Promising outlook for Saudi cement sector

While challenging market conditions are currently making life tricky for Saudi cement producers, the predicted increase in demand should ensure their return to growth. Published in MEED, 16 December 2014

Less than two years ago, Saudi Arabia was facing up to a worrying shortage of cement. Now, the opposite is true, with inventory levels rising among local producers. The long-term prospects might still be bright, but the sector is facing a tricky period as the economy decelerates and competition rises.

The shortage was caused by booming demand for construction materials, not least because of heavy government spending on infrastructure and rising demand for housing. In part, the current overcapacity is also due to the government, reflecting the impact that recent state interventions have had.

In March 2012, the government banned cement exports, and in April the following year it announced plans to set up four new cement factories, with a total capacity of about 12 million tonnes a year. At the same time, it ordered cement companies to build up a stockpile of two months’ output, via imports, to help deal with any shortfalls in production.

But while capacity and inventories have been increasing, other factors have caused demand for cement to fall. In particular, the sector has been affected by the problems in the Saudi labour market caused by a crackdown on illegal immigrants. As many as 1 million foreign workers were forced to leave the country following the government clampdown, which began in late 2013. Many worked in low-paying jobs, which Saudi nationals tend to find unappealing, including roles in the construction sector, where growth has slowed as a result.

According to the local National Commercial Bank (NCB), growth in construction output fell to 5.6 per cent in the first quarter of this year, compared with 9 per cent in the same period in 2013.

“There are signs the government’s policies are leading to labour shortages in some sectors,” says Jason Tuvey, Middle East economist at UK-based Capital Economics. “This is most evident in the construction sector, where migrants account for about 90 per cent of the workforce. Over the past year, the official number of migrants employed in the construction sector has fallen by 140,000. If illegal migrant workers were included, it would probably be a lot more. Crucially, however, firms have found it difficult to refill these posts with nationals. Compared with a year ago, only an extra 652 Saudis work in construction.”

There has been a clear knock-on effect on the cement industry as a result of the labour shortage. Local investment bank Al-Rajhi Capital says most producers are witnessing a decline in sales. However, the impact has not been uniform across the sector.

Yanbu Cement Company, one of the oldest and largest in the country, saw sales drop by 5.3 per cent in the first half of this year, compared with the same period last year. In contrast, Southern Province Cement Company (SPCC) has seen a year-on-year rise in sales of 2.2 per cent in the first five months of 2014.

Al-Rajhi Capital attributed this to the fact that SPCC has a near monopoly on the cement business in the southwest of the kingdom, with only the far smaller Najran Cement Company competing with it in the region.

SPCC has ambitious expansion plans, with new production lines being built at Tihama and Bisha. Once complete, these will make the company the largest cement producer in Saudi Arabia, overtaking Saudi Cement Company in the process.

Other, smaller producers are also expanding. In August, Al-Sawfa Cement Company awarded a $127m deal to Germany’s ThyssenKrupp Industrial Solutions for a new 5,300 tonne-a-day clinker production plant in Jebel Farasan, 150 kilometres northeast of Jeddah. The new facility will be constructed parallel to the company’s existing line at the site.

Rising cement output has pushed Saudi Arabia up the regional league table in recent years. Overall, it is the third-largest cement producer in the Middle East, after Iran and Egypt, and within the GCC it has become ever more dominant. Its share of total GCC production rose from 49 per cent in 2008 to 63 per cent by 2012, according to data compiled by the US Geological Survey. The kingdom has also been moving up in terms of global production, from 19th largest in 2008 to 11th largest in 2012.

There may be some short-term headwinds for the industry, which will prevent it rising much further, but in the longer term, the outlook for the Saudi cement sector looks promising. Across the country as a whole, demand for cement was 53.3 million tonnes in 2012, according to Yamama Cement Company. This will rise steadily in the coming years to reach about 60 million tonnes by 2015 and more than 70 million tonnes by 2019.

Currently, the residential sector accounts for about 60 per cent of cement demand, according to local investment bank Al-Jazira Capital. With the population expanding quickly and high demand for more houses, that should help drive growth in the coming years.

In addition, the heavy investment being made by the authorities in infrastructure and large construction projects should also provide a ready source of business for cement companies.

At the moment, Riyadh’s budget for the current year includes spending plans of SR855bn ($228bn), although typically, the government overshoots this by a wide margin. Among the construction plans this will support are financing for 465 new schools and 1,544 existing school construction projects, as well as eight new colleges. In addition, the government is building 11 new hospitals, 11 medical centres, 20 sports clubs, and 16 social and rehabilitation centres. It is also making heavy investment in roads, railways, airports, power and water plants, and new industrial cities.

Such largesse has been a key factor in the rapid pace of economic growth in Saudi Arabia in recent years. The country’s GDP growth was running as high as 8.6 per cent in 2011, according to the Washington-based IMF, and has been above 5.5 per cent for seven of the past nine years. However, the drop in the price of oil in the second half of 2014 could yet lead to the government scaling back some spending plans, or at least prevent it from maintaining the rapid acceleration of spending in recent years.

“The fall in oil prices, if sustained, will push the Saudi budget position into deficit,” says Tuvey. “This in itself shouldn’t cause too many problems – the government’s low debt level and large savings mean fiscal policy won’t have to be tightened. But the sharp rises in government spending seen in recent years are unlikely to be repeated.”

That could in turn lead to slower overall economic growth. It has been the non-oil sector that has been driving growth in recent times, but a lot of that is due to government spending, which is ultimately fuelled by oil revenues. With hydrocarbons income lower, most economists now suggest the non-oil economy could also slow down, potentially creating more problems for cement companies.

“While we expect the government to maintain the current elevated level of fiscal expenditures, negative sentiment associated with fiscal deficits could lead to slower non-oil economic activity,” says Fahad Alturki, chief economist at the local Jadwa Investment.

Even so, the tighter market conditions in the near term should be manageable for the cement industry. Profit margins for the sector have often exceeded 50 per cent, due to a combination of cheap raw materials and labour. That has been reflected in the dividends that listed cement companies have been paying out, which have outstripped the market average in the country. According to Al-Rajhi Capital, the cement sector pays an average dividend yield of 5.1 per cent, the highest of any sector and far above the average of 3.1 per cent for companies on the Saudi Stock Exchange (Tadawul).

The cement imports that companies have been paying for in recent times will have dented profit margins somewhat. Imported clinker is usually more expensive than domestically produced supplies, but that cannot be compensated for with higher sales prices – the government has set a maximum wholesale price of SR12 for a 50-kilogramme bag of cement, and a retail price of SR14. The price of a bulk tonne of cement is set at SR240. But even if some of their costs rise, cement producers should still be able to make a decent return.

Investors have been happy to buy into the sector, not least because shares in companies coming to the market are offered at a heavily discounted rate of SR10 each in the initial public offerings. There have been four new listings by cement firms over the past three years, including Najran Cement Company in 2012, and City Cement Company and Northern Region Cement Company in 2013.

The most recent new entrant was Riyadh-based Umm al-Qura Cement Company, which sold SR275m-worth of shares in an offering that ran from 29 April to 5 May this year. Its shares were trading at close to SR40 each in early December, but all the share prices for the other recently listed companies are also well up on their listing level.

More will be coming to the market in the future, due to the government’s desire to expand the cement sector. In February, the Commerce & Industry Ministry approved a licence for Al-Baha Cement Company, based in Riyadh. Half of the company’s shares will be offered for public subscription on the Tadawul, although a date has yet to be set for that.

Barring some major, unforeseen shocks, the prospects for Al-Baha Cement and the other established companies appear promising. In a report issued in September, Al-Rajhi Capital summed up the prospects, saying: “The cement sector is not out of the woods yet, with the labour shortage continuing to [affect] the construction sector. Nevertheless, the sector is likely to recover gradually as construction activities pick up steam once again as new labourers enter the kingdom via the legal route.”