Despite the economy being challenged by the COVID-19 pandemic, Nigerian cement demand remained robust in 2020 and 2021. While the country’s longer-term potential remains intact, pressure is building in the short- to mid-term amid slower demand growth, excess capacity and an increasingly difficult operating environment. By Moses Njuguna, EFG Hermes, Nigeria.
Nigeria’s 2023-25 Medium Term Expenditure Framework (MTEF) and Fiscal Strategy Paper, published in July 2022, serves as the pre-budget statement and is prepared as a multi-year planning tool to communicate the development aspirations of the country’s government. It is designed to accentuate the implementation of the National Development Plan (NDP) 2021-25 key objectives of achieving economic diversification, increased investment in infrastructure, improved security and good governance, investment in education and health and social investment to alleviate poverty.
According to Nigeria’s National Bureau of Statistics (NBS), the country’s GDP growth rate in 2021 was 3.4 per cent, a recovery from the 1.9 per cent contraction in 2020. One cannot discount the base effect as the 2021 recovery was supported by the re-opening of economic sectors and increased vaccination rates. As at the 1Q22, Nigeria recorded the fifth consecutive quarter of GDP growth at 3.11 per cent from the difficult 2Q20 (-6.10 per cent) and 3Q20 (-3.62 per cent). Worryingly, the Russia-Ukraine conflict poses a challenge to the global economic recovery amidst a rising universal inflationary environment coupled with ongoing supply chain disruptions in 2022E.
The IMF estimates Nigeria’s average growth rate during the 2022-25E period to be 3.1 per cent – slightly lower than the Nigerian government’s average estimate of 3.5 per cent (see Figure 1). The divergence in the IMF’s lower GDP outlook amidst a softer inflation trend (13.1 per cent average in 2022-25E) while the MTEF points to a stronger GDP in an elevated inflationary environment (16.7 per cent average in 2022-25E), as shown in Figure 2, stands out to EFG Hermes. The latest NBS report points to a 19.6 per cent inflation rate in July 2022 (+227bps vs June 2022) driven by food inflation at 22 per cent (204bps higher vs June 2022), while core inflation (all items less farm produce) was 16.3 per cent (175bps higher vs June 2022).
Additionally, Nigeria’s unemployment rate was 33.3 per cent in the 4Q20 (vs 27.1 per cent in the 2Q20), according to the latest NBS numbers, indicating that ~23.2m are unemployed. The increase can partly be attributed to the COVID-19-induced lockdown that resulted in organisations reducing workforces as a means to cope. Positively, underemployment (conditions in which people in a labour force are employed at less than full-time or regular jobs or jobs inadequate with respect to their training or economic needs) declined to 26.9 per cent from 31.5 per cent among rural dwellers and 16.2 per cent (from 23.2 per cent) among urban dwellers in the 4Q20. As businesses re-opened in 2021, unemployment should have eased, although the NBS has not updated this metric. Conclusively, the macro headwinds in Nigeria are set to be in play, at least, over the medium term.
Soft capex spend risk accelerates over 2022-25E
The current Nigerian administration had set a 30 per cent target for capex in aggregate expenditure. In 2021 budgeted capex was NGN4.9trn (US$11.23bn), 34 per cent of total expenditure. The actual performance was NGN3.4trn, 31.9 per cent lower than budgeted and accounting for 26 per cent of actual expenditure. The amended 2022 budget for aggregate capex is NGN5.4trn, 31 per cent of total expenditure. As at the 1Q22, actual capex was NGN773bn, 57 per cent lower than budget and accounting for 16.4 per cent of actual expenditure in the period. Using the MTEF, EFG Hermes computes ~16.6-18.2 per cent (2023-25E average) of budgeted expenditure to be dedicated towards capex.
It is important to highlight that there are two scenarios presented for 2023E:
1. business-as-usual – assumes petrol subsidy to remain
2. subsidy reform – assumes petrol subsidy terminates in mid-2023, in line with the government’s 18 month extension announced in early 2022.
The petrol subsidy is a significant cost line item in Nigeria’s budget, ie, under Scenario 1 it accounts for NGN6.7trn (36 per cent in budgeted total expenditure of NGN18.7trn), while in Scenario 2 it accounts for NGN3.3trn (vs NGN19.7trn of total spending). The scenarios affect only revenues and disbursement line items but maintain a GDP growth outlook of 3.8 per cent in 2023E.
Under both scenarios, capex will remain below the 30 per cent target in 2023E at 17.3 and 22.1 per cent, respectively. Going forward, EFG Hermes calculates 16.6 and 15.9 per cent as capex in total budgeted spending over the corresponding 2024-25E period. This is a concern as it implies capex is not a priority compared to other expenditure items like debt service (45.2 per cent of spending by 2025E) and recurrent expenditure (41.9 and 36.5 per cent in 2024-25E, respectively).
Domestic cement capacity to surpass 65Mta by 2026E
According to EFG Hermes calculations, Nigeria’s cement capacity was 53.75Mta in 2021 (see Figure 5), supported by Dangote Cement’s Okpella line (3Mta), which was commissioned in the 4Q21. BUA Cement’s 3Mta Sokoto line 4 was commissioned in the 1Q22, pushing industry capacity to 56.75Mta.
The cumulative annual growth rate (CAGR) for capacity over 2016-21 is calculated to be 4.2 per cent and will step up to 5.9 per cent during the 2021-24E period, due to 6Mta of additional capacity from BUA Cement (3Mta Sokoto Line 5 and 3Mta at Edo) expected by 2023. As a result, BUA Cement’s total capacity will be 17Mta by 2024E compared to 11Mta in 2022E. In terms of market share by capacity, BUA Cement is the second-largest cement producer (19.4 per cent) after Dangote Cement (62.1 per cent) in 2022E. Beyond 2022E EFG Hermes anticipates domestic cement capacity to grow at a CAGR of four per cent in the 2021-26E period to 65.45Mta by 2026E supported by BUA Cement’s aforementioned 6Mta expansion and Lafarge Africa’s debottlenecking strategy (~2.7Mta) across its operations.
In terms of market share, by 2026E Dangote Cement will remain the market leader (53.9 per cent), with BUA Cement in second place (25.9 per cent), followed by Lafarge Africa (20.2 per cent). BUA Cement’s 3Mta greenfield project in Adamawa State, northeast Nigeria, has not been included in these projections as insufficient details are available, although it remains a key factor in its strategy.
Short-term demand growth to slow but longer-term potential intact
EFG Hermes estimates that the 2016-21 demand CAGR was five per cent, buoyed by strong recovery growth of 11.3 and 11.1 per cent YoY in 2018 and 2019, respectively (see Figure 7). As the economy was challenged by the COVID pandemic, demand was, surprisingly, robust at 26.1Mt (+13.5 per cent YoY) in 2020 and 29Mt (+11.1 per cent YoY) in 2021.
Very strong growth was noted in other sub-Saharan Africa countries in 2020 and 2021, including Kenya (23.2 and 26.8 per cent YoY, respectively), Uganda (32.5 and 12.4 per cent YoY) and Tanzania (11.3 and 10.2 per cent YoY), EFG Hermes estimates. According to its analysis, the critical driver in Nigeria was increased real estate activities spurring private demand (ie, the main domestic demand component) and intensive logistics investments by cement producers to access new markets.
In 2022E EFG Hermes estimates that Nigerian cement consumption will reach 30.5Mt (+5.1 per cent YoY) as macro headwinds intensify. It computes Nigeria to comprise ~46.4 per cent of ECOWAS (Economic Community of West African States) cement demand supported by its larger population.
As shown in Figure 5, utilisation rates crossed the 50 per cent mark in 2020 to reach 51.7 per cent, the highest rate since 2016 (52.8 per cent), which is encouraging. At 54.6 per cent in 2022E, utilisation rates will reach their highest level since 2014, based on EFG Hermes estimates. Nigeria’s utilisation rate remains below the ECOWAS average of 61.3 per cent and 69.1 per cent (ECOWAS excluding Nigeria) in that period. To put this into further context, EFG Hermes calculates a 69.7 per cent average for the east Africa region (Kenya, Uganda, Tanzania, Rwanda and Burundi) in 2022E. This is a concern in the short-term, although in the longer-term Nigeria’s demand potential is immense. Figure 8 highlights per capita demand lagging the ECOWAS region, according to EFG Hermes.
Dangote Cement’s competitive advantage in Nigeria is its scale and, despite an expectation of a market share dip in 2022E (-260bps) due to BUA Cement’s ramp-up of its new facility, it is difficult to envision a threat to its dominance in the country.
EFG Hermes is reassured by the limestone deposits in Nigeria, which allow the construction of integrated plants in contrast to some of its peers across west Africa that must rely on grinding operations, eg, Cote d’Ivoire. The worry is that excess capacity is considerable in Nigeria (see Figure 10). With projected new capacity beyond 2022E and a pull-back in industry demand growth (macro challenges, election risk, etc), excess capacity may remain at elevated levels. The export market may be the release valve, but one cannot discount the general overcapacity across west Africa and the local market priority strategy adopted by all the Nigerian players, at least in the short-term. The expansion drive justification – ie, cement producers positioning themselves for longer-term demand potential – does not augur well with EFG Hermes, which is of the opinion that current industry capacity is more than satisfactory, and the focus should be to increase utilisation rates (and continued investments in new relevant technology).
Higher prices ease intense cost margin pressure – but for how long?
According to EFG Hermes’ analysis of the latest financials from Dangote Cement, BUA Cement and Lafarge Africa, industry revenues reached NGN509.5bn (~US$1.2bn) in the 1Q22, representing YoY growth of 36.8 per cent. In the 2Q22 revenues were NGN488.6bn (~US$1.1bn), with YoY growth of 24.9 per cent. Cement demand in the 1Q22 was 7.96Mt (+3.1 per cent YoY) and in the 2Q22 it fell to 7.55Mt (-2.5 per cent YoY). Consequently, the robust industry revenues uplift was clearly supported by higher average selling prices (ASP) that stood at NGN63,977/t in the 1Q22, a rise of 32.7 per cent YoY. In the 2Q22 prices were NGN64,725/t, representing growth of 28.1 per cent YoY. In local currency terms, these prices are at peak levels.
The concern is the cost inflation surge passed through via higher realised ASPs due to macro headwinds, amid a cooling-off in cement demand growth. One player stated that it does not pass on the full impact via higher ASPs and EFG Hermes calculates that its ASP was 12.6 and 12.4 per cent lower versus the industry average in the 1Q22 and 2Q22, respectively. EFG Hermes has long questioned the sustainability of the very strong demand momentum that was reflected in 2020-21 amidst a tough environment for consumers (the individual housebuilding segment is the key demand driver in Nigeria and across in sub-Saharan Africa). The cash cost per tonne shows a 31.8 per cent YoY spike to US$79.5 in the 1Q22 and a 37.8 per cent YoY increase to US$85.2 in the 2Q22. Digging deeper into this metric, EFG Hermes acknowledges the impact of an outlier as one player’s performance drags down the entire industry.
Excluding this outlier, it computes a 36.6 and 35.4 per cent YoY surge in the 1Q22 and 2Q22, respectively. Furthermore, the industry EBITDA margin was eroded by 150bps YoY to 46.9 per cent in the 1Q22 and by 570bps YoY to 43.2 per cent in the 2Q22 in an increasingly difficult operating environment.
Moreover, EFG Hermes also queries the market depth and capacity to absorb further price escalations. As noted earlier, long-term potential is undoubtedly immense, but in the shorter-term further demand growth is hamstrung by a tepid GDP outlook amidst escalating global and local inflationary environment, not to mention the election risk in 2023E.
Apart from the impact of imported inflation (through spares, etc) and global supply chain challenges, while operating in an inflationary setting, the Nigeria cement industry experienced an unexpected event. In early 2022, gas supply constraints emanated due to vandalism in the gas supply infrastructure, which impacted cement production capabilities. In general, Nigeria’s three main cement producers use gas as their primary fuel source, despite the continued implementation of alternative fuels usage to reduce carbon emissions (thermal substitution rates are low as at the 2Q22). The situation led to increased coal and low pour fuel oils (LPFO) usage to supplement industry production. One player stated the situation is easing off, as at the 2Q22, while another affirmed it remains dire. Either way, EFG Hermes believes this operating environment will burden profitability margins in 2022E.
Automotive gas oil (AGO)/diesel prices gradually escalated in 2022, recording a mammoth 208.74 per cent YoY rise to NGN774.38/l in July 2022. This led to higher industry distribution costs at NGN6818/t , a 53.2 per cent YoY surge in the 1Q22 that worsened to NGN9789/t in the 2Q22. As all players invested heavily in their own (and third-party) logistics network, this cost line will be weighty on the margin outlook.
Conclusion
In conclusion, Nigeria’s dominance (in terms of capacity and demand) across the larger west Africa region, coupled with its immense limestone deposits, implies an enormous competitive advantage potential for exports. As the current focus is on the domestic market, the existing challenges as explained above, may persist in the short- to medium term, dampening the appeal of the Nigerian cement industry. EFG Hermes remains cautiously optimistic on demand growth, concerned about excess capacity and surprised by the sustained ASP escalation (especially in local currency terms). In the short- to medium term, it believes pressure is building and the release valve could be increased exports, a sustained uptick in domestic demand or a decline in prices as competitive pressures build. Time will tell, sooner rather than later.
This article was first published in International Cement Review in December 2022.
