to wonder how it could hit Egypt’s cement market — a sector that was under pressure long before the virus entered the national lexicon. Industry players differ on the extent to which covid can impact the already-ailing sector, with some stating that it won’t have much of an impact and others suggesting that it could be devastating.

What ails the cement sector? A drawn out oversupply problem has continued to push companies deeper into the red, forcing them to slash prices and lay off workers in a bid to stay afloat. Some industry leaders we spoke with say that unless the underlying problems of oversupply and falling prices — which have driven plant shutdowns prior to the crisis — are dealt with, covid-19 is simply another nail in the coffin. Others want the state to bail the industry out with assigned export quotas and a floor on prices. And while the government has lowered natural gas prices, all agree that more needs to be done.

2019 was a rough year for the industry as the gap between supply and demand grew. Total sales volume (both for the local market and export) declined 0.8% y-o-y to 49.8 mn tonnes in FY2019, according to a research note by Pharos Holding (pdf). Local consumption alone was down 3.5% y-o-y to 48.7 mn tonnes, Arabian Cement CEO Sergio Alcantarilla tells us. This comes as the nation’s production capacity remains between 80-85 mn tonnes — a mismatch that sparked a price war as companies vied to hold on to market share. Ordinary portland cement saw prices fall from EGP 850 / tonne in January 2019, to EGP 800 / tonne by December 2019, according to data from Mubasher. Hikes in electricity prices from years of subsidy cuts added to the financial pressures on cement companies, causing production costs to rise 11%, Jose Maria Magrina, managing director of Suez Cement, told the local press last September.

As a result, private sector earnings nosedived last year. Suez Cement — the largest private sector producer with a 13% market share — saw net losses fall (pdf) 10% y-o-y to EGP 1.2 bn in FY2019. Meanwhile, Misr Beni Suef Cement — which is 20% state-owned — saw its net income falling (pdf) 66.8% y-o-y to EGP 80 mn.

Some companies simply haven’t been able to cope, with National Cement, Tourah Cement, and El Nahda Cement all shutting down operations, either temporarily or permanently, last year.

What’s the outlook for the sector 2020? More of the same — if not worse, industry leaders tell us. The outlook for 2020 will be worse than 2019 as we expect more production shutdowns and revenues will continue to decline, Alcantarilla tells us. He expects to see more plants being idled, telling us that he sees around three or four companies will not be operational by the end of the year. Meanwhile, the stronger companies will continue to hemorrhage funds and revenues will continue to decline, he added. He expects Arabian Cement’s 1Q2020 revenues to be consistent with the last four quarters, which saw declines.

Suez Cement’s Magrina sees 2020 as turning out worse than 2019, as the sector continues to slide downwards. He concurs with Alcantarilla that the shutdowns will continue and will hurt employment in the sector. Magrina had reportedly told the local press last year that, in addition to temporarily shuttering Tourah Cement, his company has had to cut around 2,300 jobs over the past two years. Whatever factors came into play last year, expect more of the same in 2020.

Both also agree that consolidation will not save the sector in 2020, as no one is buying. There are no investments coming into the sector, says Alcantarilla. Why would any investor buy into a sector whose decline looks set to continue without any tangible government support, he added. This was evident in 2019, where we saw no mergers take place due to the uncertainty in the sector, Magrina tells us. Any merged entity would lose more out of the transaction, he added.

Could cement prices fall even lower? The fair price of ordinary cement in this market should be around EGP 700-750 per tonne, says Ahmed El Zinny, who heads the construction materials division of the Federation of Egyptian Chambers of Commerce. Currently, a tonne of cement is being sold for EGP 780, he adds.

And all before covid-19 comes to play: Both El Zinny and Medhat Stefanous, vice chairman of the construction materials division of the Federation of Egyptian Industries, tell us that the impact of the covid-19 crisis could potentially be “devastating” for the sector as building projects and construction slow down due to the curfew and lockdown. While neither wanted to speculate on the extent of the damage, El Zinny does expect companies to continue operating in the red. The situation has become so bad that the state’s national projects are absorbing 60% of the nation’s total cement production, he tells us. Cement distributors have also been forced to buy cement at cost from producers, forgoing their profit margins, said El Zinny.

Thus far, the government has reacted by lowering natural gas prices for industries to USD 4.5/mmbtu from USD 6/mmbtu last month. But cement players tell us this has not been enough to make a significant impact. Pharos argues (pdf) that while this may offer some respite for industries during covid-19, it will not prevent losses.

While everybody we’ve spoken to want government intervention, they differ on what course of action to take. For Magrina and Alcantarilla, the solution is clear: the government needs to address the supply glut. “The problem is oversupply and a fragmented market as there are currently too many companies operating,” says Magrina. While there is an acknowledgement that demand is falling due to market conditions, the other side of the coin is the massive growth in supply over the past five years, when the government was issuing licenses as the oversupply was becoming clear, says Alcantarilla. In 2016, the Industrial Development Authority (IDA) awarded three cement licenses, despite an estimated oversupply of about 18 mn tonnes. The problem was made worse when the state entered with full force on the supply side by inaugurating the 13 mn tonnes/year cement plant in Beni Suef in 2018. When running at full capacity, this one plant alone holds a 26% market share.

El Zinny sees exports as the solution, and is calling on the government to impose a minimum export quota of 5% of total production to funnel out some of the excess supply. He pointed to similar actions taken by the Trade and Industry Ministry back in 2008 as having helped out the cement industry during the global financial crisis.

The problem with exports is that this isn’t 2008. Energy was subsidized, hence production costs were cheaper. In those years, Egypt was exporting around 6-8 mn tonnes of clinker to regional markets. Industry insiders tell us that as the local market was reaching equilibrium and plants began suffering from stagnant utilization, Egypt’s exports markets began building up their own capacities, while other traditional export markets (including Libya and Yemen) are not longer buyers thanks to ongoing instability. That said, the government itself appears to favor exports, and has suggested it could be considering more subsidies for exporters, Magrina revealed to us.

Unfair playing field in global export market: And while El Zinny counters that Egypt can make inroads to Europe and other African export markets, Magrina says it will be difficult, if not near impossible, to compete with regional players such as Algeria and Saudi Arabia exporting cement at cheaper prices. Fuel makes up 50-60% of all costs, so subsidies make a difference. Regional competitors are selling cement USD 12 / tonne cheaper than Egypt’s, say Magrina and the FEI’s Stefanos. Egypt does not have a competitive edge in cement, so either the domestic market must increase its demand, or some factories must cease production, Stefanos told Ahram Online last year.

The FEI is also planning on lobbying the Finance Ministry for tax relief, and is proposing an amendment to the income tax of cement companies, which are taxed using a different formula than other companies, El Zinny tells us.

Even analysts are calling for radical solutions, with Pharos stating that the government will need to either set a minimum threshold for how low cement could get — or inefficient players need to exit.

in a research note headlined “Bankruptcies are the Name of the Game,” Pharos Holdings estimated that demand for cement has to grow by roughly 47% pushing utilization rates to 85% for sector dynamics to materially improve. Otherwise, “inefficient and highly leveraged players” will be pushed out of the market.

Either way, it’s a dynamic on which everyone from real estate companies to would-be home-owners should be keeping a watchful eye.

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