Analysis

Germany’s Knauf announced this week that it is set to buy North American wallboard producer USG. The news is relevant for the cement industry because both companies are prominent gypsum producers. They are leading gypsum wallboard producers, with assets around the world, including gypsum mines. Although their focus is on wallboard a significant proportion of raw gypsum ends up being used in cement production. Hence, the takeover of a major North American producer by a European one deserves attention.

First a little background on the deal between Knauf and USG. The takeover has been a particularly acrimonious one at times, with both parties throwing strong language at each other and, although it has avoided being a hostile takeover, at times it seemed close. The deal became public in March 2018 when USG publicly said that it had rejected a bid of US$5.9bn from Knauf. It described the offer at the time as ‘wholly inadequate.’ Knauf then fought back by sending a letter to USG’s shareholders urging them to vote against director nominees at the next annual general meeting. Knauf owns 10.5% of USG’s shares. Then, in April 2018, Warren Buffett, the chief executive officer of Berkshire Hathaway, USG’s largest shareholder with a 31% stake, swung behind Knauf’s scheme. At this point it was revealed that Buffett had facilitated the initial talks between USG and Knauf. He even described the investment in USG as ‘disappointing.’ Buffett’s public move against USG in April 2018 signalled the death knell to USG’s independence. The US$7bn deal between Knauf and USG was agreed and announced on 11 June 2018. The transaction is expected to complete in early 2019.

USG operates 12 mines or quarries in North America. It also has other assets around the world including three gypsum mines in Oman, Thailand and Australia respectively that it runs in conjunction with its USG Boral joint venture in the Middle East and Asia. By contrast Knauf held over 60 quarries in 2014 with a focus on Europe.

The interesting implications from the merger may arise from what Knauf plans to do in certain regions. North America for example saw a reduction in raw mined gypsum production since the financial crash in 2008 as building markets suffered. Rising levels of synthetic gypsum production from coal power plants partly compensated for this. Buying USG gives Knauf a truly global base of natural gypsum production with which it can supply both itself and any cement customers. Knauf has a real shot of cornering the market in raw gypsum production provided it can keep the price low enough to stop enough rival mines being opened. Knauf might decide, as the construction market continues to recover in the US, to bring in the extra gypsum from elsewhere if it proved cost effective. Hooking up USG-Boral gypsum resources in Asia with Knauf’s might have implications for cement producing countries that lack sufficient gypsum supplies such as India. Oman is building itself up as the major gypsum exporter to Asia and USG-Boral is a part of it, with major gypsum resources in the country.

In terms of the cement industry it seems likely that there will be no immediate shakeup of gypsum supply. Long term supply contracts with either USG or Knauf should remain as they were and will stransfer to the new enlarged company. Knauf’s main market for gypsum is to use it to make wallboard but gypsum use for cement is a significant market as well. The ‘fun’ starts when or if Knauf starts to reorganise its supply chains. As its focus is on the wallboard business there may be implications thereafter for cement users. And since Knauf’s only major competitor at scale is Saint-Gobain, the market has just shrunk.

CRH announced changes to its structure this week. The changes to its divisions follow the rapid growth of the company and may also anticipate the new cement assets it is about to take on-board once its acquisition of Ash Grove Cement completes in the US. Buried in one its regulatory filings covering the news were two graphs of changes in cement demand in the US and Europe through various financial depressions since the 1930s.

Graph 1: Changes in cement demand in US and Europe during financial depressions. Source: CRH with data from US Geological Survey, PCA, United Nations, Morgan Stanley etc.

The graphs serve their purpose for a public company as they show both markets in the current downturn starting to rise again. In other words it looks like the perfect time to invest in a building materials company! However, thinking more broadly the graphs give a timely reminder of how bad the last decade has been for the cement market, particularly in Europe. The period only really compares to the 1930s in decline and duration if the figures are accurate. It must be considered though that while the West has suffered, markets in the East, notably led by China and India, have boomed.

The financial crash in 2008 was precipitated by the US subprime mortgage market. Other potential market killers lie ahead no doubt. One such might be the so-called ‘Carbon Bubble.’ This idea has gained media traction this week with the publication of a paper in the Nature Climate Change journal examining the economic impact of decarbonisation, if or when it happens.

It’s not a new argument but it makes the assertion that as new technologies that replace fossil fuels start to influence the markets, traditional fuel producers like oil companies may face being stuck with ‘stranded’ assets as legislation toughens up and technology mounts. This in turn could cause a financial crash and it’s this aspect that the paper has looked at.

The ace in the hole from the Nature Climate Change paper is that the modelling here suggests a way out of the usual prisoner’s dilemma approach to climate change action. Once sufficiently-low carbon technologies hit a certain level of adoption, then any country holding out and using fossil fuels instead of taking of action may start to suffer economically. Or in other words cheating won’t pay.

The carbon bubble theory is pretty convenient for the climate change lobby as it gives it a financial reason to fight its enemies by targeting investors. One counter argument is realistically how fast and deep would the decarbonisation technologies actually have to be to cause significant financial disruption. Surely the oil producers would get out of risky assets before it was too late. Then again, maybe not.

The cement industry is in exactly the same situation as the oil producers as it too depends on carbon rich assets, in this case limestone, for its business to operate. If limestone assets become ‘stranded’ due to toughened legislation then how can production continue? In addition though, volatility in the fuels and secondary cementitious materials (SCM) markets already being observed from the cement industry may make one wonder about the existence of the carbon bubble. Markets for waste-derived fuels and granulated blast furnace slag are currently changing in the wake of the tightening of Chinese legislation both in and out of the country. In theory this could mean cheaper inputs for cement production but the market is hard to predict. The other classic recent example is how the US natural gas boom from fracking has reduced global oil prices with further effects on the coal and gas that cement producers use. This in turn has placed pressure on various countries that are reliant on their petrodollars and caused pain to their local cement industries, like Saudi Arabia for example. The price of Brent Crude may be rising at the moment but once it hits a certain threshold, the hydraulic fracking of gas wells in the US will resume pumping. Of course both waste inputs and fracking could just be attributable respectively to market distortions by a large country changing policy and a new technology finding its feet.

If the carbon bubble theory carries any weight then CRH’s cement demand graph during recessions may carry a warning to producers about what might happen if decarbonisation leaves the fossil fuel producers behind. With good timing for this theme South Korea’s Ssangyong Cement announced this week that it is close to completing a waste heat recovery (WHR) unit at its Donghae plant, one of the biggest in the world with seven production lines. The interesting detail here is that the WHR unit will work in conjunction with an energy storage system to form a microgrid. This kind of setup is well suited to using energy from renewables as well as from conventional sources like a national electricity grid. In other words, this is exactly the kind of development at a cement plant that might in a small way lessen its reliance on fossil fuels in the face of any potential supply issues.

The 2nd Future Cement Conference and Exhibition looking at how the cement industry can operate in a low- or zero-carbon world will take place in Belgium in May 2019

LafargeHolcim’s announcement this week that it is to close its headquarters in Paris is the latest sign of the tension within the world’s largest cement producer. The decision is rational for a company making savings in the aftermath of the merger of two rivals – France’s Lafarge and Switzerland’s Holcim – back in 2015. Yet, it also carries symbolic weight. Lafarge was an iconic French company that had been in operation since 1833. Its hydrated lime was used to build the Suez Canal, one of the great infrastructure projects of the 19th century.

In the lead up to the merger in 2015 the union of Lafarge and Holcim was repeatedly described as one of equals. However, the diverging share price between the two companies killed that idea on the balance sheets in early 2015. Renegotiation on the share-swap ratio between the companies followed with an exchange ratio of nine Holcim shares for 10 Lafarge shares. In the end Holcim’s shareholders ended up owning 55.6% of LafargeHolcim. Lafarge’s Bruno Lafont lost out on the top job as chief executive officer (CEO) in the frenzy but the role did go to another former Lafarge executive. The new company also retained its former corporate offices in both France and Switzerland.

Since the merger LafargeHolcim has underperformed, reporting a loss of Euro1.46bn in 2017. Former senior executives from Lafarge have become embroiled in a legal investigation looking at the company’s conduct in Syria. LafargeHolcim’s first chief executive officer Eric Olsen resigned from the company in mid-2017 following fallout from a review into the Syria affair. Both Olsen and Lafont are currently under investigation by the French police into their actions with respect to a cement plant that the company kept operational during the on-going Syrian conflict. Olsen’s replacement, Jan Jenisch, is a German national who previously ran the Swiss building chemicals manufacturer Sika.

Regrettably the closure of LafargeHolcim’s corporate office in Paris will also see the loss of 97 jobs although some of the workers in Paris will be transferred to Clamart, in the south-western suburbs of the city. Another 107 jobs will also be cut in Zurich and Holderbank in Switzerland.

One more knock at the local nature of cement companies in the very international arena they operate in doesn’t mean that much beyond bruised national pride. British readers may mourn the loss of Blue Circle or Rugby Cement but the country still has a cement industry even if it mostly owned by foreign companies. France’s industry is doing better as it recovers following the lost decade since the financial crisis in 2008.

Jump to 2018 and LafargeHolcim is being run by a German with links to Switzerland, Holcim shareholders had the advantage during the merger, its former Lafarge executives and assets are facing legal scrutiny over its conduct in Syria and Lafarge’s old headquarters in Paris are being closed. LafargeHolcim in France still retains the group’s research and development centre at Lyon and a big chunk of the local industry. Yet Holcim has held an advantage ever since the final terms of the Lafarge-Holcim merger agreement were agreed so this slow slide to Switzerland is not really a surprise. From a distance it feels very much like the Holcim acquisition of Lafarge is finally complete.

UltraTech Cement’s deal to buy the cement business of Century Textiles & Industries could see it become the world’s third largest cement producer by production capacity outside of China.

It announced this week that it had entered into an acquisition agreement to buy the cement subsidiary of BK Birla Group for US$1.26bn. If the deal completes then it will gain three integrated plants in Madhya Pradesh, Chhattisgarh and Maharashtra respectively with a combined production capacity of 11.4Mt/yr and a 1Mt/yr grinding plant in West Bengal. At this point UltraTech Cement will increase its production capacity to 106Mt/yr seeing it become the third largest cement producer in the world in Global Cement’s Top 100 Report.

This latest deal is subject to the usual regulatory approval from competition bodies and the like. Bustling past this step seems far from clear at this stage given that UltraTech Cement owns cement plants already in each of the four states the proposed purchases are in. It has described the purchase as giving it, …”the opportunity for further strengthening its presence in the highly fragmented, competitive and fast growing East and Central markets and extending its footprint in the Western and Southern markets.” Synergy savings from procurement and logistics are expected to follow with further benefits to be gained from the company’s distribution network. Local and national competitors may not see it the same way and the fallout from a price war could be damaging for smaller producers.

As covered previously, UltraTech Cement seems hell bent on winning its on-going fight against Dalmia Bharat to buy Binani Cement. Rightly or wrongly UltraTech Cement tried to muscle its way into buying Binani by making a bid directly to its owners after it lost an auction for it. Legal wrangling has followed as the insolvency process for Binani Cement has clashed against the auction process of the administrator. At the time of writing it is still far from clear which company will win.

Comparing the prices of the two latest acquisition targets by UltraTech Cement may offer some insight of its motivations. The Binani Cement assets roll in at just over US$125/t of production capacity. Although, as noted below, some of this is located outside of India. The Century Textiles & Industries assets are being purchased for a little over US$100/t. This is interesting as it is lower that the Binani cost, although the close links between BK Birla Group and UltraTech Cement’s owner Aditya Birla may help to explain this.

UltraTech Cement’s milestone as it surpasses the 100Mt/yr capacity level will mark a continuing change in the world’s cement industry as it moves away from Europe and North America to developing economies. As ever the classification is a bit of a fudge given that Global Cement’s top producers list excludes Chinese producers. Partly this arises from the difficulty obtaining reliable data on the Chinese industry. Partly this comes from top producer’s list looking at multinational companies over (extremely) large national ones. Due to this UltraTech Cement remains a regional player. Or it will at least until it (or if it) manages to buy Binani Cement. Some of the assets included in that sale include plants in both the UAE and China. At this point UltraTech Cement’s claim to be the third biggest cement producer in the world will be secure.

Votorantim shone a glimmer of hope for the Brazilian cement industry with the release of its first quarter financial results this week. Increased sales volumes in Brazil, Turkey, India and Latin America led to an 11% rise in revenue to US$682m in the period. Admittedly back home in Brazil, most of this came from concrete and mortar sales, but after the slump Brazil’s had they’ll take whatever they can get. This compares to a 14% drop in sales revenue in the same period in 2017 due to falling cement consumption.

Graph 1: Accumulated 12 months local cement sales in Brazil. Source: SNIC.

SNIC, Brazil's national cement industry association, preliminary figures for April 2018 show a similar trend. Cement sales for April 2018 rose by 8.9% year-on-year to 4.35Mt from 4Mt. Sales for the first four months of the year dipped slightly by 0.2% to 16.9Mt although this is an improvement on the first quarter figures showing the benefit a strong April has had. Improvements are driven by growth in the central and southern parts of the country. SNIC’s graph of accumulated sales (Graph 1) definitely shows a slowing trend of decreasing cement sales with April 2018 being the only the second month in over two years where sales have risen.

Paulo Camillo Penna, the president of SNIC, even went as far as to speculate that the three months from April to June 2018 might see the first sustained period of improvement since 2015 and that sales could even grow by 1% for the year as a whole. This is a far cry from Penna’s description of his industry at the start of 2017 as, “One of the worst moments in its history.”

Votorantim reported that some regions of Brazil were starting to show a positive trend in the second half of 2017. Unfortunately it wasn’t enough to stop the cement producer’s overall sales falling for the year. LafargeHolcim didn’t release specific figures for its Brazilian operations in 2017 but it did say that its cost savings programme had, ‘provided for material improvement versus prior year both in recurring earnings before interest, taxation, depreciation and amortisation (EBITDA) and cash flow.’ It reckoned that despite the market contracting, it had managed to increase its market share. Meanwhile, on the supplier side RHI Magnesita said in a first quarter trading update that its cement and lime business was flat due to continuing low capacity utilisation rates in China and Brazil.

If this truly is the end of the Brazilian cement market slump then it seems surprising that there haven’t been more mergers or acquisitions. Mineração Belocal, a subsidiary of Belgium’s Lhoist, said this week that it had purchased L-Imerys, a lime producer that operates a plant at Doresópolis in Minas Gerais. Local refractory producer Magnesita merged with RHI in mid-2017.

The big deal that hasn’t happened is the sale of InterCement, the country’s second largest cement producer. Owner Camargo Corrêa was reportedly selling minority stakes in the company in 2015. Then in early 2017 local press said that it was aiming for a price of US$6.5bn for the whole company with Mexico’s Cemex as a potential bidder. Since then nothing has happened publicly although the initial public offering of InterCement’s Argentine subsidiary Loma Negra in November 2017 for US$954m may have bought Camargo Corrêa the time it needed to wait for the market to improve. Rumours of a public listing of InterCement’s European and African operations have followed.

In its World Economic Outlook in April 2018 the IMF forecast a 2.8% rise in gross domestic product (GDP) in Brazil in 2018. If SNIC’s forecast for 2018 is correct then Camargo Corrêa may have survived the worst of the slump to live to trade another day. The price for InterCement at this point can only rise, as should the prospects of the Brazilian industry.