Cement shopping

The world cement producing crown has adorned the Chinese industry since economic growth took off in the 1980s, with output reaching 1.06 billion tonnes in 2005. But the sector is so fragmented the National Development and Reform Commission (NDRC) is desperately trying to accelerate its consolidation strategy, shutting down outfits with outdated technology and low capacity.

At the same time, the cyclical industrial downturn has attracted overseas investors who are watching the cement companies, trying to see which are likely to survive the cull and flourish. "Certainly at some point [the cement industry] will consolidate sufficiently and become profitable," said Andy Xie, Asia chief economist for Morgan Stanley. "A lot of foreign investors are interested in betting on winners."

According to NDRC figures, profit in the cement industry was US$1 billion last year on sales of US$32.5 billion. Production was up 9.3% on 2004, with growth slowing by 3.2 percentage points. Nearly 36% of Chinese cement producers lost money, compared to 28% in 2004. "The cement industry is a distressed industry – price is very low," said Xie, citing oversupply and the ease of setting up a company. "We don’t see the price going back up."

The average scale of cement producers in China is very small, with annual capacity at approximately 200,000 tonnes compared to 900,000 tonnes internationally. Expanding scale through mergers and acquisitions will increase the competitiveness of the industry by removing the least efficient, most wasteful and most heavily-polluting producers.

Size does matter

The NDRC has decided that new projects with capacity of less than 730,000 tones will in future have to apply to the State Council for approval, rather than to provincial authorities. The number of cement producers is expected to drop to about 3,500 by the end of the decade from the current official estimate of over 6,000.

Through pursuing organizational changes and raising capital to fund the construction of more modern dry-process production facilities, a few firms have risen relatively quickly from the pool to become major conglomerates. At the same time, a number of overseas firms have been tempted by the prospect of future infrastructure projects in rural regions. The relatively underdeveloped western part of the country is proving particularly popular.

"Lafarge has been there for quite a long time – right now they have set up a pretty good market base in Sichuan province," said Trina Chen, basic materials analyst at Credit Suisse. "We are seeing an increasing amount of M&A activity in China." Formed in August 2005, Lafarge Shui On Cement – a 55-45 joint venture between the giant French outfit Lafarge and Hong Kong-listed Shui On Construction and Materials (SOCAM) – has become the largest producer in southwest China and third largest nationally.
Lafarge Shui On boosted its portfolio in November with the acquisition of Shuangma Investment Group, which controls three cement plants in Sichuan. Taking into account existing debt and allocations for short-term investment to make improvements to the facilities, the investment is worth about US$160 million.

It seems Lafarge is set to continue targeting the fast-growing Southwest, having originally entered China in 1994. "Our development in China has been through acquisitions, largely," said Lucy Wadge, a Paris-based spokesperson for the company. "It’s a very fragmented market so there is potential for further consolidation. We examine opportunities as they arise to the extent that they would allow us to consolidate our existing positions ? but we won’t acquire at any price."

Meanwhile, Holcim is set to be the first overseas cement investor to control a mainland-listed company as it increases its stake in Hubei province’s Huaxin Cement to 50.3%, up from 26.1%. The Swiss firm, the second largest cement producer in the world after Lafarge, will pay about US$125 million, which will help Huaxin increase capacity to 36 million tones a year from 22 million tones. Heidelberg Cement, the number four producer worldwide, has also been active, forming a 50-50 joint venture in northwestern Shaanxi province with firm Tangshan Jidong Cement.

In addition to much-needed capital, the overseas companies are helping their Chinese counterparts incorporate updated technology. In 2004, new dry-process production lines accounted for only 31% of production, though this proportion is rising. There is a concurrent program of shutting shaft kilns, which is due for completion in Zhejiang province in 2007, for example. A similar strategy in Henan province should result in the elimination of 10 million tones of low quality cement capacity per year.

Tech changes

"There is always the need to replace existing old plants with new technology," said Wadge of Lafarge Group. "There seem to be new requirements from the Chinese authorities, because the old plants consume far more energy and are not as clean as new plants, emitting more CO2, for example."

The sector has weakened since the government moved to dampen enthusiasm for excessive fixed-asset investment which was creating overcapacity. Fixed-asset investment fell by 8.6% between January and June 2005, compared to a rise of 58.5% during 2004. Energy price increases have also reduced profit margins. "Industry fundamentals are improving and development costs are at least stable," said Credit Suisse’s Chen. "The cost to rebuild cement plants is getting more expensive, but there is potential for more consolidation."

Of particular interest, Chen said, was the April announcement from China Resources Holdings – the controlling shareholder of China Resources Cement – of a privatization plan worth the equivalent of US$55 million, less than three years since the firm listed and following a profits slump. Holdings will pay the equivalent of US$0.32 per share in cash for the outstanding 29.3% stake – a premium of 35.4% on Cement’s last closing price.

Also in April, Morgan Stanley’s private equity unit MS Asia Investment and the International Finance Corporation, a unit of the World Bank, agreed to pay US$158.5 million for a 14.3% stake in Anhui Conch Cement – the listed unit of the biggest producer and seller of cement in China, state-owned Anhui Conch Cement Group.

Morgan Stanley is buying into cement relatively cheaply, paying the equivalent of US$0.88 a share – a 31% discount to the closing price of Conch’s traded stock the day before the deal was announced. Anhui Conch Cement reported profits for the first half of 2005 plummeted by 89% to US$11.4 million year-on-year, citing higher costs and lower selling prices.

The cement industry has much in common with other heavy industrial sectors, according to Chen. "I see this in some capital intensive materials industries," she said. "China has overbuilt quite a lot of capital in the last few years – right now some of these sectors are oversupplied ? I am also seeing lots of foreign companies coming in for bargain hunting."