Opportunity for Pan-African cement champion
SOUTH African cement producers have no option but to consolidate their assets to withstand the headwinds of a shrinking domestic market and take advantage of continued rapid growth in many countries in sub-Saharan Africa (SSA).
Without a strong position in their home base, they will not be able to have the financial power to pursue an Africa strategy that competes against the continent’s cement majors and absorbs unexpected shocks.
The high road in a domestic industry realignment would be a merger between PPC and Afrisam. In December 2017, PPC rejected an offer by Fairfax Africa Investment, a Canadian company, to merge the two companies.
Such a merger would have created SSA’s third-largest cement company with combined capacity of 17.3 million tons (m/t). It would have had the scale to launch a challenge to market leaders Dangote Cement (Dangote), LafargeHolcim and HeidelbergCement in the region.
A merger between PPC and AfriSam would have created a new company with assets of R28 billion, revenues of R16.2bn and earnings before tax, interest, depreciation and amortisation of R3.2bn. It would have had operations in six other African countries – Botswana, the Democratic Republic of Congo (DRC), Ethiopia, Rwanda, Tanzania and Zimbabwe – with cement capacity of 5.7m/t. The new company would have employed 5 400 people, including 1 000 in the rest of Africa.
Currently, the three largest cement companies in terms of installed capacity in Africa are Dangote (45.8m/t), Lafarge Holcim (42.4m/t) and HeidelbergCement (27m/t). The three companies have a combined capacity of 115.2m/t.
If one strips out operations in the mature North African countries, the three companies have installed capacity in SSA of 78m/t.
Following a merger between PPC and AfriSam, the four leading SSA cement producers would have had combined installed capacity of 95.3m/t. This would have been equivalent to 70 percent of SSA’s installed capacity of 136m/t.
The installed capacity of the leading producers would have been Dangote (45.8m/t), LafargeHolcim (21.8m/t), PPCAfrisam (17.3m/t) and HeidelbergCement (10.4m/t). Their market shares would have been: Dangote (33.7 percent), LafargeHolcim (16 percent), PPC Afrisam (12.7 percent) and Heidelberg Cement (7.6 percent). Under such a scenario, the two largest indigenous African companies – Dangote and PPC-Afrisam – would have had installed capacity of 63.1m/t, equivalent to 46.3 percent of the SSA total.
The merger would have been in line with a global trend toward consolidation of global cement majors. The recent mega mergers that created LafargeHolcim and HeidelbergCement resulted in significant consolidation in African cement markets. After restructuring their operations, the two companies will be in a stronger position to expand their footprint in SSA.
Over the past 15 years, Dangote has emerged from nowhere to become Africa’s largest cement company. It has built a firm foothold in its home base in Nigeria, where it has a market share of about 65 percent. It has used excess profits in Africa’s largest cement market to fund entry losses elsewhere.
Dangote has disrupted SSA cement markets and invested $6.5bn (R76.05bn) in new capacity. This included $3.9bn in Nigeria and $2.6bn in Cameroon ($138m), Congo ($312m), Ethiopia ($521m), Senegal ($358m), Sierra Leone ($52m), South Africa ($330m), Tanzania ($540m) and Zambia ($358m).
By comparison, PPC busted its balance sheet after investing in projects worth $702m together with partners (11 percent of Dangote’s investments) in the DRC ($280m), Ethiopia ($175m), Rwanda ($165m) and Zimbabwe ($82m). It suffered a debt downgrade. To repair the damage, it had a R4bn rights issue in 2016.
With a presence in 10 countries, Dangote’s target is to achieve installed capacity of 80m/t in SSA, with 40m/t outside Nigeria. In 2016, the company had installed capacity outside Nigeria of 16.5m/t. Sales volumes were 8.6m/t. With 34.2m/t of new cement capacity set to be available in SSA over the next few years, Dangote is clearly taking a long-term view of future consumption, considering that current consumption is about 108.5m/t, according to the company’s estimates.
This means that any competitor to Dangote must have the balance sheet to fund its own entry losses. In many SSA markets, there is excess capacity and intense competition with new players jostling for a slice of the cement pie. PPC has to contend with high risks with its operations in the DRC and Zimbabwe. In East Africa, risks for PPC (in Ethiopia and Rwanda) and AfriSam (in Tanzania) relate to cut-throat competition that has put pressure on prices, margins, capacity utilisation and profits.
Since PPC could not fund a modest Africa strategy in the context of declining profitability within the home base, a new pan-African cement champion should have the financial muscle to fund investments in fast-growing SSA markets and be able to withstand potential financial curve balls in politically and economically unstable markets such the DRC and Zimbabwe.
In South Africa, cement demand increased by 7.9 percent a year between 2000 and 2007 to more than 15m/t on the back of a boom in infrastructure spending. Cement producers reported record profits and invested in new capacity. Demand dropped sharply over the next few years to about 12m/t in 2011. There was a slow recovery over the next few years. In 2016, South Africa had cement capacity of about 17.5m/t, according to Dangote Cement.
According to other estimates, from PPC and Afrisam, which include mothballed capacity, the country has capacity of 20.1m/t. But demand was only 13.4m/t, according to Econometrix, and was forecast to decline to 12.7m/t in 2017 and 12.5m/t in 2018. There will be a marginal increase in demand to 13.6m/t by 2021, the company says.
This means that cement demand in 2021 will still be lower than it was in 2007. By 2021, the cement industry will have experienced 14 lean years. The recent budget speech announced fiscal consolidation and austerity measures of R63bn – or 1.3 percent of GDP. This will result in lower GDP growth and continued pressure on government capital spending.
In the context of a dismal economic outlook – the IMF has forecast annual GDP growth of 1.7 percent in South Africa between 2017 and 2022 – there is no option but for South African cement producers to consolidate their assets and reduce costs. The low road would be continuing competition – with new entrants Dangote-controlled Sephaku Cement and Mamba Cement – and pressure on profit margins in a declining market.
South African producers would not generate the resources to diversify into fast-growing SSA markets. Under such a scenario, some of the SSA cement majors – Dangote, LafargeHolcim and HeidelbergCement – would take over distressed South African producers.
Successful diversification into new markets requires a firm foothold in the home base. Cemex, the world’s fifth-largest cement company, established a strong position in Mexico, which was used to expand to other countries.
LafargeHolcim and HeidelbergCement, the world’s largest and fourth-largest cement companies, established strong positions in their home bases, in France and Switzerland respectively, which were used to expand to the rest of Europe and other continents.
According to McKinsey: “Since the early 2000s, as emerging regional economies have become more important to world markets, a new type of cement player has come to prominence in Africa, Asia and Latin America: the regional champion.
“These companies drew their original strength from a robust footprint in one country; they were then able to expand to capture leading positions regionally. As demand growth has shifted to emerging markets, value-creating regional champions have delivered superior returns when compared with the multiregional global companies. Between 2010 and 2014, regional companies attained return on invested capital levels that were twice as high as the multiregional companies, whose returns were below investor expectations,” the company says.
With low GDP growth expected in South Africa over the next five years, there is an opportunity for a new pan-African cement champion to emulate these successful regional champions by increasing exposure to high-growth cement markets in SSA.