The current economic and political climate in South Africa, the African continent and also in the rest of the world, make it tough for especially smaller players in the cement industry. Wilhelm du Plessis spoke to Richard Tomes, Executive, Sales & Marketing at AfriSam about the challenges and opportunities for cement companies in this challenging time.

Global cement picture

According to SAFCEC’s State of the South African civil engineering industry report for the second quarter of 2017, the world economy gained momentum in the fourth quarter of 2016 – especially in advanced economies such the USA and UK. However, economic performance amongst emerging economies has remained mixed.

Cementing future growth

This uneven economic performance in especially the emerging markets makes this period challenging for multinational cement companies. Luckily for them the global outlook is anchored by the positive trends in the major markets of China, India and the USA – which offset the poor performance elsewhere. The large cement producers have diversified their portfolios in a strategic effort to capture growth in such markets. The performance in these high-growth areas is vital to the financial health of these groups.

“Of the world’s five billions tons of installed cement capacity, China, an emerging market, demands two million tons to feed the needs of its increasing population,” Tomes says.

China is followed by India and the USA, with Europe (as a collective) fourth in the cement demand stakes. “Africa’s combined cement demand is similar to Europe’s. The continent has seen good volume growth, but in South Africa,” says Tomes, “the demand has been flat.”

“Countries that have an increased cement appetite include Pakistan, Turkey, Vietnam, India, Kenya, Switzerland, Germany, Poland, and the USA. South Africa, Chile and Spain have performed badly, while the worst performer is Brazil. Here cement sales have fallen by 9% year-on-year. This was caused by political uncertainty, the impeachment of the president and ratings downgrades. “It is worrisome because we are seeing similar trends in South Africa,” says Tomes.

SA’s historical reality

“For many years,” explains Tomes, “the local cement industry was run as a government sanctioned cartel – it was protected as it was regarded as strategic.” The country was in isolation and did not trade with the rest of the world. During this period, the way cement companies set up new capacity, was in the framework of a cartel and all the players maintained market share. “The regional dominance that various cement companies had, was based on this cartel-thinking,” adds Tomes.

“When South Africa became a democracy in 1994, the country’s economy had to become efficient as it now had to trade with the rest of the world,” says Tomes. Between 2002 and 2007 the country ran out of cement capacity and had to start importing cement, while the opportunity attracted new entrants. “Demand outstripped supply – there was a time when cement companies made EBITDA margins of between 30 and 40%. So if you are a Mr Dangote or a Chinese player, and there is no or little growth in the rest of the world, you would want to invest in South Africa,” adds Tomes. “We attracted new players in the process – Sephaku and Mamba Cement. As demand has now dropped off significantly, competition is fierce – everyone is scurrying for market share. In fact, cement prices are now back at levels last seen in 2009,” Tomes says.

A false sense

Tomes explains that between 2002 and 2007 cement demand in South Africa doubled as World Cup stadia was built, and the country had various infrastructure projects including SANRAL’s road projects, the Gautrain, and airport upgrades.

“It illustrates what is possible when there is economic confidence. The country had a successful political transition, peaceful democratic elections, hosted the 1995 rugby World Cup and was to host the first FIFA World Cup on the African continent in 2010. The industry had great momentum and confidence – and the major contractors did well on the back of confidence and good infrastructure investment,” he says.

Unfortunately the confidence and momentum did not last. “Economists and industry experts indicate that confidence levels are back at levels we experienced in the run-up to the first democratic elections in 1994.”

The political situation is the primary cause of this uncertainty. Last year’s local government elections yielded a few ‘fragile’ coalition governments in some of South Africa’s major metros around the country. In some instances, as witnessed in the Port Elizabeth metro, a failure to develop a good working relationship across party lines has impacted service delivery, impacting infrastructure spend, and with that cement demand. There are concerns about the ruling party’s elective conference and who is likely to emerge as leader and possibly the next president of the country, should the ANC win the elections in 2019.

All this uncertainty is causing many investors and potential investors to simply just play a wait and see game. At the recent Concrete Conference held in Johannesburg, attended by all the major civil engineering and built environment associations, Industry Insight shared the massive decline in tender activity, with more than double the amount of construction projects either being postponed or cancelled when compared to the previous year.

Fortunately for South Africa, shortly after our miraculous and peaceful transition to a democracy, the country had the 1995 Rugby World Cup and the 1996 Africa Cup of Nations. These two events were fantastic marketing events for the country and gave the investor community a massive confidence boost. This time around there is nothing on the horizon that seems to suggest that confidence will return in the short term followed by an uptick in construction activity.

The reality

The mostly negative sentiment has a direct bearing on major civil engineering contractors. With the economic outlook subdued, results are down all round. “The industry as a whole is not stable because there is not enough work. This feeds back to the cement and concrete industry. Private development still happens, but is nowhere near enough. From a civils perspective Limpopo, Mpumalanga and KwaZulu-Natal are still doing well, while this is not the case in the Eastern Cape. Gauteng, which consumes 40% of the national cement demand, is significantly down,” says Tomes.

Even though the South African hardware retail sector has been showing reasonable growth in the last while, they too are now starting to see their numbers decline, Tomes says.

An uncertain South African reality

Tomes says that South Africa has an installed capacity for cement production of 20 million tons. “Current demand is at around 13 million tons – this means that we have an oversupply of just over 30%. “If one takes an extremely optimistic view and assumes that South Africa can make a miraculous recovery and achieve economic growth rates of 7,5% per annum (which has never been done before), then capacity and demand will start matching each other by 2020. A more realistic view is to use the long term annual compound growth of 2,5%. This means that South Africa will only run out of capacity by 2030,” Tomes explains.

The situation could even be worse as this calculation does not take into account the establishment of cement factories in Namibia and Mozambique which until now have not been able to successfully export cement across their borders into South Africa.

Challenges facing the cement industry

The biggest challenge, says Tomes, is lack of growth, which obviously causes low demand. “None of the South African cement companies are operating at optimum capacity levels,” he says.

As the cement producing industry is an energy intensive process, the proposed energy tariff increases will mean that energy costs will spike. The cement industry won’t be able to recover this cost through price increases as the market is already oversupplied. “All that will happen is that we will see more margin squeeze happening,” Tomes cautions.

The availability of skills is a major challenge. “Skilled people are reaching retirement age – to replace these with younger, skilled and experienced people is proving to be a challenge. If you add our desire to transform while not having access to the necessary skills, it means that you are forever on the back foot. “We are faced with the challenge that our schooling system is not yielding enough learners with sufficient maths and science marks to get the engineering qualifications that we need. Transformation is always going to be a challenge unless we get that right,” says Tomes.

The impact on AfriSam

AfriSam is an 83 year old business. “The newest kiln was installed at Ulco, AfriSam’s flagship plant, which is already between 30 and 40 years old. From an energy efficiency point of view we do not have the most efficient plants,” Tomes explains.

The advantage of Ulco is that its mining costs are fairly low. It mines into a hill and uses less fuel as the trucks that carry payloads drive downhill. “From a pure technology and plant perspective, if we did not have the mining advantage, we would struggle to remain competitive against some of the new players,” Tomes admits. New entrants have installed modern kilns that are a bit more efficient; this slight advantage is however offset in certain markets when one considers haulage and transportation costs.

“AfriSam is also fortunate as the Ulco plant is located in an area where there are no other plants close by. It has a particular reach – Free State, Northern Cape, Eastern Cape and some coastal areas where the newer entrants are not present. This is an area where AfriSam can compete well, but demand in these areas is unfortunately not sufficient, so we are forced to haul the product over long distances in order to achieve the desired capacity utilisation required to sustain the plant.

“The Gauteng market, even though demand is not great in terms of growth, still accounts for 40% of the country’s cement consumption,” says Tomes. “It is fiercely competitive. All the cement producers compete here and apart from the new entrants, independent blenders who mix fly ash and cement are also competitors.

Fortunately for AfriSam, it is a diversified business. “It does not only rely on cement – it has a good aggregate business which generates better returns than the cement business, in terms of return on capital, and has been able to contain its costs much better because its production is not as energy intensive as cement. It has a capacity to produce 10 million tons and is currently running at 80% of capacity,” says Tomes. He adds that the Western Cape is struggling to keep up with demand, but more recently, since the water crises, the outlook there *is also starting to look a bit bleak.

AfriSam’s readymix business vies with Lafarge as the biggest readymix producer in the country.

“If you take readymix, aggregates and cement into account, AfriSam is an attractive business. We consume a large percentage of our own cement through our readymix business, and in turn we consume a large percentage of aggregate though our readymix business. We have a channel and a route-to-market in the form of our readymix business which can produce about 4 million cubic metres of concrete per annum,” says Tomes

“AfriSam is holding its own in terms of its ready-mix concrete and aggregates businesses, but is facing much stiffer competition on the cement side because of the oversupply situation and newer entrants with slightly more energy efficient plants,” he admits.

The impact of multi-national mergers on smaller players

Tomes says that the consolidation that is seen around the world, is now increasingly also happening in Africa. “Lafarge and Holcim consolidated their operations, while Heidelberg is another multinational with a significant presence in Africa. The Dangote Group has roughly 30 million tons of installed capacity in Africa.

“Multinationals have a diversified portfolio around the world so they can take advantage of growth in areas of increased demand, and offset this against low growth areas. Players like AfriSam and PPC are concentrated on the southern tip of Africa. For many years it was ok: South Africa was the leading economy on the continent, but things have changed,” he says.

“Smaller and independent players must either make peace with the fact that they are a small player and therefore operate very lean structures whilst looking for opportunistic growth; something which is proving extremely difficult at the moment or they need start to think about consolidation, as this will enable them to strengthen balance sheets collectively and set them up for the growth period which lies ahead,” says Tomes about the proposal to merge with PPC. “The African continent, despite some of its challenges, still remains the last big growth opportunity. Soon the continent will have more than one billion people, many of whom are still living in under developed rural areas. With the expected urbanisation likely to happen over the next 10 to 20 years, Africa is certainly the place to be if you are in the cement or infrastructure related industries.

In the short to medium term however, AfriSam and PPC need to pursue the opportunity to create a strong national cement champion in South Africa, which is the home base and still accounts for more than half the income for both companies. On the back of a strong home base, degeared balance sheets and leaner structures, a merged entity will be in a much stronger position to deal with some of the current headwinds whilst aggressively pursuing growth in a more structured and slightly less risky way on the continent” says Tomes. Having said that though, the two companies should be careful not to get completely distracted by all these merger negotiations. As AfriSam, we still have a business to run and customers to serve, which is why we continue to look for ways of improving our profitability and sustaining our business and leave the negotiations up to the deal makers.

Possible future growth

A growth opportunity is the limestone deposit that AfriSam owns in the Western Cape. “For years now we have not considered exploiting the opportunity that this deposit offers us, mainly due to timing and the current oversupply of cement in South Africa. In addition we had to settle down the business after the Holcim deal: We had to bring new shareholders on board and restructure our balance sheet for the next wave of growth,” says Tomes.

AfriSam has enjoyed good support from its shareholders and we are encouraged by the continued support as well as interest shown by other potential partners to establish a long term presence in the Western Cape. We currently supply all our readymix operations with cement from our Ulco plant and have started targeting other cement users in the area as well. Establishing a cement plant in the Western Cape will allow us to reduce the cost of cement to our readymix concrete operations, whilst being able to pursue other users more aggressively. Establishing a fully integrated plant could cost anything in excess of R3,0 billion, so one option might be to start with a cement mill and bagging plant and only build the kiln once there is sufficient demand to support that level of investment. We already have an approved EIA and discussions with potential partners regarding plant design, funding etc. are ongoing.

In conclusion Tomes says that AfriSam aims to consolidate its South African base, strengthen the balance sheet, get costs under control, remain competitive, continue to be cash generative and give shareholders confidence that the business is on the right trajectory. “And when growth comes, we will be in a good position to justify a major capital expenditure,” he says.