Nigiraa vetiva research-cement-sector-study


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Nigiraa vetiva research-cement-sector-study

  1. 1. Nigerian Cement Sector Unbundling Potentials January 4, 2011In this report, we update our views on the Nigerian cement industry, Analystassessing the sector’s long term potentials from a global standpoint. On Tosin Oluwakiyesi t.oluwakiyesi@vetiva.coma company-specific level, we upgrade our rating on Nigeria’s biggestcement producer – Dangote Cement to “Accumulate” whilst downgradingour rating on Ashaka Cement to a “Reduce”. Market Cap: N2,060bn (US$13.7bn) Slight price cuts likely in the short term… In view of the recent % of NSE: 26.2% inventory build-up in the industry, we envisage some reduction in prices, albeit in the short term. In our view, cement producers, in a bid to clear out Forward 2011 P/E: 10.1x accumulated inventory, may further reduce prices directly or indirectly through bonuses and rebates. In contrast to our previous views, we are not likely to see EV/2011 EBITDA: 9.0x the anticipated boost in private sector lending till late Q2, hence strong demand 2011 Div Yield: 6.5% would only resume in the latter half of 2011 into 2012. Whilst sluggish demand persists in the short term, we believe maintaining lower prices at current or YTD perf: 38.81% higher capacity utilisation rates is a better option, compared to reducing Recommendations list capacity utilisation, in view of the huge operational gearing of the industry. Dangote Cement: ACCUMULATE …Notwithstanding, mid to long term fundamentals remain impressive: The need to meet Nigeria‟s huge infrastructural deficit cannot be Lafarge WAPCO: ACCUMULATE overemphasized. Despite its large population and rapidly growing urbanisation, Ashaka Cement: REDUCE Nigerias roads network significantly lags comparable African countries and emerging markets countries (30% paved, in comparison to North Africa average Cement Co. of North. Nig: UNDERWEIGHT of 68%, BRIC average of 64%). Housing deficit has been widely reported as 16 – 18 million units, with an estimated N60 trillion (more than twice Nigeria‟s GDP) needed to bridge the gap. It is evident therefore that the sector‟s long 52-week share price performance (rebased to Dec ‟09) term potential is unquestionable; nonetheless, we believe the potentials are 1.8 gradually unfolding. 1.6 Pivotal to SSA‟s infrastructural development: With the bigger global 1.4 players (Lafarge, Heidelberg, CEMEX) focusing on deleveraging, there would probably be little on-going investment in cement plant expansion in Africa. 1.2 Thus, given the inherent possibility of exports to other African countries in the 1 medium to long term, the Nigerian cement sector can potentially become a 0.8 dominant player within the continent. Furthermore, the planned expansion of 31-Aug 30-Apr 31-Oct 31-Dec 31-Dec 28-Feb 30-Jun Dangote Cement in southern, central and western Africa shows the important role Nigeria‟s cement sector is set to play in sub-Saharan African. ASI Building Materials Index Valuations: On a relative valuation basis, the cement producers are cheap; Source: NSE, Vetiva Research Nigerian cement producers are trading at a 2011 weighted P/E and EV/EBITDA of 10.1x and 9.0x relative to emerging market peer average of 14.2x and 8.9x Vetiva Capital Management Limited respectively. Our valuations for the cement producers are based on an 80/20 266B Kofo Abayomi Street Victoria Island, Lagos weights of Discounted Cashflow and EV/EBITDA valuation methodologies respectively. Thus, we upgrade our rating on Dangote Cement to an Tel: +234-1-46175213 “Accumulate” (11% upside to our fair value), maintain our “Accumulate” Fax: +234-1-4617524 Email: and “Underweight” rating on Lafarge WAPCO and CCNN respectively but downgrade our rating on AshakaCem to a „reduce‟ (11% downside to our fair value). Nigerian Cement Sector: Unbundling Potentials I January 2011 I
  2. 2. Nigeria I Building Materials I Equities Table of Contents Summary ................... 1 A global perspective .................... 3 Nigerian Cement Sector: The Value Proposition................... 4 Industry Outlook ................... 8 Industry Structure .................. 13 Demand Dynamics .................. 19 Changing Landscape of Supply ................... 21 Pricing dynamics ................... 23 Regulatory Perspective ..................... 26 Investment Summary .................... 28 Quoted Companies ................... 34  Dangote Cement Plc  Lafarge WAPCO Cement Plc  AshakaCem Plc  Cement Company of Northern Nigeria Plc Non-quoted Companies ................... 90 Disclosures ................... 91Nigerian Cement Sector: Unbundling Potentials I January 2011 I 1
  3. 3. Nigeria I Building Materials I EquitiesA global perspectiveTimes are changing for global cement producers as they struggle to grow earnings More global cement producers areunder a weight of debt and slowing demand in developed economies. The focus of shifting focus to deleveraging andglobal players on minimising costs and debt exposure, and slowing down on cost cuttingexpansion and investment may make them lose out on the growth prospectsexpected in frontier markets in sub-Saharan Africa. Among the global cementproducers, Lafarge is perhaps the only one well poised to benefit from theongoing and expected economic growth in Africa and the Middle-East, as theregion has the second highest contribution to its global revenue, unlike Holcimand Heiderberg which have very little presence in these regions. The five keyplayers dominating the global cement industry - Lafarge (France), Holcim(Switzerland), Heidelberg (Germany), CEMEX (Mexico) and Italcementi (Italy),account for c.20% (Industry HHI* is 6,685) of global cement sales in 2008,indicating the highly concentrated nature of the industry. Furthermore, the Apart from Lafarge, other globalmature state of most of the global players, has been compounded by the recent players are not likely to embark on any major expansion in Africadownturn in global economy, thus there is considerable pressure on the growthpotentials of the global players, especially in developed economies. Figure 1: Market Share (mill. tonnes of top five global cement producers) 2008 data 220 205 194 165 155 143 103 110 96 89 87 77 63 55 0 Lafarge Holcim Heidelberg Cemex Italcementi Cement Sales Capacity Source: CemNet In Western Europe, where the global players have a major market share, Decline in construction activities in construction activities have been on a decline since the onset of 2010. The Europe considerably affected the eurozone debt crisis further slowed down recovery as the affected earnings of the key global players governments embarked on fiscal cuts, thus reducing the spend on new infrastructural and non-residential public projects which should have stimulated construction activity. Regional split of sales for the producers (as at half year 2010) shows declining sales in Europe, with slight pick-ups in North- America, Asia and Africa. * HHI means Herfindahl HirschMan Index, calculated as the sum of the squared market share of industry players. It‟s a measure of industry concentration.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 2
  4. 4. Nigeria I Building Materials I Equities Figure 2: Regional Split of Sales (based on interim quarterly results) of the top three global cement producers Lafarge Africa/ Africa/ Middle Holcim Middle Heidelberg East: East: Africa/ 5.3% 1% Middle Asia East: Pacific:2 Europe: Europe: 27% 1% 36.0% 29.40% Europe: 37% Asia Pacific: Latin 37.40% America Asia North : 13% Pacific:1 Latin America North 5% North America : America America : 12.50% : 28% Latin 15.40% :17% America : 5% Sources: Company‟s websites, Vetiva Research While we still see some potential in less developed eastern european countries, we believe the expected slow-down in growth in more developed western europe would cause an overall strain on earnings growth from the european Global cement producers with market. Apart from Lafarge, who virtually had presence in almost all the significant presence in Africa are better poised to grow earnings in African sub-regions – North Africa (Lafarge Ciments – Morocco, Orascom - the long term Egypt), East Africa (Bamburi Cement – Kenya), West Africa (Lafarge WAPCO and Ashaka Cement - Nigeria) and Lafarge S.A (South Africa), the other global players at best only operate in one or two sub-regions. Therefore, based on the current low level of social and physical infrastructure penetration in Africa, and the boom expected from increasing discovery of mineral resources and commodities, we make a case for Africa as the next frontier of global economic growth, with Nigeria‟s cement sector strategically positioned to drive the expected growth in physical infrastructure. The African story: the next frontier of growth With the growth in the developed economies expected to slow-down Though the African continent still lags significantly in infrastructure, we believe over the next decade, whilst SSA‟s the next pioneer of global economic growth would be Africa. Asia, aided by the growth trends up, Africa can be the very rapid growth of China, India, Singapore, Malaysia, Indonesia, Thailand, next pioneer of global growth which are classified by the International Monetary Fund (IMF) as Newly Industrialised Asian Economies (NIAE) over the last two decades, has been the propelling force of global economic growth.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 3
  5. 5. Nigeria I Building Materials I EquitiesHowever, economic growth in Asia would gradually slow down over the nextdecade; thus we expect growth in Africa, especially SSA (excluding south Africa)to gradually trend up on the back of increasing discovery of mineral resources,strong commodity prices and improving political landscape. Figure 3: Economic growth of some regions1 of the world (2000-2015E) 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 2010E 2011E 2012E 2013E 2014E 2015E 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 -2.00% -4.00% Advanced Economies NIAE MENA SSA Sources: IMF, Vetiva Research 1 MENA: Middle East and North Africa, NIAE: Newly Industrialised Asian Economies, SSA: Subsaharan Africa In our view, there‟s an increasingly lesser potential for infrastructural Africa‟s infrastructure deficit development in advanced and fast growing Asian economies. Thus, Africa has portends significant growth the highest untapped potential for economic growth and infrastructural opportunities in the longer term development. According to a recent World Bank report – Africa Infrastructure: Time for Transformation, Africa is estimated to have an infrastructural deficit of $93 billion out of which we estimate that about a third, c.$31 billion would be used for electric power and about $25 billion for the construction of physical infrastructure (roads, bridges, ports and rails). Based on the same report, most African cities face the challenge of acute housing shortage. In most African countries, real estate and government agencies are only able to meet at most one quarter of housing demand, leaving three-quarter to the informal market. Based on UN Habitat estimates, as much as 70 percent of Africa‟s urban population reside in slums. However, the infrastructure deficit is not evenly spaced across the African sub-regions. For instance, countries in the Northern Africa region particularly Egypt, despite its inherent minor challenges, is way ahead of others in cement consumption, housing delivery and other physical infrastructure.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 4
  6. 6. Nigeria I Building Materials I Equities The major deficits in housing and other phyiscal infrastructure in Africa is more concentrated in West, Central and East African sub regions. In view of Nigeria‟s enormous population (a sixth of Africa‟s population), we see the highest prospects for infrastructural development in Nigeria. Hence, we believe the Nigerian cement sector offers a very robust growth potential. Nigeria‟s cement sector: The value proposition Among the top five major markets in Africa (South Africa, Egypt, Algeria, Given Nigeria‟s massive Morocco and Nigeria), Nigeria offers the highest growth opportunity in the population and fast-paced cement sector. Using cement consumption patterns, Nigeria‟s cement urbanisation, Nigeria offers the highest growth in the cement consumption per capita significantly lags that of the remaining top four sector among the top markets in markets. Egypt has the highest cement production capacity on the continent Africa (as at 2008). Owing to the impact of the rapid development of the Middle East region on North Africa, the sub-region generally leads in cement consumption pattern on the continent. Average cement consumption per capita for North Africa is slightly above 300 kg, the highest on the continent. Given Nigeria‟s heavy cement supply deficit and historically low local production capacity, Nigeria‟s cement consumption level is significantly lower at about 105 kg per capita. The dynamics of Nigerian cement production is however changing tremendously since the entrant of key players like Dangote Cement. We present the following as the Investment thesis for Nigeria‟s cement sector. Based on our estimates, c.112m Robust Housing Deficit: According to estimates from industry experts, tonnes of cement would be Nigeria has an estimated deficit of 16 million to 18 million housing units. In required to meet just half of 2009, the Presidential Committee on Implementation of Affordable Housing Nigeria‟s estimated housing has estimated that about N60 trillion would be needed to bridge the deficit. deficit Assuming that federal, state governments, and private sector makes very Africa significant efforts, within the next 10 years to provide cheap and affordable ideal housing stock (at least a 2- bedroom apartment) to meet half of the estimated deficit (c.9million housing stock), cement consumption based on this premise would be c.112 million tonnes. With expected rise in local manufacturing capacity to c.28 million tonnes by 2012, it would take 5 to 6 years to provide half of the estimated housing deficit. On a more realistic stance, we believe it would take longer than 6 years to at least provide half of the estimated housing deficit. However, with the Federal Housing Authority‟s 2009 – 2013 action plans to provide 100,000 units of houses annually, the increasing mass of private real estate developers and state governments‟ participation in housing delivery; we expect Nigeria‟s housing deficit to shrink considerably over the next 10 years.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 5
  7. 7. Nigeria I Building Materials I Equities Figure 4: Comparison of Nigeria‟s housing deficit 120 90 60 30 0 South Africa Nigeria Egypt India Brazil China Housing Deficits(Mill units) Housing deficit per capita(1/1000 units) Sources: Nationsencyclopedia, National housing ministries websites, Vetiva Research estimates Roads: Another major case for the strong potential of Nigeria‟s cement sector is the current insufficient and inadequate road transportation network. With the shift of the global construction industry to concrete and steel (from the more primitive stone and mortar) in construction activities, cement demand Nigeria‟s total road network is only 30% paved compared to has occupied a pivotal position in the construction industry. According to the North Africa average of 69% and Federal Ministry of Transport, Nigeria has a road network of c.195,000 km “N-11” average of 63% with only 30% paved in comparison to 63% average for emerging N-11 countries and 69.7% average for Egypt, Algeria, Morocco and Tunisia, based on data from World Bank and International Road Federation (IRF), see figure 5 below. Based on IRF definition, paved roads refer to length of roads that are surfaced with crushed stone (macadam) and hydrocarbon binder or bituminized agents, with concrete or with cobblestones. Therefore, the use of concrete in road construction implies a concurrent use of cement.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 6
  8. 8. Nigeria I Building Materials I Equities Figure 5: Comparison of Nigeria‟s paved road network 100% 80% 60% 40% 20% 0% Egypt China Germany UAE South Korea Libya Italy Morocco France Japan Nigeria N/Africa Average Algeria Tunisia India Malaysia N-11 average Russia Czech Republic Sources: World Bank database, World Road Federation, Vetiva Research  Rail and ports construction: The increasing use of concrete ties in railroad construction (rather than wood), has meant a significant surge in cement Nigeria‟s 3,505 km rail network ranks lowest amongst highly demand globally. Thus, in Nigeria, the current abysmal state of railroad populated countries network portends a major opportunity for continuing growth in the cement sector. With a total rail network of 3,505 km (from Federal Ministry of Transport), Nigeria‟s rail network ranks among the lowest for highly populated countries. In line with the Federal Ministry of Transport‟s 25 year National Ports Master Plan, several port development projects including sea- ports expansion, rehabilitation of facilities and channel towage development have been embarked upon. If the master-plan would be diligently followed, more investments in ports development and maintenance are underway, even into the longer term.  Vast raw material deposit: Apart from the expected boom in physical infrastructure, which would be the key propeller of growth in the cement sector, the presence of limestone and other additives used in the production Infrastructural boom and of cement in vast quantities, is an additional plus for Nigeria‟s cement sector. abundance of raw materials would also encourage cement Nigeria has an estimated 837 million tonnes of limestone deposits in 22 out production of 36 states, but currently has cement plants in only 6 states. Gypsum, the major binding substance used in the final stage of cement production is also present in commercial quantities in some Nigerian states, even though it is not being mined or produced in commercial quantities; leaving producers to import the substance. According to China‟s leading cement equipment supplier – Jiangsu Pengfei Group Co. Ltd, the high purity level and shadow- buried depth of Nigeria‟s limestone deposits are characteristics which make it easily exploitable and desirable. Limestone is mined in just about half of West African countries, but then not as major economic activities.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 7
  9. 9. Nigeria I Building Materials I Equities Hence, cement production is significantly low in West Africa and the region‟s countries rank among those with lowest cement consumption per capita on the continent. Nigeria‟s vast limestone deposits therefore potentially place the country at an advantage in the sub-region if it can harness the opportunities.  Potential FX earner: Nigeria depends almost entirely on crude oil as the main government revenue and foreign exchange earner. Like the developed Asian countries – China, Japan and Thailand which are top exporters of Cement deficits in African cement globally, Nigeria can also become a net-exporter of cement through countries drive potential for continuous investment in local production. The cement deficits across West export, as local production is expected to exceed demand in and Central African countries present Nigeria with immense opportunity for the longer term export when local production exceeds demand. We predict that this would likely occur by 2013 at which point local production, estimated at 28 million, would slightly surpass demand (estimated at 27.5 million tonnes). In our view, more investments in local manufacturing would be needed beyond this point for the sector to contribute meaningfully to the country‟s exports.  Government‟s Medium term Fiscal Commitment: We view government‟s recent medium-term budgetary frame-work (based on National Improved efficiency of Implementation Plan for NV2020) as a catalyst for sustained spending on Government‟s short-term plan for capital projects. Whilst noting that NV2020 has been flawed with criticism in projects is expected to boost view of Nigeria‟s poor history of implementation of national goals, the physical infrastructural projects, medium term frame-work offers a more realistic expectation in government‟s hence demand for cement commitment to achieve the goal, and also presents a shorter-term frame work to examine and monitor performance and progression. Therefore, with government being the biggest spender on physical infrastructure and perhaps the largest consumer of building materials, one can readily project cement demand, at least in the short to medium term. More important in the recently launched medium term National Implementation Plan (NIP) is the fact that emphasis is placed on capital expenditure (CAPEX) in the development of critical infrastructure. Industry Outlook Cement consumption hinged on government‟s revenue We restate that Nigeria‟s investment case for the cement sector and the broader building materials industry is quite attractive, thus we reaffirm our long term optimistic outlook for the industry. Our outlook on cement demand is hinged on expected government revenue from crude oil (since crude oil constitutes c.90% of government‟s revenue), the proportionate spending of the revenue on physical infrastructure while drawing historical correlation between federal government‟s physical infrastructural spending and cement consumption.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 8
  10. 10. Nigeria I Building Materials I EquitiesFigure 6: Federal Government Revenue assumptions 2010 2011 2012 2013 Crude Oil Production (mbpd) 2.4 2.5 2.5 2.5 Crude Oil Price (US$) 60 60 60 60 Real GDP Growth rate (%) 8.2 10.9 11.8 13.1 Population Growth rate (%) 2.8 2.8 2.8 2.8 Source: NIP implementation plan In our view, projecting cement consumption this way presents a fundamental Poor economic conditions argue basis for the expected boom, especially because with the vast majority of against domestic demand by the Nigeria‟s population living below the poverty line, it is difficult to justify that masses, putting the spotlight on the expected rise in cement production can be absorbed by the rather weak the government purchasing power of the of the citizenry. Thus, a base case assumption for cement consumption that is directly linked to government‟s expected revenue, in our view, provides a more fundamental backing for our outlook on cement demand. We note however, the increasing involvement of the private sector through Public Private Partnerships and the rising spate of debt issuance by governments (both state and federal) to fund major capital projects. Thus, we reiterate that our outlook represents a base case on which higher expectations can be built, in view of other possible sources of funding for physical infrastructure. Medium term outlook on cement consumption Following from our overall expectation of government revenue being the key However, fundamentals still point driver of cement consumption, we expect, based on the analysis of a little in the direction of the governments‟ (both states and federal) medium term CAPEX on housing and Private sector contribution road construction, that cement consumption will increase at 4-year CAGR of through Public-Private projects 16.7% to 27.54 million tonnes by 2013. Over the four year period, 2010 – . 2013, we expect cement consumption to sum up to c.70 million tonnes. Figure 7: Estimated CAPEX on housing and transportation infrastructure (2011 – 2013) State Government (N‟Trn) 3.55 Federal Government (N‟Trn) 1.68 Total (N‟Trn) 5.23 Cement Consumption (000 tonnes) 69,088 Sources: National Planning Commission, Vetiva ResearchNigerian Cement Sector: Unbundling Potentials I January 2011 I 9
  11. 11. Nigeria I Building Materials I Equities Figure 8: Federal and State government CAPEX on housing, roads, rail and ports (N‟bn) and cement consumption construction (million tonnes) 2006 – 2013E 30000 2000 24000 1500 18000 1000 12000 500 6000 0 0 2006 2007 2008 2009 2010E 2011E 2012E 2013E Cement Consumption Government CAPEX Sources: CBN, Ministry of National Planning Vetiva Research estimates As seen in the table above, we arrive at an estimated sum of N5.2 trillion (c.US$35 billion) for housing, road, ports and rail transportation CAPEX Estimates show N5.23 trillion in (including only projects which based on our view are directly correlated to government spending on cement consumption while adjusting for outliers). Following from minister of Infrastructure with 50% implementation and a potential to finance recent affirmation of about 50% budgetary implementation for 2010, ramp up in subsequent years we assume about 60% execution of physical infrastructure projects (relating to housing and transportation only) for 2010 and while gradually scale percentage . execution upwards to 75% by 2011, 85% by 2012 and 95% by 2013. We also assume that unspent allocations on these projects would be automatically rolled over to the following year. Potential for export in the medium term? Based on the medium term outlook presented for cement consumption above, Actualizing the export potential the potential for export in the sector may not be realized prior to or by 2013. might take more than 2 years Exports of about 4 million tonnes of cement would only be feasible by 2012 if due to the ramping up associated we make an aggressive assumption that all existing and new cement plants with cement plant expansion would operate at full capacity by 2012. While this might be possible, we consider it very unlikely in view of the usual ramping up phase for most . cement plants. Historically, based on Dangote Cement‟s Gboko Plant expansion (former Benue Cement Company) in 2008 and Obajana Cement Plant built in 2007, we believe that it will take a minimum of 2 to 2.5 years before a new cement plant or line can reach full capacity utilisation.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 10
  12. 12. Nigeria I Building Materials I Equities Figure 9: Aggressive case: Cement production vs Figure 10: Normal case: Cement production vs consumption (million tonnes) consumption (million tonnes) 30000 30000 22500 22500 15000 15000 7500 Production outstrips 7500 Production lags consumption; exports likely consumption; exports unlikely 0 0 2009 2010E 2011E 2012E 2013E 2009 2010E 2011E 2012E 2013E Consumption Production Consumption Production Sources: Industry, Vetiva Research estimatesLonger term outlook – Where will it swing?The outlook for the cement industry in the longer term is strongly correlated to In the long run, economiceconomic and population growth. From the development pattern of most prosperity and population growthdeveloped economies and emerging markets, the link between GDP growth and would be the major drivers of thecement consumption is well established. (Figure 11 below shows the correlation of demand for cementthe two) . Figure 11: G-20 countries: Cement Consumption Vs GDP per consumption 1400 S/Arabia 1200 China S/Korea 1000 800 Italy Turkey 600 Japan Mexico Germany 400 Russia Canada Australia Brazil S/Africa Argentina France USA 200 Indonesia United Kingdom India 0 Nigeria 0 10000 20000 30000 40000 50000 60000 Cement Production Per Capita Sources: Industry, Vetiva Research estimatesNigerian Cement Sector: Unbundling Potentials I January 2011 I 11
  13. 13. Nigeria I Building Materials I Equities In our view, the potential for strong economic growth in Nigeria is Nigeria‟s economic growth is largely dependent on government‟s ability to intensely increase its strongly linked to increased revenue and the success of its medium term (2010 – 2013) power funding and the success of the sector reform. We highlight the following as the reasons undergirding this power sector reforms view. . Government‟s oil revenue is not sufficient to cater for all its long term investments; hence the private sector is pivotal to the achievement of these goals. However, the power sector reform must be successfully implemented to Diversification of sources and encourage sustainable private sector investment. Notwithstanding, we believe private sector participation are government can achieve more if its revenue base becomes substantially expected to back up Crude oil proceeds in boosting revenue diversified to reduce the heavy dependence on crude oil revenue. Agriculture and Manufacturing are two key sectors that can help Nigeria achieve the . desired diversification. The growth prospects in the Agriculture and Manufacturing sectors are almost entirely dependent on the success of the power and banking sector reforms. Stable power supply would significantly minimize overheads and encourage large scale private sector involvement in these sectors. Furthermore, re- structuring of the banking sector to enable Small and Medium Scale Enterprises (SMEs) access credit facilities is imperative. If these are achieved, the effect on the broader economy would be higher revenue to government, lower unemployment and a significant improvement in the purchasing power of the citizenry. Government spending has historically been the major driver of cement A slight shift off the Government consumption in Nigeria. While we believe government‟s expenditure would still in cement consumption may help close the cement deficit faster as account for a sizeable portion of cement consumption in the medium to longer effective demand grows term, a more rapid growth could be achieved in the longer term if purchasing power becomes less concentrated in government‟s hands. Currently, there‟s . still a huge deficit in Nigeria‟s cement consumption despite the inventory build-up which had plagued the industry in the last few months as a result of lower effective demand (demand backed by purchasing power). Barring failures in Government‟s Assuming a successful implementation of government‟s medium term plan on infrastructural programs and local critical infrastructure and steady strengthening of commodity prices, demand boom, cement particularly crude oil, cement consumption would continue to rise beyond consumption would soon outpace 2013 and would soon out-pace local capacity except new capacities are local production capacities added. . In line with this, we assume a base case outlook of cement consumption continuing to rise at a constant CAGR of 13.5% beyond 2013. However, cement consumption may grow at a much quicker pace if there is massive influx of the private sector in real estate development, higher purchasing power and stronger government revenue base.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 12
  14. 14. Nigeria I Building Materials I EquitiesHomogeneous product - prospects for integration?Competition gradually rising...In our view, the Nigerian cement sector isbecoming increasingly competitive. Industry players have attributed the slower While manufacturers blame waning sales on odd rains andsales that characterised the industry for most part of this year to heavier-than- lack of funding, facts point tousual rainfalls and strained credit flow. While this is partly valid, we believe increased competition especiallycompetitive pressures are gradually increasing in view of rising surplus. Recently, in the citiesLafarge WAPCO launched a new brand of its cement - “Elephant Supaset”- whichportrays, as explained by the company, that the brand would harden or set faster .under water compared to the usual Portland cement. As we have alwaysmaintained, this buttresses our view that Lafarge WAPCO would be facing intensecompetition from Dangote Cement and would gradually incur higher marketingexpenses to defend its market share. We expect the competition to heighten,especially in the Lagos and Abuja regions when the on-going expansion projectsfrom Dangote Cement and Lafarge WAPCO are completed next year....Vertical integration possible in the longer term: We believe the Nigeriancement industry would move towards vertical integration in the longer term, as Product homogeneity and marketobtainable in developed countries and emerging economies. Cement is relatively structure are bound to encouragehomogenous in physical attributes and little brand differentiation can be achieved, vertical integration in the longtherefore, as it has historically being in Nigeria, competitive effects relating to term as profit margins eventuallypricing arise more from market structure rather than product alterations. For softensinstance cement is usually cheaper in areas closer to plant or depot locations. .Eventually, in the longer term, profit margins would either start reducing orremain constant, if prices decline or at best remain constant. We believe playerswho generate huge volumes would have the upper-hand, until a saturation pointwhen volume increases might create a glut, and vertical integration wouldbecome imperative to achieve some cushioning in revenue base.Dynamics of vertical integration in the cement industry: The most commonform of vertical integration in the cement industry involves the acquisition or Common integration involvessetting-up of ready-mix concrete, aggregate businesses and production of obtaining ready-mix andgypsum. Construction activities in most developed countries have been quite aggregate business units; thesesimplified with the use of ready-mix concrete and aggregates. Ready-mix would help simplify constructionconcretes (also referred to as customised concrete), which have significant and accelerate permeation ofadvantages over site-mix concrete in terms of labour costs and wastage, would be low-cost housingneeded to achieve faster and cheaper housing delivery in Nigeria. .Industry StructureHigh concentration: The Nigerian cement industry (importation and localproduction) is highly concentrated. Based on available data for 2009 cementconsumption from industry sources, the cement industry had a HHI of about2,840 which based on global standards on anti-thrust policies implies a highly With a HHI of 2,840, the Nigerianconcentrated and less competitive industry. According to US anti-thrust policy an Cement Industry is quiteindustry with a HHI of less than 1000 is considered a competitive market; HH1 of concentrated1000 – 1800 is considered moderately competitive, while HHI greater than 1800implies a highly concentrated and less competitive industry. The higher the HHI,the closer the industry is to being a monopoly. Using FY‟09 data from industrysources, Dangote Cement controls c.50% of the Nigerian cement industry (bothlocal production and importation).Nigerian Cement Sector: Unbundling Potentials I January 2011 I 13
  15. 15. Nigeria I Building Materials I EquitiesThough 2010 cement consumption data are unavailable, we guesstimate from theinterim earnings announcement of publicly listed cement producers that industryconcentration has increased with Dangote gaining market share, as most otherproducers recorded YoY decline in sales. In view of the much anticipatedcompletion of Dangote Cement and Lafarge WAPCO‟s expansion next year, theconcentration level of the industry would rise further as we expect DangoteCement‟s market share to rise to c.70% by end of 2011. Figure 12: Current market share of Nigerian Figure 13: Expected market share at the cement producers completion of on-going expansion 4.4% 6.2% 8.8% 18.3% Ashaka Ashaka 14.8% Dangote Dangote 1.8% CCNN CCNN 14.7% Lafarge WAPCO Lafarge WAPCO Unicem 57.1% Unicem 70.3% 3.7% Sources: Industry, Vetiva Research EstimatesWide variations in operating efficiency: The different fuel types and energy/cost dynamics of Nigerian cement producers have translated into variedprofitability margins in the industry, with big producers like Dangote Cementhaving PBT margins slightly in excess of 50% (based interim Q3‟10 earnings),whilst that of small-scale producers like Cement Company of Nigeria andAshakaCem Plc are as low as 11% and 20% respectively. Figure 14: Industry Average PBT/tonne (N) and Figure 15: Industry Average PBT/tonne (N) and PBT margin (%) with Dangote Cement PBT margin (%) without Dangote Cement 10000 40% 8695 10000 40% 8304 34% 7286 32% 7500 30% 7500 30% 26% 6284 6357 5537 5544 24% 23% 5000 20% 20% 5000 4447 20% 18% 16% 2500 10% 2500 10% 0 0% 0 0% 2009 2010E 2011E 2012E 2009 2010E 2011E 2012E PBT/Tonne PBT Margin PBT/Tonne PBT Margin Sources: Annual, Vetiva Research EstimatesNigerian Cement Sector: Unbundling Potentials I January 2011 I 14
  16. 16. Nigeria I Building Materials I EquitiesEven with the least profitable producer having a PBT margin in the low double- Though technology sets Nigeriandigits, the cement industry, having an average PBT margin (based on latest cement players apart, the sectorinterim results) of 28%, is still more attractive than the food/beverage, is profitable on the overall,conglomerates and breweries sectors of the Nigerian Stock Exchange, which has outclassing the local FMCG‟s andaverage PBT margins of 12.4%, 11.6% and 21.0% respectively. matching continental counterparts. Figure 16: Average Pre-tax profit margins of key sectors on the Nigerian Stock Exchange (based on latest interim earnings) . 30% 28% 21% 23% 19% 15% 12% 12% 8% 5.4% 0% Petroleum Banking Breweries Conglomerates Food/Beverage Building Materials Marketing (Cement) Sources: Company Filings, Vetiva ResearchOperational gearing: Given the huge fixed asset base of the industry, Manufacturers would aim tooperational gearing is high and producers can only reduce its impact through soften gearing effects by uppinghigher sales. Overall, the bigger players have the best opportunity to minimise sales, tipping the scales the wayoperational leverage at higher volumes. of the big players.Domination by local players: In comparison to bigger cement markets in Africawhich are still dominated by global players, the Nigerian cement industry haswitnessed a radical shift with the entry of the Dangote Group into cementproduction. Suez group, the biggest cement producer in Egypt is owned by the Dominated by Dangote Cement,Italcementi group – the fifth largest cement producer globally. Other global local influence is strong in theplayers like Lafarge, Holcim, and Cemex also have major presence in other North Nigerian cement market, asAfrican countries. In a similar vein, the Lafarge Group has a significant presence against trends in other Africanin South Africa. Although, the Lafarge Group (through its subsidiaries – Lafarge countries.WAPCO and Ashaka Cement) is the second largest producer in Nigeria, its marketshare of c.13% significantly lags behind Dangote Cement‟s 50%.Prior to 2007, Lafarge WAPCO dominated cement production in Nigeria with amarket share of c.60%. Whilst the Dangote Group has always had a significanthold on cement importation, its backward integration which culminated in thecommissioning of the Obajana plant in 2007, pushed its dominance to localproduction, hence displacing Lafarge WAPCO. Germany‟s top cement producer -the Heidelberg group, until 2009, had a minute exposure to Nigerian Cementindustry through the Cement Company of Northern Nigeria (CCNN).Nigerian Cement Sector: Unbundling Potentials I January 2011 I 15
  17. 17. Nigeria I Building Materials I EquitiesPerhaps due to inability to compete adequately as a result of the small productionscale of CCNN (0.5 million tonnes annual capacity) and its obsolete state, theHeidelberg group pulled out of the Nigerian cement industry, selling its stake inCCNN to a local conglomerate – the BUA group, in 2009. The Holcim group, whichentered the Nigerian cement industry in 2005, operates through the Unicem plantin Calabar (South-South Nigeria). The company is a Joint Venture with Flour Mill,and Lafarge. Figure 17: Dominant Cement Producers in some African Countries (put companybefore parent) Production1 Country Company Parent Capacity Egypt Suez Italcementi 12.0 Morocco Lafarge Ciment Lafarge 7.0 ** South-Africa PPC Barloworld 8.0 Kenya Bamburi Lafarge 2.5 Ghana Ghana Cement Heidelberg 2.4 Nigeria Dangote Cement Dangote 8.0 Source: Vetiva Research** PPC - Pretoria Portland Cement, 1Current Production Capacity onlyNigerian Cement Sector: Unbundling Potentials I January 2011 I 16
  18. 18. Nigeria I Building Materials I EquitiesFigure 18: Emerging market cement producers‟ comparable metrics EBITDA (Mkt Mn EBIT Margin ROE (%) EV/EBITDA P/E (x) Dividend yield Company Margin USD) Country 2010E 2011E 2010E 2011E 2010E 2011E 2010E 2011E 2010E 2011E 2010E 2011E Pret. Portland S/Africa 2,715.5 38% 38% 33% 34% 112.9 99.3 8.7 7.8 13.1 11.5 5.9 6.7 Cement Anhui Hong Kong 13,400.2 26% 26% 20% 20% 15.4 16.5 12.1 9.9 21.5 17.8 0.9 1.1 Ambuja India 4,771.3 28% 26% 21% 21% 19.6 18.0 9.4 9.1 15.9 15.1 1.8 1.9 Bamburi Kenya 885.5 30% 33% 32% 32% 26.6 29.0 7.1 5.5 12.9 9.9 4.7 6.3 Cement ACC Limited India 4,191.8 25% 24% 22% 19% 20.4 17.9 8.4 8.0 14.1 13.7 2.2 2.3 Gulf Cement UAE 359.8 18% 26% n/a n/a 5.3 12.0 8.5 5.5 24.8 11.5 n/a n/a Sib Cement Russia 714.0 30% 33% 22% 22% n/a n/a 7.5 5.1 15.0 7.0 n/a n/a Huaxin China 1,098.9 17% 19% 8% 9% 6.8 9.5 10.7 7.8 23.6 14.9 0.7 1.0 Cement Siam Cement Thailand 12,842.1 17% 17% 11% 12% 22.9 23.9 10.9 9.2 14.7 12.2 3.1 4.0 Holcim Phillipines 1,561.7 33% 33% 27% 27% 23.9 24.9 7.9 7.1 15.0 13.1 3.8 5.5 Phillipines MISR Cement Egypt n/a 52% 50% 46% 44% 45.2 41.7 n/a n/a 7.3 7.6 11.7 11.0 Sinai Cement Egypt 588.9 51% 49% 45% 47% 36.6 32.4 3.7 3.9 5.0 5.1 12.1 13.1 Tai Shan China 4,182.1 20% 26% 20% 21% 18.0 20.0 12.8 9.9 18.3 13.9 0.7 1.0 Jidong Ashaka Nigeria 358.5 25% 34% 23% 32% 20% 25% 10.8 7.4 15.8 11.5 2.3 3.2 Lafarge Nigeria 860.2 35% 29% 26% 22% 14% 18% 9.9 7.8 18.2 12.9 0.6 1.2 WAPCO Dangote Nigeria 13,553.40 58% 61% 51% 56% 59% 83% 18.3 11.1 20.9 12.7 3.7 5.9 CementNigerian Cement Sector: Unbundling Potentials I December 2010 I
  19. 19. Nigeria I Building Materials I EquitiesDemand Dynamics – What drives consumption?Government‟s expected spend on the built environment- Government, As capital expenditure grows,both at state and federal levels, would still be the major driver of cement government spending ondemand in the medium term, as it has been historically. The expected CAPEX on Infrastructure follows suit, eveninfrastructural development as detailed in the medium term National Plan would as new road constructionbe the boost for demand in the next three years, if adequately implemented. techniques use to cementCement constitutes about 7% to 15% of concrete-(a mixture of cement and .other aggregates), a key material in construction; thus an increase inconstruction activities naturally means a rise in demand for cement as well. As apointer to the fact that increasing government spending on housing and roadconstruction has been a key driver of the upswing seen in demand for cement inNigeria, the federal government‟s capital spending rose by c.212% between2004 and 2008. In the same vein, state governments (Federal Capital Territoryinclusive) CAPEX on housing and transportation infrastructures have also peakedsignificantly over the last five years. According to figures from CBN‟s 2008annual reports, state governments and FCT capital spending on housing and roadconstruction rose to N388.3 billion in 2008, from N50.2 billion in 2004. Weexpect an additional 144% rise in federal and state governments CAPEX onhousing and transportation (road, rail and port construction) between 2009 and2013 (See figure 19 below). Figure 19:Actual and forecast Government (state and federal) CAPEX (N‟Bn) and yearly growth (%) on housing and physical infrastructure in transportation 2000 104% 100% 1500 76% 78% 60% 1000 23% 21% 500 17% 17% 20% -8% 0 -20% 2006 2007 2008 2009 2010E 2011E 2012E 2013E Government CAPEX Y-o-Y growth Sources: CBN, Vetiva Research EstimatesApart from government‟s CAPEX, recurrent expenditure on road maintenanceand housing are key contributors to the increase seen in the demand for cementover the years. Recently, the chairman of Dangote Group, Alhaji Aliko Dangoteproposed the use of concrete, rather than bitumen, in road maintenance. Whilstsome local government roads in major cities like Lagos are already being re-constructed using pre-cast concrete, the suggestion may cause stakeholders tointroduce more of concrete in road maintenance, as it is the case in South Africa. Nigerian Cement Sector: Unbundling Potentials I December 2010 I 18
  20. 20. Nigeria I Building Materials I EquitiesIf the use of concrete in road maintenance receives increased acceptance,cement consumption would considerably rise faster than our forecasts, whichhave been solely based on expenditures on capital projects.Public-Private Partnerships (PPPs) in real estate development: Thegrowing involvement of public-private partnerships in real estate development With about 600,000housing unitsacross the country would also continue to contribute substantially to cement expected from PPPs, close todemand. In 2009, the federal government signed partnership agreements with N105 billion would be spent onten private sector real estate developers and investors, to increase national housing provision in the next 3housing stock by 1,694 units in Osun, Adamawa, Ondo and Niger states, and the yearsFederal Capital Territory. According to the erstwhile minister of works, housingand urban development - Dr Muhammed Lawal, the federal government hadsigned 80 partnership and Development Lease Agreement to spur developmentof affordable housing in Nigeria. Also in the government‟s national developmentplan on housing, increased emphasis is placed on forming more PPPs to helpdrive the national plan on housing delivery. Thus, the federal government plansto deliver 600,000 housing units under Public Private Partnerships (PPPs)arrangement, estimated at cost of c.N105 billion over a three year period from2011 to 2013.Growth in private sector real estate development: Whilst admittinggovernments‟ (at State and Federal levels) efforts on housing delivery to its While the Private sector plays acitizenry, one should note that the complexities surrounding the effectiveness of growing role in housing provisionthe land use regulations in Nigeria, and the fast rate of urban migration in for Nigerians, funding challengesNigeria have continued to promote the growth of private sector in housing have limited delivery in 2010delivery. We conclude therefore, that the private sector (either at organized levelas real estate development companies, or through individuals) is increasinglybecoming the major provider of housing to Nigerians. This year however, theslow-down in credit to the private sector has adversely affected overall cementconsumption. Figure 20: Credit to Government vs Credit to Private Sector (% growth over 2009 levels) 70 Credit to Government 60 Credit to Private Sector 50 40 30 20 10 0 -10 Jan Feb Mar Apr May Jun Jul Aug Sept Oct Source: Central Bank of Nigeria, Vetiva ResearchNigerian Cement Sector: Unbundling Potentials I January 2011 I 19
  21. 21. Nigeria I Building Materials I EquitiesPrivate real estate developers became quite pivotal in housing delivery in thecountry after federal government‟s housing reforms of 2003/2004. We note also Private real estate developerssome key features of the reform which catalysed the rapid growth seen in the benefitted from the 2004 housingnumber of private estate developers between 2004 and 2008. Some of these reforms, riding on the 2008features include; assignment to government of primary infrastructure for new economic boom to boost demandestate development, an amendment of the Land Use Act, development of a for housing ergo cementsecondary mortgage market and a five-year tax holiday for developers. In linewith the general economic boom of the 2007/2008 era, real estate developmentalso witnessed a significant boom during this period, translating therefore intohuge demand for cement and other building materials.Changing landscape of supplyCement glut…possible? The dynamics of cement supply in Nigeria is graduallychanging from being predominantly dominated by imports to local production. In Local manufacturing is growingline with the additional supply expected to come from new capacities by 2012, fast, significantly cutting importswe believe imports would gradually shrink within the next 2 to 3 years. Whilst wedo not expect the slow-down in cement demand this year to persist, we are notoverly bullish on cement demand rising significantly next year for politicalreasons, as development projects typically slow-down during election years inmost African countries. Furthermore, credit to the private sector is not yet at thedesirable level after last year‟s shake-up of the banking sector.Further compounded by the Central Bank‟s rising concern on inflationarypressures and its somewhat weariness to continue to stimulate banks to lend tothe real economy as indicated by recent rate hikes, credit extension to the We expect minimal improvementsprivate sector is not likely to witness any significant improvement in the short over this year‟s consumptionterm, at least until after the April 2011 polls. This implies that the slow-down seem likely, in view of the slow-seen in demand this year may only improve slightly in 2011, if weather down in new infrastructure spendconditions (heavy rainfalls) are not as adverse as they were in 2010. In our view expected pre-electionstherefore, supply would likely still outstrip effective demand next year and bigproducers like Dangote Cement and Lafarge WAPCO, which expect additionalcapacities next year, must begin to seek creative means to sell their product.Dangote Cement which is currently planning to commence exports, would likelysee its revenue cushioned by exports to other West African countries. Thealternative for Lafarge WAPCO and other smaller producers might be to reducecapacity utilisation rates.Post-elections, especially by 2012, we believe there would be majorimprovements in demand and purchasing power, especially in view of theexpected improvements in power supply, coupled with stability and increased As availability of power, politicallending to the private sector. With our expectation of increasing implementation stability and access to loansrate of the medium term National Development Plan, local demand would likely converge in 2011; demand forsurge again to fully absorb cement supply. Prior to 2010, cement demand had cement is bound to increasesignificantly outstripped supply and the resultant supply deficit made Nigeria thethird largest importer of cement in the world. Between 2004 and 2008, importsaccounted for about 64% on average of cement supply, while local productiononly accounted for 36%.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 20
  22. 22. Nigeria I Building Materials I EquitiesSupply dynamics however changed in 2009 as Dangote Obajana and BCCrecorded higher utilisation rates. We note that local production now accounts for With the expected up-shoot inthe larger proportion of cement supply in Nigeria. Industry estimates for 2009 local supply, companies haveput production at c.59% and importation at c.41% of total cement supply. In developed more frameworks forview of the bulky nature of cement which posts significant problem in distribution, with Dangote cementtransportation over long distances, supply is typically localised to the immediate running the broadest networkregion of cement manufacturers. The south west region has historically beendominated by Lafarge WAPCO‟s Elephant Cement, Flour Mill‟s Burham Cementand Dangote Cement. In a similar vein, the north-west region is dominated byCement Company of Northern Nigeria - CCNN‟s Sokoto Cement while the north-east region is largely controlled by Ashaka Cement. Benue Cement Company andObajana Cement - both owned by Dangote Industries (before the Merger of thetwo entities), accounted for the larger portion of local production and cementsupply in 2009. Dangote Cement is however able to penetrate most regions ofthe country because of its extensive depot network.Tighter importation policy: In line with the changing dynamics of cementsupply in Nigeria, government policies on cement imports have become tighter. Regulations favour local production as conditions forThe new cement import policy announced by the federal government in August importation have become more2010, involves re-stating the 20% import duty on bulk cement and the stringentimposition of a 15% levy on the cost, insurance and freight price of bulk cementto substitute the existing N500 per tonne, which would be utilised in thedevelopment of the Cement Technology Institute. Also, as a part of the newcement import policy, the federal government cancelled all existing un-utilisedcement import quota between 2002 and 2008, and stated that an annual reviewof local production would be carried out going forward, to determine the need forcement imports.Figure 21: Cement import terminal operators and import quota (Jul.-Dec. 2010) Capacity Import Company Location („tonnes) Quota2 Eastern Bulkcem P/Harcourt 600,000 225,000 Ibeto P/Harcourt 1,500,000 245,000 BUA Floating terminal, Lagos 1,051,000 225,000 Flour Mill Apapa Port, Lagos 2,000,000 600,000 Dangote Cement P/Harcourt, Onne 3,000,000 895,000 Apapa, Tincan & Aliko 3,000,000 terminals, Lagos Lafarge: Atlas P/Harcourt 2,000,000 160,000 Sources: Media, Industry sourcesLocal manufacturing capacity and utilisation rates: Besides the expected Apart from new plants, rampingrise in volume from the new cement plants which would be commissioned next up of utilisation by older plantsyear, existing plants will continue to ramp up capacity. Based on our estimates, would also increase supplyaverage capacity utilisation in the industry as at Q3‟10 in 2010 was about 62%,even though Obajana Plant‟s capacity utilisation was c.90%.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 21
  23. 23. Nigeria I Building Materials I EquitiesAccording to the Nigerian Bureau of Statistics, Nigeria‟s average utilisation ratefor the cement manufacturing sector stood at 53.39% between 2002 and 2007.Owing to the gradual ramp up of the Obajana plant and Gboko (former BenueCement Company), which were commissioned in 2007 and 2008, capacityutilisation dropped to 47% in 2007, but steadily rose to 59% in 2009, usingavailable data from industry sources. Based on our estimate, average capacityutilisation in the cement industry stood at 66% as at Q3‟10. However, we projectthat average industry capacity utilisation would dip slightly to 65% in 2011, butrise again in 2012 when most of the new plants would have ramped upcapacities. Figure 22: Actual and forecasts of production volume („000 tonnes) and capacity utilisation rates (%) from local manufacturing 25000 90.0% 82.1% 82% 20000 64.7% 58.8% 60.0% 15000 54.5% 10000 30.0% 5000 0 0.0% 2008 2009 2010E 2011E 2012E Production Volume Utilisation Rate Sources: Annual reports, Vetiva Research Estimates Pricing Dynamics: Likelihood of crashing? Notwithstanding the significant increase in cement capacity anticipated nextyear, we do not see major cuts in cement prices in the mid to long term. Tostimulate sales in 2011 in view of the inventory build-up witnessed by producers We believe cement prices wouldthis year, a slight cut in prices next year is likely. In our view, once producers be kept relatively stable by volume adjustments despiteclear up built-up inventory, the alternative would be to reduce capacity utilisation foreshadows of changes in supplyto minimize production rather than embark on aggressive price cuts to stimulate and demandsales. We however believe that it would be more profitable for cement producersto maintain higher capacity utilisation given the huge operational gearing of theindustry. By Q4‟11 we believe demand would increasingly become stronger, asthe newly elected government settles in, and continue the pursuance of themedium term National Development Plan on infrastructure development.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 22