Analysis

The prospects for the East African cement industry have risen this week following the formal agreement to build a new railway line linking the port city of Mombasa and Nairobi in Kenya. The US$3.8bn project will replace the existing 100 year old narrow gauge track with work scheduled to start in October 2014 and a completion date in 2018. The second phase of the project is then intended to extend the line to neighbouring inland countries including Uganda, South Sudan and Rwanda among others.

The bottom line here from Reuters' reporting is that the new line will cut freight costs by more than half to US$0.08/t per km from US$0.20/t per km. Anybody considering sending freight along the 610km line could see their costs drop from US$122/t to US$49/t. With the average cement price in Kenya reported at US$75/t at the start of 2014, these kind of prices seem unlikely to throw the market to the mercy of overseas imports. Moving one tonne of cement along the full length of the line would cost more than half of the selling price. Yet the effect on input costs or transport over smaller distances may have an effect, especially if the inland extension actually gets built.

Kenya has four integrated cement plants with a production capacity of 3.4Mt/yr. Of these three - ARM Cement, Bamburi Cement (Lafarge) and Mombasa Cements are on the coast – and only one plant, the East African Portland Cement Company, is based inland in Nairobi. In addition National Cement and Savannah Cement both run clinker grinding plants near Nairobi.

A number of plants are being built. Most recently, Savannah Cement announced plans in April 2014 to build a clinker production plant. The East Africa Portland Cement Company plans to build a plant in Kajiado for operation by 2016. Nigeria's Dangote Cement has a 1.5Mt/yr cement plant planned to start operation in 2016 in Kitui, between Nairobi and the coast with ARM seeking funding to build a 2.5Mt/yr cement plant in the same region. Cemtech, a company owned by India's Sanghi Group, has plans to build a plant in West Pokot County in western Kenya but the project has been delayed due to issues with land acquisition.

Despite all this development activity Kenyan Bureau of Statistics figures suggest that more cement is being produced in the country than is officially being consumed. In 2013, 4.8Mt of cement was produced but only 3.94Mt was consumed. Yet both production and consumption have more than doubled since 2004 from 1.87Mt and 1.27Mt respectively. With the Kenyan construction sector averaging a growth rate of 6.45%/yr between 2004 and 2012, it looks likely that consumption will continue to rise and all these new cement plants are poised to benefit form this.

The old Ugandan railway, which the new railway seeks to replace, started construction in 1896 and was backed by the British government. It was nicknamed the 'Lunatic Line' given the harsh terrain and the high worker fatalities. The perils facing the project were capped by a pair of man-eating lions who attacked workers as depicted in the book 'The Man-Eaters of Tsavo' and eventually made into a film called 'The Ghost and the Darkness' starring Michael Douglass. Then as today the potential benefits of connecting the African coast to the interior were seen as high.

Mexico: Lorenzo Zambrano, CEO of Cemex died on 12 May 2014 in Madrid aged 70. There were no immediate details about the cause of death in a statement released by Cemex and there had been no reports of illness. The company added that it will continue to operate normally.

Founded by Zambrano's grandfather more than a century ago, the company started producing cement in the northern city of Monterrey, which later became one of Mexico's industrial hubs. Zambrano was born on 27 March 1944. He joined the company after graduate school in 1968, when he earned his master degree in business administration at Stanford University. By 1985 the board of directors give him full power as CEO. Then, through a series of acquisitions, Zamrano extended Cemex's reach to five continents with operations in 50 countries.

However a US$16bn acquisition of Australian building materials company Rinker in 2007 subjected Cemex to the subprime housing crisis. At the time, Zambrano put a brave face on it. "We've shown that a company that is born in a developing country can compete in the whole world and we want to keep doing it," he said. Cemex spent the following years coping with large debt obligations, struggling to make deals with lenders and trimming costs by outsourcing and restructuring jobs.

Article updated: 14 May 2014

Egypt's cement producers have taken their fight to use coal to the opposition in recent weeks. Producers like Suez Cement and Titan have started pushing the benefits of using coal including its place as an international mainstay and highlighting the potential savings for the state.

In March 2014 the Minister of Trade and Industry Mounir Abdel Nour announced that cement companies could start using coal from September 2014. However, with pressure from environmental activists and even the Minister of Environment voicing disapproval for coal this seems to be a long way off. Fuel issues continue to bedevil Egyptian cement producers as reports emerged this week that gas supplies to 10 cement plants were cut. The plants, which represent 70% of the country's production base, have been forced to close temporarily. Egypt is one of the largest non-OPEC (Organisation of the Petroleum Exporting Countries) oil producers in Africa and the second largest dry natural gas producer on the continent.

The Egyptian government has been planning a reduction in the use of natural gas by industry. Yet the scale of the reduction has shifted. At first the Ministry of Petroleum intended to reduce supplies to cement plants by 35% in January and February 2014. Reportedly the price of cement then shot up by 30% in March 2014 to offset the rise in energy prices. Then the gas was cut completely, leading to the shutdowns.

In response Egyptian cement producers are investing in converting to using coal. This week Suez Cement announced a planned investment of US$40m to convert two of its four plants to use coal instead of natural gas subject to approval from the Ministry of Environment. Back in November 2013 Suez Cement announced similar plans to spend US$72.5m on converting its plants for coal. Similarly, Lafarge's preparations to use petcoke were also delayed by the ministry in February 2014.

Users of Egypt's gas supplies are caught between the reform of energy subsidies, a shortage in gas supplies and an increase in local demand. Industrial users like cement plants are stuck in a queue behind export markets and power plants. In addition international events such as the political instability in Ukraine might potentially rock the Egyptian gas market if Russian supplies were affected. The European markets would then start scrambling to secure their gas from other places such as Egypt.

In this situation, moving to the use of imported coal makes sense for cement producers. Yet groups like the 'Egyptians Against Coal' campaign argue that the issue is also about Egypt's sovereignty over its energy sources, not just pollution. Despite the optimism of the activists it seems unlikely that they can resist market pressures for long, especially with producers such as Suez Cement and the Arabian Cement Company announcing plans for increased alternative fuels substitution rates alongside their bigger plans for coal. Whether this is more than a sop remains to be seen.

Once dubbed 'King Coal' for its leading place in British industry before the second half of the 20th Century, coal is looking likely to take the crown as the fuel of choice in the Egyptian cement industry. How long it retains its crown though depends on the on-going competition between coal and gas use around the world.

Holcim released its first quarter results for 2014 this week and benefits of a merger seemed clear: both sales and profit were down. Net sales fell by 5.4% to Euro3.35bn and net income fell by 57.5% to Euro65.6m. However, Chief Financial Officer Thomas Aebischer was upbeat on meeting the regulatory requirements of any merger and the prospect of divestment opportunities.

This week we have a guest contributor - Andy Gboka, an analyst at Exotix LLP, a London-based broker specialised in Frontier markets – writing about the impact in Africa from the Lafarge-Holcim merger:

No change in Sub-Saharan Africa cement markets

Looking at (1) the location and size of the assets that both groups operate across the region but also (2) the expansion projects recently announced, we do not anticipate any upheaval in the competitive landscape, at least in the medium term.

Potential reshuffle of African assets

We identify Nigeria and Morocco as the main countries where the two companies are likely to reorganise their operations post-deal.

After the market excitement Lafarge / Holcim's price gains have averaged 9% since the announcement versus +8% the same day (04/04/14). We think it timely to discuss, from a competition angle, the likely impact on sector dynamics in Africa.

Starting with Sub-Saharan Africa where Lafarge and Holcim have been present for decades, the two groups have grown their output capability over time to reach a combined ~20.7Mt/yr. Holcim is a much smaller cement producer through its ~2.6Mt/yr in Ivory Coast, Guinea and Nigeria, whereas the French manufacturer is a regional leader with ~18.1Mt/yr capacity across 10 different countries. North African exposure paints a similar picture, as the Swiss company's installed capacity is ~9.6Mt/yr versus ~21.6Mt/yr for Lafarge (including their respective shareholdings in Lafarge Cement Egypt).

Although we do not believe the proposed merger will significantly alter Africa's competitive environment, business reorganisation is likely in:

(1) Nigeria. LafargeHolcim would control more than ~70% of the United Cement Company of Nigeria Ltd (UNICEM, 2.5Mt/yr in Calabar) which, in our view, is a suitable context for minorities' buyout.

(2) Morocco. More than ~50% of the industry's production capacity is controlled by the two players, a situation that may lead to asset disposals after review by the local competition commission.

Beyond the corporate implications, this announcement also puts into perspective the multiples investors are willing to pay for companies operating in Africa. Indeed, for 2014/2015 financial year the enterprise multiple (enterprise value / earnings before depreciation and amortisation) and price-to-book ratio for the main stocks listed in Nigeria and Kenya average 10.3x and 2.9x respectively, vs. 8.4x and 1.3x for LafargeHolcim (Bloomberg). While demand growth prospects in the teen digits or margins above ~25% (especially in Nigeria) would support a premium for the former names, we think the extent of that premium is questionable.

The best illustration is Dangote Cement, whose market capitalisation stands at ~US$25bn for total capacity estimated at 50 – 55Mt/yr by the 2016 financial year, relatively high when compared to the expected ~US$55bn market capitalisation for LafargeHolcim with (1) 427Mt/yr cement capacity globally and (2) ~60% of its revenue from emerging markets. This underpins our cautious stance on the sector.

Source: Andy Gboka, analyst at Exotix LLP (London-Based broker specialised in Frontier markets).

Andy Gboka will be speaking at the forthcoming Global CemTrader Conference, taking place in London on 2 -3 June 2014.

Zuari Cement's ground breaking of a new port-side packing terminal in Kochi, Kerala is the latest Indian cement news story with an eye on the sea. The Italcementi subsidiary's terminal won't be open until 2015 but the move shows that Indian producers are starting to tackle industry over-capacity through shipping lanes.

The Italcementi subsidiary holds two integrated cement plants and a grinding plant in Andhra Padesh and Tamil Nadu, two of India's biggest cement-producing states. In 2013 Italcementi reported that cement consumption fell for the first time in 10 years. Although Italcementi's cement and clinker sales rose by 1.6% in India in 2013, its revenue fell by 14% to Euro214m. Profit indicators like earnings before interest, taxes, depreciation, and amortisation (EBITDA) also fell. Targeting Kerala, one of the country's smallest cement producing states (0.6Mt/yr in 2013), makes sense.

Zuari Cement isn't the only Indian cement producer with its eye on shipping or on Kerala. At the end of March 2014, Gujarat producer Sanghi Industries announced plans to invest US$25m in ships and sea terminals. It plans to acquire six vessels in the next five years. It is also in the process of setting up terminals at Navlakhi port in Gujarat and at Mumbai port in Maharashtra.

Sanghi has stated that its aims are to find new markets, reduce fuel costs and increase its distribution networks. In an interview with Alok Sanghi, the director of Sanghi Cement, for a forthcoming issue of Global Cement Magazine, Sanghi revealed that Kerala is one of the four markets the producer focuses on within India (alongside Gujarat, Rajasthan and Maharashtra).

Neighbouring Pakistan is no stranger to exporting its cement around the world. Frequent complaints from east and south African press and cement producers attest to this. However, this week's story about plans to build the country's first 'dirty cargo' terminal at Port Qasim, Karachi marks a change from the normal narrative.

According to a Pakistan cement producer who Global Cement interviewed earlier in 2014, coal is the most common fuel used to fire cement kilns following a shift from gas in recent years. Subsequently coal prices rose, leading to higher cement prices in the country. A new terminal with the capacity to handle 12Mt/yr of coal (growing to 20Mt/yr in a second phase of the build) could certainly help cut input prices for the industry.

The producer also mentioned that most of the coal that Pakistan currently uses is imported from Indonesia and South Africa. So, indirectly, the South African coal industry appears to be making money helping to make Pakistan cement that eventually arrives back in South Africa to undercut local cement producers! They say that market always finds a way. Ships certainly help.