“Cement demand will be robust post-COVID”
Mapleleaf Cement is a fast-growing cement company in an expanding cement industry. BR Research spoke with Waleed Saigol who is a director at Mapleleaf Cement to talk about the growth of the industry as it wakes up from its most recent lull brought forth by lockdowns and reduced demand, especially in light of the construction and housing related packages PM Imran Khan has recently announced to give impetus to the industry
Following are edited excerpts:
BRR: What is your cement demand outlook over the next 6 months and a year given PM’s announcement of the construction policy and the Naya Pakistan Housing Plan (NPHP)?
Waleed Saigol: Demand is very strong at the moment and that is very encouraging for the industry. If you look at the North Zone, demand might be marginally higher than what it was pre-COVID. There are two factors working together: the first is the season. After the harvest, demand is usually high because people start construction and renovation activities right after monsoon. The other factor that we have observed over the past few years is growth of the private sector. In South Zone, demand is not that high but firms in the south have the opportunity to export, so the southern plants are doing well from that perspective.
As far as the future is concerned, if the lockdown isn’t imposed again, demand will continue to remain robust. Even during the COVID-19 outbreak, the industry has not been impacted as adversely as we had feared.
BRR: You mentioned that private sector is a major growth driver for cement. Can you give us some estimates of the share of the private sector in total demand?
WS: It would be difficult to find such statistical data for the Pakistani economy, but my sense is that appetite of the private sector has grown, probably even higher than that from government projects. As we have witnessed, the PSDP allocations have not been fully utilised over the past year or so and next year we believe, these numbers won’t be as high either.
BRR: Cement consumption in Pakistan is one of the worst in the region. Infrastructure spending has shrunk and PSDP spendings have also been slashed. How can the government contribute?
WS: We need a multipronged approach. Certainly, PSDP spending is a major contributor and one would hope that government finances would allow the PSDP spendings to revive. The government is the biggest driver for demand even with the private sector now starting to emerge and catching up through housing schemes and mega housing and commercial projects.
The second important factor is the taxation policy of the cement industry. Around the world, excise duty is a production tax that is put on items that a government wants to discourage the production of - so there is no justification whatsoever for a country like Pakistan, which is trying to promote construction to have such higher excise duties. To promote construction-led growth, the input cost would have to be lowered and there shouldn’t be any place for the excise duty. They should be collecting sales tax and mining royalties from cement producers that they are currently paying.
Another important factor is consistency. Steel bars industry does not have excise duty. The raw material for the industry is imported while cement’s raw material is mostly indigenous but we have to pay an excise duty. An import-based construction industry has an advantage over cement. This is a very big anomaly. The government has to make taxes uniform on building materials. An excise duty should not be imposed on cement, if it is not imposed on steel.
BRR: Cement has environmental concerns. Cement factories have been found to pollute groundwater in many instances. Do you think an excise duty is valid in that case?
WS: After the ruling of the Supreme Court, water costs have increased significantly in Punjab. We pay the highest rate of water out of all the industries. If the government wants to put an environmental tax, that’s a different argument, but it will have to imposed on all of the polluting industries, not just cement. It would have to include furnace oil producing refineries, OMCs, textiles, automobiles and so on. The policy has to be consistent.
BRR: Is the cement industry cartelized?
WS: Let’s first address the pricing issue. In the last 12 years, the headline inflation of Pakistan has been around 8-8.25 percent. Cement price inflation is around 2.2 percent. It is the lowest inflation out of any commodity in Pakistan; so if a cartel exists, its probably the most responsible cartel in the world, because it is increasing the price at a lower rate than inflation.
Let’s look at other fundamentals. Is the cement industry making runaway profits? No. Most of the financial accounts are available publicly for cement companies. If we look at the 10-year ROE, most companies have not even managed to make a ROE that’s greater than the discount rate of Pakistan. That’s the first issue: profit. Just looking at the 10-year average return should paint a compelling picture. If I give you Mapleleaf’s example, we have put more money into the business than taken out in the form dividends. The industry is not as lucrative as people from the outside like to believe. Take my investment in dollar terms and take my return in dollar terms—in dollar terms, my return would probably be in the negative.
Then, is there any player that has an overwhelming majority in the industry where it has the power to control prices and quantity? No. Cement is a very competitive industry in which there are lots of players. There are no geographical regions and no one company has a territory formed in any city. Every brand is selling in every market, at varied prices. There are differentiated markets, differentiated prices, differentiation of brands all across the industry. If you look at our brand, it is very strong in Lahore but very weak in Karachi. And every player is selling in every market at different prices.
BRR: But the industry is protected through an import duty, which in a competitive market should not exist at all.
WS: Frankly, I don’t believe that in Pakistan generally a lot of cement can be imported. The import duty protection is there because of the sub-standard cement that was flowing into the country and it is to discourage consumption of poor-quality cement, which can be dangerous in construction.
Also remember that we are in a region where we are surrounded by cement producing countries (Iran, China etc.) which are subsidized by their governments and have natural resources that help them to produce cement much cheaper. Without a duty, they would dump cement into the country and the government would have to impost an anti-dumping duty because dumping would certainly harm local production.
BRR: Why do companies in the cement industry go into expansion together? Historically, we have witnessed expansion in the industry occur in phases with majority of the firms expanding together.
WS: It is a game of market share and every company wants to maintain its share in the market and not lose its relative size as other companies expand. There is some responsibility as well. If the industry is reaching 100 percent capacity utilization and we believe demand would go up substantially in the near future, companies would invest in production. That’s a responsible thing to do. Otherwise, if the excess demand is served through imports, it would further put pressure on the balance of payments that Pakistan has traditionally suffered with.
BRR: There are many investors trying to enter the market but may be facing licensing issues, especially in Punjab, which makes market entry difficult and creates a distorted market.
WS: I want to say this categorically, cement should not be a regulated industry and whoever wants a license should be allowed to get one and should be able to put up their plants.
The government however may have other concerns. The rationale has been that the government did not want those business groups investing that did not have the requisite environmental experience. The government does not want large scale polluters to come into the industry. Secondly, the government wants reputable groups to enter the sector. Often, many investors sit with the licenses but don’t set up any plant. In Karachi, we have seen a lot of interested parties with neither the financial capability nor the experience who were sitting with the license and wanted to make money by selling them.
I think, it is important for the government to prevent that corruption, and have the regulatory oversight necessary to avoid misuse, illegal and corrupt activities.
BRR: To circle back to the pricing issue, what is the price differential between cement exports and domestic markets, on average. Calculations suggest domestic price may be double of the price Pakistani cement is being sold abroad.
WS: As far as exports are concerned, we are competing against the whole world. There is China, Iran, and then we are looking at other major markets such as India that are selling cement. And you also have to bear in mind that there have been a lot of regional expansions that have taken place. Recently, there has been a global slowdown in demand which has placed an intense pressure on prices. The rates of clinker and cement both have been declining. To remain competitive, we have to sell at those rates. But our exports are not that high. We are usually exporting from the south of the country where they incur lower transportation costs while the north mostly exports regionally to Afghanistan and India.
One thing to note here is that a lot of exports in cement are actually clinker which is a basic commodity and the pricing is at variable cost. When the variable cost is low, whichever supplier gets a margin is able to sell.
BRR: You mentioned exports are pretty low. Is there an industry strategy to read more export markets? How are cement companies creating these linkages?
WS: We mainly sell to importers. It is not easy for a company to build a network, especially for instance in a country like Afghanistan. But we have seen Pakistani brands with strong presence in export markets through years of experience. As for developing a presence, the exports market is a perfect storm. There are many good players and not enough markets, because there’s a slowdown. Players already in key markets will continue to sell.