Despite rising domestic demand, new capacity and constraints on exports are eating into margins
Cement production in Saudi Arabia is a profitable business. Gross margins for producers averaged 53.5 per cent in 2009, compared with an international industry average of 32 per cent. The kingdom’s eight listed cement companies, which account for 80 per cent of market share, reported a combined net profit of SR3.68bn ($981m) last year.
However, local investment bank NCB Capital (NCBC) says in its latest report on the Saudi cement sector that this profitability is being eroded. The combined net profit for 2009 represents a fall of 6.7 per cent on the 2008 figure of SR3.9bn, and the average margin is expected to continue falling, reaching 48 per cent by 2015.
Several factors are influencing this drop in profitability but two reasons stand out: firms have been banned from exporting cement by the Ministry of Commerce and Industry since June 2008; and domestic capacity is rising faster than demand. This has disrupted the supply/demand balance and weighed down on cement prices in the kingdom. As a result, prices have fallen from SR253 a tonne in 2008 to around SR235 a tonne today. NCBC predicts that by 2015 cement will average SR217 a tonne.
Although the export ban was officially lifted in May 2009, the ministry has placed conditions on exports that cement companies have largely been unable to satisfy. The first is that they must sell cement domestically at SR200 a tonne, before exporting at higher rates; secondly all local demand must be met before exports can be sold; and finally each producer must keep 10 per cent of production capacity in reserve. In 2009, 37.8 million tonnes of cement were produced against a capacity of 49 million tonnes.
These caveats, particularly the first, have led to the industry to complain that as it is so uneconomical to export, the ban effectively still exists. But despite the restrictions, some firms are being forced to look to export markets. Unlike the western and central regions, a lack of major infrastructure projects in the east is putting pressure on cement firms based in this area of the kingdom.
“From our discussions with leading industry players, we believe up to four of the 12 cement companies have already relented and are meeting the government conditions,” says NCBC analyst and report author Farouk Miah.
Most cement companies expect the conditions on exports to remain in place at least until 2011. This is particularly bad news for some of the more recent market entrants, who began developing before the ban was put in place. “Much of the capacity expansions initiated prior to the ban were done with exports specifically in mind. For example, we believe that some companies, such as Tabuk Cement in the north and Eastern Cement in the east, were primarily set up for exports. Thus the potential for export has played a critical role in the development of the cement industry in Saudi Arabia. The ban has led to a crippling oversupply and pricing pressure,” says Miah.
The other factor contributing to this crippling oversupply is the arriving of new capacity in the market is outpacing demand growth. In 2006-07, rapidly rising cement demand, profits and exports prompted a wave of investment into the sector. By 2008, four new
private producers had introduced 6.2 million tonnes a year (t/y) of cement capacity into the kingdom, and a further 3.3 million t/y was added through capacity expansions at the eight existing firms.
The new private firms: Najran Cement, Riyadh Cement, City Cement and Northern Province Cement went on to take 14 per cent of the local market share in 2008. According to NCBC this grew to 20 per cent in 2009.
A further three privately owned cement producers are expected to start commercial production in 2010. According to NCBC, Western Region Cement, Al-Jouf Cement and Al-Jazeera Cement will combined add 4.5 million t/y of capacity.
Existing firms are also expanding their facilities. Yanbu Cement alone is planning to add 3 million t/y of capacity by 2012. But some new projects have been put on hold. Al-Ahsa Development has delayed its proposed 1.8 million t/y Hofuf plant until at least the end of 2010. Other schemes such as the 1.2 million t/y Jizan cement plant, the 1.8 million t/y Al-Bayan cement plant in Riyadh and the 2.75 million t/y Labuna cement plant, have also been put on hold.
This has led NCBC to develop three capacity scenarios in its industry forecasts. If all announced developments are executed production, capacity will hit 65.7 million t/y by 2015. However, if several projects remain on hold, NCBC expects to see capacity of about 60 million t/y. A minimum scenario of 53 million t/y has also been developed, which assumes the closure of all lines that opened before 1985.
Domestic demand, meanwhile, is estimated to reach 57.6 million t/y by 2015, with NCBC expecting a compound annual growth rate of 8 per cent, driven by a series of major projects from railways and roads, to a raft of university schemes and much needed housing schemes.
According to regional projects tracker, MEED Projects, $692bn-worth of construction projects are planned or under way in the kingdom. Much of the new construction, particularly social infrastructure, is situated in the western and central regions.
Consumption is currently much stronger than it was a year ago, when the global recession first hit and before the government stepped up infrastructure spending to stimulate the economy. Sales in March 2010 were up 23 per cent on the same month in 2009. Production across the 12 companies hit 4.05 million tonnes, a rise of 22.6 per cent on March 2009. Local deliveries were also up 19 per cent from 3.33 million tonnes to 3.96 million tonnes.
Cement prices were rising until the export ban was implemented in 2008. Levels then held at $6.4 a 50kg bag from July 2008 to July 2009 and before falling steadily, to reach a low of $3.1/bag in February 2010 (20 50kg bags are equivalent to one tonne of cement). However, over the past few weeks prices have risen to $3.9 a bag.
But NCBC predicts that over the long term, cement prices will take a downward trajectory. “The absolute demand in volumes will continue to remain below the capacity levels. We believe this excess supply in the market will lead to average cement prices falling by 1 per cent in 2010 and 8 per cent by 2015 to SR217 a tonne,” Miah. For this reason, NCBC says it has a cautious assessment of performance of the cement sector for the coming years.
Two of the eight listed cement companies have recently had their ratings downgraded by NCBC, including Eastern Province Cement and Yanbu Cement. The former had a neutral rating, but is now considered underweight. This is in part due to the absence of major construction projects in the eastern region limiting the growth potential for sales. In the west, Yanbu Cement is suffering from increased competition and operational issues with its older production lines; this has changed its rating from overweight to neutral. The firm is expected to report a 6.5 per cent fall in revenues for 2010 to SR882m, compared to SR943m in 2009. But it has new lines under construction that will become operational in 2011, leading to performance improving over the long term.
The fastest-growing cement firm in 2009 was Qassim Cement, which reported a 20.9 per cent growth in revenues and has an initial NCBC rating of neutral. It is also the country’s lowest-cost producer with a cost per tonne of SR98, against a sale price of SR231, resulting in a net margin of 53.2 per cent. Its revenues in 2010 are expected to climb by a further 8.2 per cent. Only Riyadh-based Yamama Cement is expected to grow faster, with 12.8 per cent revenue growth.
In the longer term, given the current constraints on exports, profit margins will inevitably be squeezed across the industry as capacity growth outstrips demand. Domestic demand, however, is set to show strong growth over the next decade, with firms in the west and central regions benefiting most. But cement companies that have pinned their hopes on a removal of export conditions may be doubly disappointed as the government shows no sign of lifting the restraints and, at the same time, international demand, particularly in the GCC has fallen.