Analysis on the cement industry in pakistan
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Analysis on the cement industry in pakistan

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a report on the cement industry in Pakistan

a report on the cement industry in Pakistan

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    Analysis on the cement industry in pakistan Analysis on the cement industry in pakistan Document Transcript

    • ANALYSIS ON THE CEMENT INDUSTRY IN PAKISTAN Managerial Economics Javeria Siddiqui & Mohammed Tallal 12/17/2011
    • TABLE OF CONTENTSSTUDY OBJECTIVES & HYPOTHESES 3METHODOLOGY 3HISTORICAL OVERVIEW 4INDUSTRY ANALYSIS Market Structure 5 Growth Trends & Expansion Cycles 8 Factors Affecting Growth 10FUTURE OUTLOOK 12CONCLUSION 12APPENDIX 1 – Herfindahl Calculation 13APPENDIX 2 – Concentration Ratios 14REFERENCES 15 2
    • STUDY OBJECTIVES & HYPOTHESESThis report aims to evaluate the cement industry in Pakistan with respect to growth and thecompetitive structure of the market.The objective of the research will be two-fold:1. To determine Industry dynamics by evaluating historical performance and background as well as market structure and degree of competition.2. To identify factors that drive growth and capacity and expansion cycles.Hypotheses for this research study are developed as follows:Hypotheses 1: The cement industry follows an oligopolistic market structure.Hypotheses 2: The cement industry will follow economic trends of the country.METHODOLOGYThe research methodology largely employed secondary research for data collection andanalyses utilizing industry research reports, publicly available financial statements andliterature on the industry available online.A minor part of primary research entailed gaining insight on the industry’s future outlookthrough one-on-one interviews with industry experts. 3
    • HISTORICAL OVERVIEWPakistan’s cement industry has shown tremendous progress since Independence. In 1947, therewere only four operational cement units in West Pakistan with the total production capacity ofapproximately half a million tonnes per annum. Demand during the same period was estimatedat over a million tonnes. The industry experienced gradual growth as five plants were set up inthe 1950’s with a total capacity of 2.8 million tonnes with four more set up in the 1960’s. Thesewere the Ayub years when the construction industry went through a boom as demand grewbecause of an expanding economy and by 1969 the cement industry of Pakistan had 14operational cement plants with an annual rated capacity of 3.3 million tonnes.Following this expansionary phase of the cement industry, the Economic Reforms Order of 1972brought about nationalization of the private sector plants and resulted in a relatively stuntedgrowth of the industry in the subsequent years. Nationalization merged state owned plants toform the State Cement Corporation of Pakistan (SCCP) and this “State Cement era” lasted from1972 to 1992. During these three decades, production increased from 3.5 million tonnes to amere 8.4 million tonnes by 1992 and Pakistan’s cement requirements were largely being metthrough exports which had started in 1977 and continued till 1995.Government policy moved towards denationalization in 1977-1988 and emphasis was placedon housing and construction. To meet demand in the 1980s, the government allowed 7 moreunits to be set up by the private sector housing a total capacity of 2.54 million tonnes and 4plants were set up by the SCCP in the public sector. By the end of this period 24 cement plantoperated in Pakistan. However, there were enormous price differentials between private andpublic sector as the SCCP fixed cement prices on the lower side for the public sector companies.Through to 1995, local capacity was unable to fulfill local demand particularly in the north andPakistan continued to import cement in huge quantities to satisfy need and some plants closeddown in between. Prices in the 1990s were, therefore, high as a result of import costs andshortage of local cement. With projections for accelerated growth in demand in the world andlocal economy, five more plants were set up to gratify cement requirements locally. However,the local demand did not grow as expected during 1995 to 2000 and the cement sectorexperienced poor growth rates of 8% per annum. Therefore in post-industry expansion of thenineties, cement manufacturers had to go through a problematic period of capacity utilization.Pakistan began exporting in the years 2001-2002 to utilize excess capacity. Reduced deficits andfocus on infrastructure building (by attracting foreign investors during the Musharraf years)pumped cement demand growth to approximately 20% YoY in the mid-2000’s. Existing playersincreased capacity foreseeing further boom in economy in these middle years with totalproduction capacity resting at 44.7 million tonnes of cement as of the fiscal year 2009-2010. 4
    • INDUSTRY ANALYSISMarket StructureAlthough the cement comprises a relatively large number of manufacturing units (24) with aHerfindahl index of 0.10 that indicates competitiveness tilted towards perfect competition, thecompetitive nature of the cement industry is in actuality oligopolistic in terms of marketstructure. This is because of the following reasons: The industry is dominated by a few major players. This factor is by far the most important one in determining the cement sector’s market structure. Out of the 24 companies in the cement sector, four of them hold majority market share and are therefore able to drive industry prices. The chart below shows major industry players: CEMENT INDUSTRY MARKET SHARE (FY 2010-11) Others, 23% Lucky Cement , 20% Bestway Attock Cement Cement , 6% , 11% DG Khan Pioneer Cement , 15% Cement , 4% Lafarge Cement , 6% Kohat Maple Leaf Cement , 5% Cement , 10% A great hold on the market of a few players is also verified from the four and eight-firm concentration ratios which come out to be 0.55 and 0.77 respectively. Even though the four-firm concentration ratio depicts medium concentration and implies a relative oligopoly, the 8-firm concentration ratio of 0.77 shows high concentration and illustrates the major reason for government concern over the nature of competition for the industry. The table below shows four and eight-firm concentration ratios for local dispatches and exports as well as for the overall industry: Concentration Ratios (FY 2010) 4-Firm 8-Firm Local Dispatches 0.54 0.77 Exports 0.58 0.80 Overall 0.55 0.77 5
    • Interdependence & CollusionAnother factor that provides evidence to the oligopolistic nature of the cement industry inPakistan is the interdependence and proof of cartelization between the major players indetermining cost structures, raw material sourcing and most importantly in price setting.Additionally, the smaller-players are known to indulge in price-wars off and on as they cutprices and try to sell at discounts before end of each quarter.The major players in the industry on the other hand have been known to collude in the pastoperating as a cartel for over a decade under the umbrella of All Pakistan CementManufacturers Association (APCMA). The sector has been accused of cartelization thrice inthe past and was under probe of the Monopoly Control Authority.The cartelization issue reached its climax in 2009 when the Competition Commission ofPakistan issued fines of 7.5% of their last annual turnover amounting to Rs. 6.35 billion on20 companies that were found guilty of operating as a cartel and raising prices undermutual agreement. Cement prices rose tremendously immediately prior to the periodbefore the CCP took action. An example was the increase in cement prices to the extent of20 percent despite coal prices having gone down in the international market to $124 fromnearly $ 140 in November 2007 to January 2008. Cement prices had soared to as high as Rs.430 per bag in the later part of 2006. The table below shows some of the companies thatwere fined heftily: Name of Company Fine Imposed (RS) Pioneer Cement 364,032,300 Attock Cement 374,358,825 D.G.Khan Cement 933,449,700 Dadabhoy Cement 28,393,875The debate sparked a legal battle between the government and the manufacturers as thefines were challenged through litigation but at the same time, it worked to break thecollusion. However, post-imposition of fines, as the collusion ended speculation of pricewars broke out amongst all players.Coupled with the increase in factor prices and the global economic crisis, further strain hasbeen placed on consumer pockets in terms of cement purchases as manufacturers try tomake up in price what they have lost in volume. Despite a reduction in excise duty from Rs.700 to Rs. 500 in the budget for FY 2011-2012, cement companies have increased prices toRs. 430 per 50kg bag in lieu of maintaining operational profitability as Sales of cementsector grew by 14 per cent year-on-year to Rs124 billion in fiscal year 2011 compared toRs109 billion in the previous year. 6
    • Product homogeneity.Through-out the industry, the products are homogenous with non-existent levels of productdifferentiation as the major product for most manufacturers is Ordinary Portland Cement(90%-94%). Additionally, the other major types of cement product by plants in Pakistan alsoinclude Sulphate Resisting Cement (SRC), Blast Furnace Slag Cement (BFSC), and WhiteCement. This implies that competition is based on proximity to raw materials and marketsand tends to limit small-scale manufacturers as far as price-setting is concerned.Latent barriers to entry.At the outset, the cement industry does not face any major barriers to entry. However,manufacturers cost structures have increasingly placed greater pressure on smallmanufacturers to bring in cost-efficiencies or else be forced out of the market. Coststructures are maintained such that they protect the interests of the manufacturers asopposed to that of consumers.Moreover, government policies are also in favor of the cement sector with extensivelobbying being done by the APCMA to maintain such policies. 7
    • Growth Trends & Expansion CyclesThe cement industry has grown phenomenally since inception. It is one of the most establishedand advanced sector of the Pakistani economy today having been ranked the 5 th largest cementexporter in the world. It plays a key role in development of physical infrastructure with itsdependent on energy factors such as coal, gas and fuel and generates revenue boostingeconomic activities in downstream industries like construction as well as employing well over150,000 people.The following chart illustrates capacity utilization in comparison to domestic and exportdemand growth trends from the 1990s onwards: Source: APCMAThe trends show that capacity utilization has steadily increased from the 1990s when excesscapacity had been planned in light of optimistic demand projections which were not realized.Demand fell over the years during the late 1990s and picked up pace during Musharraf yearswith the growing economy and a booming constructions industry as well as demand for exportsparticularly in the Afghanistan and Pakistan’s close geographic proximity to it. Following theeconomic melt-down in 2007, domestic demand fell again but cement manufacturers,especially in the Southern region focused on diversifying markets to maintain profitability.Historically there has been a strong correlation between both domestic consumption, Pakistanproduction capacity and growth in real GDP. Demand has been seen to grow as the economymoves its trajectory upward. Capacity expansion plans have also been put in place where 8
    • optimistic future projections have been made as in the 1990s where the industry went throughtwo such capacity expansion cycles. However, with reference to capacity expansion it has beenobserved that expansion is aimed at catering to domestic markets as opposed to exportmarkets since the greatest capacity expansions have taken place in the Northern region awayfrom the sea routes of the South. Capacity Increase in CapacityThe graph above illustrates capacity expansion cycles through the last two decades showinghow expansions have taken place immediately following a positive outlook on industry growth.Capacity growth along with utilization and growth in total dispatches can be observed below: Capacity % Change TOTAL % change Utilization Excess Cap. FY (Mn. Tonnes) (Mn. Tonnes) (Total) % age (Mn. Tonnes) 1990-91 8.89 0% 7.290 0% 81.99% 1.601 1991-92 8.89 0% 7.712 6% 86.74% 1.179 1992-93 8.89 0% 8.324 8% 93.62% 0.567 1993-94 9.048 2% 8.136 -2% 89.92% 0.912 1994-95 10.173 12% 8.380 3% 82.37% 1.793 1995-96 10.173 0% 9.431 13% 92.70% 0.743 1996-97 12.504 23% 9.650 2% 77.17% 2.855 1997-98 15.528 24% 9.193 -5% 59.20% 6.335 1998-99 16.410 6% 9.621 5% 58.63% 6.790 1999-00 16.379 0% 9.937 3% 60.67% 6.442 2000-01 15.534 -5% 9.933 0% 63.95% 5.600 2001-02 15.723 1% 9.940 0% 63.22% 5.783 2002-03 16.321 4% 11.410 15% 69.91% 4.911 2003-04 16.936 4% 13.663 20% 80.68% 3.272 2004-05 17.909 6% 16.353 20% 91.32% 1.555 2005-06 20.955 17% 18.412 13% 87.87% 2.543 2006-07 30.251 44% 24.248 32% 80.16% 6.003 2007-08 37.157 23% 30.293 25% 81.53% 6.863 2008-09 41.760 12% 31.286 3% 74.92% 10.475 2009-10 44.682 7% 34.195 9% 76.53% 10.487 9
    • Factors Affecting GrowthA great number of factors affect the growth of the cement industry in Pakistan which are bothinternal to the industry as well as external.There are 2 main factors that affect demand for cement and are as follows: Economic Growth Growth in the GDP of the country contributes enormously to demand for cement. This is determined through the growth trends discussed earlier which clearly illustrate increasing demand as the economic variables improve as well as in the table below that shows cement demand growth relative to real GDP growth for the first half of the last decade: FY 02 FY 03 FY 04 FY 05 FY 06 Real GDP Growth 3.1% 4.8% 6.4% 8.4% 6.5% Domestic Demand Growth -1.1% 11.8% 14.2% 18.2% 15% Cement/GDP Growth -0.36 2.46 2.22 2.16 2.30 This is because economic growth is directly related to the growth of the housing and construction industry which consumes roughly 40% of cement demand as well as an indicator of attracting foreign investors which fuels growth in turn. Government Development Expenditures Another source of demand for the cement industry is government expenditures which account for a little less than one third of cement consumption. Higher expenditure allocated to development projects in essence fuel demand for cement. These development projects are typically centered round dam building, reconstruction activities in terrorism affected areas like Waziristan and the Swat Valley as well as rehabilitation activities that focus on earthquake and flood affected areas in Pakistan. 10
    • In addition to the factors mentioned above, the cement industry is also affected by the globaleconomy as well as Pakistan has forayed in to exports.Factors that affect the supply side of the cement industry are: Production factor costs This is true for any industry. As energy costs surge, factor costs for the cement industry goes up which consumes a considerable amount of energy resources. The cement industry is increasingly seeking out cheaper alternatives to coal so as to reduce production costs. Financial Costs In the recent past, it has been observed that the cement sector’s profitability is severely affected by financial costs. Falling interest rates help strengthen the bottom line for the manufacturers who can then focus on cost-cutting initiatives to have a competitive edge in the domestic and international markets. Capacity Utilization Historically, capacity utilization has been a long-standing issue of concern amongst suppliers. This is because excess capacity limits manufacturers’ ability to benefit from economies of scale the benefits of which cannot be transferred to the consumer. Consequently, suppliers become uncompetitive and consumers have to pay a high price for inefficient production. 11
    • FUTURE OUTLOOKIn the future therefore, it is expected that the cement industry will follow trends of economicgrowth within the country. This means that as GDP rises, the demand for cement will also rise.Additionally, the cement demand will grow in direct proportion to the developmentexpenditure allocation by the government of Pakistan. However, in order to be competitive thecement industry requires controlled or regulated costs for the factors of production as well aslower discount rates so as to reduce debt-equity ratios for the industry which have gone up toas much as 114%. Additionally, because of the oligopolistic structure of the market and cementmanufacturers past evidence of collusion, control measures need to be put in place to enableincreased competition which will not only bring further efficiencies in production but also seekto establish a relatively level playing field for smaller players.CONCLUSIONFrom the analysis conducted in this report, we can accept both hypotheses established earlierthat is:Hypotheses 1: The cement industry follows an oligopolistic market structure.This has been determined through the Herfindahl index and concentration ratios as well as thefrom the evidence of cartelization to regulate prices in the industry.Hypotheses 2: The cement industry will follow economic trends of the country.This hypotheses is accepted on the basis of evaluating GDP trends, expansion cyclescorresponding to cement demand. 12
    • APPENDIX 1 – HERFINDAHL INDEX CALCULATION HERFINDAHL INDEX Local market Mkt Mkt share Share^2 Export market share Share^2 1 Lucky Cement 17% 0.03 28% 0.08 2 Bestway Cement 13% 0.02 5.73% 0.00 3 DG Khan Cement 14% 0.02 16% 0.02 4 Maple Leaf Cement 10% 0.01 8% 0.01 5 Kohat Cement 5.23% 0.00 4.35% 0.00 6 Gharibwal Cement 3.20% 0.00 0.65% 0.00 7 Lafarge Cement 5.71% 0.00 6.13% 0.00 8 Pioneer Cement 5.00% 0.00 3.36% 0.00 9 Dewan Cement 5.18% 0.00 1.19% 0.0010 Attock Cement 6.49% 0.00 6.00% 0.0011 Flying Cement 0.42% 0.00 0.01% 0.0012 Fauji Cement 3.14% 0.00 5.11% 0.00 Mustehkam13 Cement 3.04% 0.00 3.60% 0.0014 Cherat Cement 2.67% 0.00 4.49% 0.0015 Fecto Cement 2.32% 0.00 3.17% 0.0016 Dandot Cement 0.80% 0.00 0.00% 0.0017 Al Abbas Cement 1.21% 0.00 2.76% 0.0018 Thatta Cement 1.30% 0.00 1.24% 0.00 HERFINDAHL 0.10 0.13 13
    • APPENDIX 2 – CONCENTRATION RATIOS CONCENTRATION RATIOS Local Dispatches Exports Total Market Share TOTAL 23.54 10.66 34.20 1 Lucky Cement 3.93 2.98 6.91 20% 2 Bestway Cement 3.10 0.61 3.71 11% 3 DG Khan Cement 3.38 1.68 5.05 15% 4 Maple Leaf Cement 2.38 0.90 3.28 10% 5 Kohat Cement 1.23 0.46 1.69 5% 6 Gharibwal Cement 0.75 0.07 0.82 2% 7 Lafarge Cement 1.34 0.65 2.00 6% 8 Pioneer Cement 1.18 0.36 1.53 4% 9 Dewan Cement 1.22 0.13 1.35 4% 10 Attock Cement 1.53 0.64 2.17 6% 11 Flying Cement 0.10 0.00 0.10 0% 12 Fauji Cement 0.74 0.55 1.28 4% 13 Mustehkam Cement 0.72 0.38 1.10 3% 14 Cherat Cement 0.63 0.48 1.11 3% 15 Fecto Cement 0.55 0.34 0.88 3% 16 Dandot Cement 0.19 0.00 0.19 1% 17 Al Abbas Cement 0.28 0.29 0.58 2% 18 Thatta Cement 0.31 0.13 0.44 1% 4- firm 0.54 0.58 0.55 8 firm 0.77 0.80 0.77REFERENCES 1. http://tribune.com.pk/story/267809/cement-prices-increased-to-rs400-per-bag/ 2. http://www.scribd.com/doc/26152245/Cement-Industry-Pakistan-a-Strategic-Analysis 3. Personal interview with Ayub Humayun Ansari, Senior Analyst, AKD Securities. 4. http://www.scribd.com/doc/965425/Cement-Industry-Pakistan 5. http://www.cement.com.pk/latest-developments/107-latest-news-test2.html 6. www.apcma.com 7. http://www.slideshare.net/msaadafridi/cement-industry-of-pakistan 14
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