Analysis

We said to expect more consolidation in Italy. Well, today it happened. Last time Global Cement Weekly covered the country, in June 2017, it reported upon the Buzzi Unicem deal to buy Cementizillo. Today, HeidelbergCement announced that it is going to buy Cementir Italia from Cementir Holding for Euro315m.

Our first reaction is that the deal seems cheap. The agreement covers five integrated cement plants and two cement grinding plants with a total capacity of 5.5Mt/yr, as well as the network of terminals and concrete plants. HeidelbergCement is buying all of this for Euro57/t. This suggests a downward trend given that Buzzi Unicem paid Euro80/t for the Cementizillo units in mid-2017. Although, Cementir only paid Euro38/t when it purchased Sacci in mid-2016.

Cementir’s acquisition of Compagnie des Ciments Belges (CCB) boosted its sales revenue, volume and operating profit in 2016 and in the first half of 2017. However these figures suffered on a like-for-like basis due to falling revenue in Turkey and Malaysia. Overall revenue rose in Italy for the company in 2016 due to a growing ready mix concrete business. However, with this removed, its sales revenue would have fallen by 14% year-on-year due to a 13.5% decrease in the sales volumes of cement.

Cementir Holding chief executive officer (CEO) Francesco Caltagirone has framed the sale of Cementir Italia in terms of improved financial leverage. He’s placed it at close to 0.5x by the end of 2018. This, he says, will allow the group to “…take the opportunities arising in the future, as it has happened during the last twelve months.” By this he likely means the purchase of CCB. Given the low cost for what Cementir picked up the bankrupt Sacci, it makes one wonder whether their plan all along was to leave Italy and they just happened to pick up a bargain along the way.

Meanwhile, HeidelbergCement has framed its acquisition in terms of preparing its presence in the Italian market for the future when the recovery kicks in. The usual talk about synergies is also there and Italian workers for both Italcementi and Cementir Italia will be wondering what this means for their jobs. Given that the group’s overall sales have struggled to grow so far in 2017, the company may be telling the truth when it says it’s banking on the medium to long term in Italy. After all, in its half-year report for 2017, it described the Italian economy as subdued and reported cement sales volumes as ‘stable.’

Once the deal completes, Cementir Holding will be an Italian-based cement company without any production facilities in Italy. Unless the group is planning to re-enter its home market at a later date, it does suggest a certain lack of confidence at home. Let’s see if HeidelbergCement has the nerve to stick it out.

Weather always seems like an excuse in cement company financial reports. It seems that it can pop up when a producer has nothing else to blame for its poor performance. Except, of course, when there has actually been some bad weather. With this in mind the weather is likely to have a rather larger presence in the next set of results for companies in the Caribbean and Florida in the aftermath of Hurricane Irma. The storm tore across the region in a rough north-western bearing, reaching Category Five hurricane status on the Saffir–Simpson scale with sustained winds of over 252km/hr. It caused loss of life and mass destruction to property and infrastructure.

Bottom lines flutter in the wind as construction markets upend in the wake of the weather. Yet cement companies have a more direct relationship with extreme weather events. Cement plants themselves are large industrial sites with staff and equipment that are vulnerable to the elements. This is covered by a company’s resilience strategy but it can include things like reducing non-essential staff levels, shutting down production and securing a site. Cemex USA, for example, set up telephone lines to help employees in need of assistance for both Hurricane Harvey in Texas in late August 2017 and Irma this week. Titan America shut down its Florida operations over the weekend ahead of Irma and then started reopening them on 12 September 2017.

To look at one facet of preparing a cement plant shutting a clinker kiln down with adequate notice, like for a maintenance period, is one thing. Yet doing it in an emergency is an entirely different proposition as the kiln generally needs time to cool down. Global Cement discovered what happens when a kiln is simply stopped when it visited the Cemex South Ferriby plant in the UK. The plant suffered a complete electrical outage following a tidal surge at the site. A 22m-long section of one of the kiln shells had to be replaced because it had been distorted by the sudden cooling.

Secondly, the concrete that cement is used to make plays a key role in what the Portland Cement Association (PCA) and others call resilient construction. Typically concrete structures and buildings survive extreme weather events better than other weaker building materials. Although a wide range of other factors such as building design, foundations and roofing construction are also important. Notably, much of the footage that emerged during the storm in Florida was shot from concrete buildings. As Cary Cohrs, former chairman of the PCA put it: "The greenest building is the one still standing." At the time of this push 2013 Cohrs and the PCA were lobbying to strengthen US building codes and standards. It is likely that the association will renew its efforts in the wake of Irma.

With the winds slackening, the clean up operation starts. Cemex USA’s Houston Terminal said it had reopened for business after Harvey despite being two feet under water a week earlier. As reports start to emerge about the scale of the devastation in the region following Hurricane Irma the insured losses have been estimated at US$20 – 65bn by analysts quoted by the Financial Times. Two things are certain though. One, bad weather is likely to make an appearance in the third quarter financial reports and, two, the rebuilding is going to need lots of cement.

ARM Cement’s declining fortunes this week may signal the end of the current growth cycle in the Kenyan cement industry. The cement producer posted a 20% year-on-year drop in its sales revenue to US$52m for the first half of 2017. Its financial returns have been turbulent since 2015. However, inward investment from the UK’s CDC Group in 2016 had appeared to help the company enabling it to pay of debts and even consider an upgrade project to the grinding capacity at its Athi River plant.

Graph 1: Cement production in Kenya for first half of year, 2013 - 2017. Source: Kenya National Bureau of Statistics.

Graph 2: Cement consumption in Kenya for first five months of year, 2013 - 2017. Source: Kenya National Bureau of Statistics.

Unfortunately it now appears that the Kenyan cement market may have peaked in 2016. As can be seen from Kenya National Bureau of Statistics figures in Graph 1 and 2, production hit a high of 3.31Mt in the first half of 2016 and it has fallen to 3.18Mt for the same period in 2017. Consumption too has fallen, to 2.5Mt for the first five months of 2017. At the same time the value of building plans approved by the Nairobi City Council dropped by 12% to US$1.02bn for the first five months of 2017 with falls in both residential and non-residential applications although the decline in residential was more pronounced. One of the country’s larger infrastructure projects, the Standard Gauge Railway from Mombasa to Nairobi entered its final stage of construction towards the end of 2016 with the completion of track laying.

Bamburi Cement has also reported falling revenue and profit so far in 2017. Its turnover fell by 8% to US$170 and its profit decreased by 36% to US$18m for the half year. Bamburi blamed it on a contracting market, low private sector investment leading to residential sector issues, delays in some infrastructure projects and droughts. The drought also hit the company’s operating profit via higher energy costs. On the plus side though Bamburi’s subsidiary in neighbouring Uganda did record a good performance.

It’s likely that the general election in Kenya in early August 2017 has slowed down the construction industry through uncertainty about infrastructure investment and general fears about political unrest. Thankfully these latter concerns have appeared unfounded so far but the memory of the disorder following the poll in 2007, where over 1000 people died, remains acute. And of course the 2017 election is not over yet following the intervention of the Supreme Court to nullify the result of the first ballot and call for a second. A longer election period with the impending rerun will further add to the pressure on the construction and cement industries.

An industry report on East Africa in February 2017 by the Dyer & Blair Investment Bank fleshes out much of the situation in the region. One particular point it makes though is that, as it stands at present, building materials may be too expensive to grow the market fully. Dyer & Blair suggest that lower construction costs and more affordable home ownership methods might be the key to driving low end housing demands and in turn this might grow cement consumption.

With lots of new production capacity coming online both locally and in neighbouring countries such as Uganda and Ethiopia, the Kenyan cement market faces the dilemma of trying to balance the medium to long-term demographics with the picture on the ground. Low per capita cement consumption suggests growing markets but if the demand isn’t present in the short term then the impetus for cement producers to expand shrivels especially with aggressive imports, rising energy costs and growing local competition. Once the election period finishes the picture will be clearer but the boom times may have abated for now.

There have been sounds of discontent coming out of South Africa this week, as AfriSam and PPC continue to (apparently) fail to come to an agreement on the terms of their long-discussed proposed merger. The pair have formally been in discussion since February 2017 but the situation now looks precarious. AfriSam has cancelled the heads of terms that had stood since that month. PPC has now hit back by giving AfriSam until this Friday (1 September 2017) to come up with a new and ‘sufficiently interesting’ deal for it and its shareholders. AfriSam’s acting Chief Executive Rob Wessels said, "AfriSam remains firm that a transaction between AfriSam and PPC will greatly benefit the stakeholders of both companies.” However, PPC’s chairperson Peter Nelson said that his shareholders were ‘frightened about the prospect’ of the merger.

If you think all of this to-and-fro sounds a bit familiar, that’s because it should. AfriSam and PPC have been courting not just since February 2017, but since December 2014. At that time, following the surprise resignation of CEO Ketso Gordhan, discussions lasted until the end of March 2015 before fizzling out. PPC’s (then) new CEO Daryll Castle confirmed that neither party could agree on terms. The two parties were also able to save some face by pointing out that the merged entity would have had around 60% of all South African cement capacity. While this is a pretty big potential stumbling block, it would been pretty obvious before discussions started and is by no means insurmountable. One gets the feeling that, given more enthusiastic partners, the discussions might have found a way forward.

At the time PPC and AfriSam played their cards close to their chests and we can’t be sure quite why the discussions really broke down. However, regardless of what happened last time, there do appear to be a lot of parallels with the current situation.

Firstly, PPC is, once again, in a state of transition. CEO Darryll Castle announced in July 2017 that he would be leaving to ‘pursue other interests,’ although neither an exact departure date nor destination was provided. Johan Claassen, the current managing director of PPC, has been appointed to the role, but only on an interim basis, presumably in anticipation for the expected merger. Other positions in the group’s executive team were reshuffled in the past couple of weeks and there was also the resignation of Tito Mboweni, a non-executive director, rumoured to be over a difference of opinion regarding the merger. On top of this, AfriSam’s CEO Wessels is also on a short-term contract. Could all of these pre-merger moves now be in vain?

Secondly, PPC continues to suffer from a combination of a poor domestic construction market and increasing competition and from imports coming in from rampantly over-productive markets across the Indian Ocean. Arguably both of these effects are now worse than they were in 2015, although PPC did recently say that the second quarter of 2017 had been a lot better across South Africa than the first. However, PPC saw its full-year earnings collapse by 93% year-on-year in the first quarter of 2017, after it was awarded ‘junk’ status in May 2016 by credit-rating agencies. Is it this result alone that has gotten AfriSam thinking? Despite this, PPC remains the larger of the two parties. It certainly wants to be seen to be calling the shots with its 1 September ultimatum.

However, the two producers now share less than 50% of the integrated cement capacity in South Africa, not 60% as in 2015. According to the Global Cement Directory 2017 they share around 7.8Mt/yr of integrated capacity against 8Mt/yr in the hands of others. This is due to the commissioning of the monster 3.5Mt/yr Anganang clinker plant and associated Delmas grinding plant by Sephaku Cement (Dangote Cement) and the full commissioning of Mamba Cement, part of Jidong Development. Could this smaller combined market share make it easier for PPC and AfriSam to identify those assets that can be sold to appease the competition authorities? Could this yet save the discussions?

Whatever happens after Friday, it is apparent that some form of consolidation is essential for PPC (and the wider southern African market) if the industry is to ‘right-size’ for the future. The region is awash with cement. News from PPC Zimbabwe this week even hinted that the effects of imports are now so strong in that country that it is considering shutting down clinker production at its Colleen Bawn plant, which has operated for more than 70 years. This effect is in play all the way down the coast from the Horn of Africa to Capetown and has been discussed previously with reference to Kenya, Tanzania and Mozambique.

Even if it doesn’t get the ‘right answer’ from AfriSam this week, PPC may still stand to gain from the merger, even if it’s only in the short term. In March 2015 its shares jumped up 5% on the news that the merger talks had collapsed. Given its recent performance, another 5% boost would probably not be turned down.

There is plenty to mull over on the Chinese cement market at the moment as the half-year reports for the major cement producers are being published. Anhui Conch revealed this week a glowing balance sheet with a 33% jump in its sales revenue to US$4.79bn. It attributed the boost to a ‘significant’ increase in prices and continued discipline with production and operation costs. Although CNBM is scheduled to release its results at the end of August 2017, Anhui Conch appear to be well ahead of its next largest rivals locally as can be seen in Graph 1.

Graph 1: Sales revenue of major selected Chinese cement producers. Sources: Company financial results.

Beyond the headline figures it is interesting to pinpoint the areas in China where Anhui Conch says it isn’t doing as well. Its South China region, comprising Guangdong and Guangxi provinces, suffered from competition in the form of new production capacity, which also in turn dented prices. Despite this ‘black spot’ in the company’s regional revenue still grew its sales in double-digits by 14%.

The other point to note is the growing number of overseas projects with the completion of a cement grinding plant in Indonesia, new plants being built in Indonesia, Cambodia and Laos, and projects being actively planned in Russia, Laos and Myanmar. The cement producer also opened seven grinding plants at home in China during the reporting period. It’s not there yet but it will mark a serious tipping point when the company starts to open more plants outside of China than within it. With the government still pushing for production capacity reduction it can only be a matter of time. On that last point China Resources Cement (CRC) reckoned in its half-year results that only four new clinker production lines, with a production capacity of 5.1Mt/yr, were opened in China in the first half of 2017.

After a testing year in 2016 CRC’s turnover has picked up so far in the first-half of 2017 as its sales revenue for the period rose by 17% to US$1.67bn. Despite its cement sales volumes falling by 9% to 33.6Mt, its price increased. Given that over two thirds of its cement sales arose from Guangdong and Guangxi it seems likely that CRC suffered from the same competition issues that Anhui Conch complained about.

Graph 2: Chinese cement production by half year, 2014 – 2017. Source: National Bureau of Statistics of China.

Graph 2 adds to the picture of a resurgent local cement industry suggesting that the Chinese government’s response to the overcapacity crisis may be starting to deliver growth again. After cement production hit a high in 2014 in fell in 2015 and started to revive in 2016. So far 2017 seems to be following this trend.

Returning to the foreign ambitions of China’s cement producers brings up another story from this week with news about the Nepalese government’s decision to delay signed an investment agreement with a Chinese joint venture that is currently building a cement plant in the country. With the prime minister visiting India the local press is painting it as a face-saving move by the Nepalese to avoid antagonising either of the country’s main infrastructure partners. This is relevant because the cement industries of both China and India are starting look abroad as they consolidate and rationalise. Once China’s cement producer start building more capacity overseas than at home, conflicts with Indian producers are likely to grow and present more awkward situations for states caught in the middle.