East Africa: keeping the lights on

With overcapacity and pricing pressures weighing in on the east African cement industry, cement producers are setting their sights on the return of strong demand by 2023. In the meantime, will they prepare by taking up a stronger position, possibly through industry consolidation? By Standard Investment Bank, Kenya.

The East African Community (EAC) recorded real GDP growth of 5.9 per cent in 2019, slower than the 6.6 per cent growth in 2018, with the deceleration cutting across most member countries. GDP growth in Uganda was 4.9 per cent in 2019 compared to 6.1 per cent in 2018, while Tanzania’s was 6.3 per cent compared to seven per cent in 2018. Burundi recorded an improvement from 1.6 per cent in 2018 to 1.8 per cent in 2019. Rwanda recorded the highest GDP growth rate of 10.1 per cent, supported by both the private and public sector. Kenya’s GDP growth is estimated at 5.4 per cent in 2019 compared to 6.3 per cent in 2018, with growth more pronounced in service-oriented sectors.

The construction sector in Kenya, which makes up 5.6 per cent of GDP, registered a growth of 6.4 per cent in 2019, lower than the 6.9 per cent in 2018 – recording slower growth for the fourth year running due to the slowdown in infrastructure development. However, the real estate sector grew by 5.3 per cent, an improvement from the 4.1 per cent growth in 2018.

Cement sector: keeping the lights on

EAC member states are generally experiencing similar trends in the cement sector, grappling with overcapacity, pricing pressures and weakening demand.  Rwanda is somewhat of an exception with sufficient demand and one operational cement manufacturer, CIMERWA, while Tanzania saw a recovery from 2019. The region seems to be on a downward trend in the cyclical nature of the sector, with hopes for a recovery in demand within the next three years. Adding fuel to the fire is the COVID-19 pandemic that is limiting economic activity, consequently repressing cement demand and production, as well as hampering the importation of production inputs.

Kenya

In Kenya cement consumption declined by 1.3 per cent in 2019 to 5.8Mt while production decreased by 2.3 per cent, shrinking for the third-consecutive year to record the lowest output in five years. The weak demand is a result of the slowdown in construction and real estate, lag in infrastructure development, fiscal budget cuts, lower exports and low credit access to the sector, which is currently considered as risky. Cement exports from Kenya have been declining since 2015 and fell from 144,275t in 2018 to 61,658t in 2019, largely on increased capacity in export markets.

Domestic cement consumption has been falling since 2017, following a gentle upward trajectory from the beginning of the century and a strengthening from 2009 on the back of increased demand from aggressive infrastructure development. Consumption peaked in 2016 at 6.3Mt and eased in subsequent years.

The upturn resulted in the expansion of capacity that is now the bane of the sector, following a slowdown in planned government projects (Standard Gauge Railway, roads, stadiums, dams, etc) and commercial property. Demand for office space in Nairobi is estimated to have fallen to an eight-year low in 2019. Currently, capacity of at least 10.6Mta stands against demand of 5.8Mt. Coupled with lower demand in the private sector and export markets, as well as a softening economy, manufacturers in this low-margin business are doing their utmost to keep the lights on. Competition for market share has resulted in price undercutting, yet the cost of production remains high, further eroding margins. COVID-19 is likely to force manufacturers and distributors to slash costs further. Production may be increasingly hindered by importation constraints during the pandemic, providing an edge to manufacturers with self-sufficient clinker.

The individual homebuilder, who was the major consumer before the infrastructure boom, is increasingly significant in light of the plunge in infrastructure and commercial development. Though also suffering from low disposable incomes on slowed economic growth and limited access to affordable credit, the homebuilder serves in keeping the lights on for cement manufacturers.

In February 2020, Bamburi Cement launched a low-cost cement called Fundi (22.5) for masonry and plasterwork, suited for single-storey houses, retailing at lower market prices (US$5.10-5.30/50kg bag). LafargeHolcim has a similar product in Tanzania. 

Tanzania

Tanzania is well-endowed with limestone, natural gas and coal deposits, making it favourable for cement production. Similar to Kenya, competition has been very stiff in the past five years with the entry of new producers and capacity expansion by older players, resulting in pricing pressures. However, the Tanzanian cement market started to recover in 2019 and players posted better margins, thanks to increased infrastructure spending, lower imports from Kenya, credit supply growth and reduced competition from the stalled operations of ARM Cement. Lower imports were aggravated by a border dispute between Kenya and Tanzania in 2018-19, which triggered import restrictions that included a ban on cement imports from Kenya to Tanzania. Tanzania had locked out cement products from Kenya in 2018 due to the use of imported clinker, but it was resolved after bilateral talks and a verification process by Tanzania. Nonetheless, there are fewer cement imports to Tanzania from Kenya on increased production capacity.

Policy uncertainty has been a challenge with the current government in Tanzania, especially among investors and corporates, due to the erratic nature of its protectionist policy directives. One of these directives was a ban on coal announced in August 2016. The ban was initially viewed negatively with low-quality supplies and sub-optimal utilisation rates of cement plants. However, the effect is neutral and depends on a company’s terms with coal providers and the transport cost. In the fight for market share and with coal mines located in southern Tanzania, distribution efficiency has been a critical success factor in sustaining margins.

Consolidation: stronger together

2019 saw a key transaction in east Africa: the administration of ARM Cement and the subsequent sale of assets in Kenya and Tanzania. ARM Cement was placed under administration in August 2018 by its creditors and some of the assets sold in 2019. ARM Cement operates five grinding plants (two in Kenya, two in Tanzania and one in Rwanda) and two clinker plants, including a 1.2Mta clinker plant in Tanzania.

National Cement, which has taken the lead in transactions in the cement sector, acquired assets of ARM Cement in Kenya in 2019 for US$50m. National Cement is a Kenyan cement manufacturer, owned by the Devki Group of companies, with a subsidiary in Uganda and produces the Simba Cement brand. National Cement had also acquired Cemtech (a subsidiary of the Sanghi Group, India) earlier in 2019 for an undisclosed amount. Cemtech received initial approvals to mine limestone and manufacture cement in 2009, with plans to reap from the vast limestone deposits in West Pokot, Kenya. Ten years later, the plant had not been set up, dogged by regulatory challenges. National Cement acquired Cemtech in March 2019 but is yet to commence construction.

National Cement is the only cement producer in Kenya on an aggressive expansion drive (target: 3.5Mta). The company installed additional capacity of 1.2Mta clinker in 2018 and 0.75Mta grinding in 2020. Moreover, it aims to double the capacity of the new 0.75Mta plant in 2020, in addition to benefitting from the acquisition of distressed assets.

Globally, 2019 saw increased discussions around acquisitions, mergers and takeovers in the cement sector, with some large players such as LafargeHolcim considering divestment in Middle East and African markets. LafargeHolcim’s subsidiary in Kenya, Bamburi Cement, has reported lower earnings for the last three years but remains one of the strongest players. It has a subsidiary in Uganda, Hima Cement, which is struggling with land acquisition and sales in Rwanda due to a Uganda-Rwanda border dispute. With Rwanda looking to increase local cement manufacturers, the future looks dim for Hima Cement.

Meanwhile, Chinese cement players are targeting global expansion partly through acquisition. ARM Cement’s assets in Tanzania were acquired by Huaxin Cement, a Chinese company, where LafargeHolcim is the largest shareholder.

Outlook

EAC economies are expected to post lower economic growth in 2020, in line with contracting global growth. The IMF predicts a three per cent contraction of the global economy due to disruptions to economic activity as a result of the COVID-19 pandemic. Kenya is projected to grow its economy by between 1-2.3 per cent in 2020 and around two per cent is forecast for Tanzania.

A momentary decline in construction sector growth is expected in Tanzania in 2020, on account of the pandemic as well as upcoming general elections. Nonetheless, the sector should pick up afterwards, supported by infrastructure development and credit supply growth. An optimistic longer-term outlook is dependent on the sustainability of demand growth, supported by both the private and public sectors. 

Equally, demand for real estate and construction in Kenya will be suppressed in 2020 due to the economic effects of the pandemic. Though the period until  demand recovery is uncertain, there is a general expectation of a recovery after 2022 (general elections) – a new government will most likely be keen to have its own legacy infrastructure projects. In the meantime, the tough spell could be moderately eased by the government’s Housing pillar under the Big Four agenda as well as housing and infrastructure deals secured between Kenya and the UK. The government of Kenya initiated an affordable housing programme with a target of 500,000 units by 2022 as part of its Big Four Agenda. The programme is being implemented as a public-private partnership where the government provides land and a private developer puts up the units. In January 2020 at the UK-Africa Investment Summit, Kenya secured investment deals worth over GBP1.3bn, which include infrastructure financing and housing. Some of the significant announcements include mobilising private finance into Kenyan projects, support in designing a new facility to underpin infrastructure projects across Africa, including Kenya, and a GBP30m investment into the construction of 10,000 energy-efficient affordable homes for rent and sale.

For cement companies, the competitive advantage will lie in operational efficiency and balance sheet strength. Unleveraged manufacturers and those producing their own clinker locally have the upper hand on continuity through the current low-demand cycle and the global pandemic.

In addition, sustainability is an emergent trend in the cement sector, and though more entrenched in developed economies, there are visible initiatives in east Africa, mostly under the LafargeHolcim group. Beyond the constructive environmental impact of sustainability initiatives, there is a resultant long-term cost reduction effect, providing a competitive edge. 

Standard Investment Bank’s review of the east African market last year envisaged consolidation within the Kenyan cement sector in the short- to medium term, driven by the need to boost margins in a highly competitive market. In a market where demand growth will be subdued for a considerable period, consolidation remains the ideal means of survival. 

This article was first published in the July 2020 issue of International Cement Review.