Cement Industry Pakistan

Document Sample
Cement Industry Pakistan Powered By Docstoc
					INDUSTRIAL AND COMPETITIVE ANALYSIS
CEMENT INDUSTRY OF PAKISTAN Submitted to: Ms. Zainab Dar
BBA 2K5-B 6/30/2007

TEAM MEMBERS:
SYED USMAN WAZIR (GL) FATIMA SYED QURAT-UL-AIN RAUF ASIM REHMAN ZEESHAN AHMED

1

Table of Contents
Introduction: ................................................................................................................................................. 3 Structure:..................................................................................................................................................... 4 Conduct ....................................................................................................................................................... 5 Performance ................................................................................................................................................. 5 Related governmental regulations .............................................................................................................. 6 Herfindahl Index .......................................................................................................................................... 7 Lerners Index: .............................................................................................................................................. 8 Advertisements: ........................................................................................................................................... 9 New Product Development: ....................................................................................................................... 9 Capacity Expansion cycle: ......................................................................................................................10 Capacity addition cycles in the industry ..................................................................................................11 Capacity expansions are targeted at domestic markets: ........................................................................11 Demand and growth:..................................................................................................................................12 Competition in export markets:.................................................................................................................19 Problems of overcapacity: .........................................................................................................................19 Oversupply situation in local markets:......................................................................................................20 Financial Obligations will determine price strategy:................................................................................21 Conclusion: ................................................................................................................................................23

2

INDUSTRY: - CEMENT INDUSTRY OF PAKISTAN

Introduction:
Cement industry is indeed a highly important segment of industrial sector that plays a pivotal role in the socio-economic development. Though the cement industry in Pakistan has witnessed its lows and highs in recent past, it has recovered during the last couple of years and is buoyant once again.

3

Structure:
A market is a group of buyers and sellers exchanging goods that are highly substitutable for one another. Markets are defined by demand conditions; they embody the zone of consumer choice for the goods. Now, market for Cement in Pakistan exists in two main dimensions: 1. Product type 2. Geographic area.

Product type: Since cement is a specialized product, requiring sophisticated infrastructure and production location. So, most of the cement industries in Pakistan are located near/within mountainous regions that are rich in clay, iron and mineral capacity. Structure of Cement industry in Pakistan is as such that there is not much substitutability to buyers. Which shows that the Cross elasticity of demand is negligible. Geographical Area: The other factor i.e. geographic location also doesn’t affects a lot considering the flexibility of demand. Example can be taken from the fact that if DG cement in DG KHAN raises its price and MAPLE LEAF CEMENT in DaudKhel will raise its price to match DG cement’s. This is due to cartel of all of the cement manufacturers in Pakistan. Thus the customer has no choice at all to switch between two brands of cement. As the cement market is moving from a virtual 'sellers' market' to an over-supply situation, it is expected that when prices stagnate and profitability becomes a function of volume and economies of scale, location advantage and proximity to markets will become extremely important factors. At present the freight charges are a massive 20% of the retail prices. The plants located very close to each other and tapping the same market will have to expand their markets which will increase their freight expenses. Dandot, Pioneer, Maple Leaf and

4

Garibwal are all located within a radius of 100 kilometers and are selling bulk of their production in the same areas and will thus face serious competition from each other. Market Share: The market share if Cement industry is as such that since large number of manufacturers are in the market and are targeting the entire market through the formation of Cartel. So the dominancy of market share is yet to be analyzed by us. This dominancy can be attributed to two factors: 1. Brand name 2. Product quality. Since pricing is similar so production capacity can provide a vague idea with regards to the market share of all the players.

Conduct Conduct
Cement industries in Pakistan are currently operating at their maximum capacity due to the boom in commercial and industrial construction within Pakistan. Consumers face a tough decision with regards to prefer which brand over which because of the similar pricing of cement industry. The formation of cartel by the cement manufacturers have exploited local consumers a lot and this has led to the concentrated degree of oligopoly, where the firms are acting as a single unit to perform their monopoly. Their combined market power is simply a diluted version of the dominance that a single firm with a monopoly market share can exert.

Performance
The demand of Pakistani cement is expected to continue to grow at the rate of 20 per cent for about four years to come. It may then follow traditional growth rate of seven per cent per year. Announcement of major dams will dramatically increase this demand. Deregulation after accession of Pakistan to WTO is expected to open the window of competition from cheaper markets. There

5

may be no tariff after this deregulation on import of cement allowing its entry into Pakistan from cheaper market at lower rate. Cement from cheaper markets may also block Pakistan’s export of cement to its neighboring countries. Global market has vigorously taken up the advantage of economy of scales and multinational giants now control more than 40 per cent of world production—(China not included). The recent acquisition of Chakwal Cement by an Egyptian giant, Orascom may be a beginning of such an entry in Pakistan by multinationals. New avenues for export of cement are opening up for the indigenous industry as Sri Lanka has recently shown interest to import 30,000 tons cement from Pakistan every month. If the industry is able for avail the opportunity offered, it may secure a significant share of Sri Lanka market by supplying 360,000 tons of cement annually.

Related governmental regulations
The policy of the Government is to keep a balance between rapid economic development, on the one hand, and social justice and consumer’s protection, on the other. There is a traditional conflict between these two aims. It is, therefore, necessary to regulate trade, commerce or industry in the interest of free competition therein. The Ordinance was promulgated to provide for measures against un-due concentration of economic power, growth of un-reasonable monopoly power and un-reasonably restrictive trade practices. Thus cement industry too is monitored and answerable to rules and regulations developed by the monopoly control authority of Pakistan. The government is considering allowing further concessions and additional incentives for cement export, with a view to increase overall export volume. These measures will immensely help in promoting and protecting high investments made in cement sector in recent years. In the wake of its huge surplus production as a result of massive capacity expansion undertaken it rather seems

6

imperative for Pakistani cement industry, on one hand, to sustain existing export markets and, on the other, explore new markets.

Herfindahl Index
In Pakistan there are 27 cement manufacturers that are playing a vital role in the build up of country’s economy and contribution towards growth and prosperity. For the calculation of Herfindahl index we have chosen 5 dominant industries of Pakistan, on the basis of their production capacity. The market share of these firms is as follows: • • • • • Askari cement (NZP) DG cement Lucky cement Maple leaf Pioneer cement 7.6% 9.8% 12.7% 7.1% 5.5%

Where si is the market share of firm i in the market and n is the number of firms.

(0.127^2)+ (0.098^2) + (0.076^2) + (0.071^2) + (0.055^2) = 0.395 Since the Hirfindahl index is above the standard set of (0.18) for an unequally distributed market share industry. This indicates that there is a high concentration in the cement industry.

7

Market share
Askari cement (NZP) DG cement Lucky cement Maple leaf Pioneer cement Others

Lerners Index:
Average industry price of cement bag/50Kg Average industry cost of cement bag/50Kg = Rs.235 = Rs.192.5

L = (P-C)/P Where L is the Lerners index and is also = H/EoP for the whole industry. Now L = (235-192.5)/235 = 0.181 And EoP = .395/.181 = 2.18

8

Advertisements:
The firm’s optimal level of advertising intensity (Advertisement/Revenue) is equal to the ratio of its elasticity of demand to the price elasticity of demand that it faces. The important implication of this demonstration is that the level of advertising is chosen simultaneously with the level of price, there is no cause and effect relationship between these two variables. For oligopolistic competition as in cement industry, the firms have to make decisions taking into account the decision of their rivals. So advertising decisions are measured to the extent on which amount of reaction it would generate from the rival firms. In brief we can conclude that advertising is an instrument of an oligopolistic competition.

New Product Development:
Assume two firms A and B who want to decide whether they should attempt to produce a new product with marginal cost c. The demand for the good is P = a-bQ and as for the R&D effort, the costs of setting up a research lab are K and the probability that the lab will successfully develop the product is %. If both firms successfully develop the product they will be a Cournot duopoly. While, if one of them develops a new product then the first mover advantage would embark rewarding the developer to maintain a monopoly. Everybody’s doing it, so why shouldn’t we? This is probably the thought reverberating through every cement magnate’s mind these days. The current expansion spree now seems to be a bandwagon effect. Cement manufacturers, especially the larger ones, are sitting on the horns of a dilemma where the only way to maintain market share is to expand capacity, but only at the expense of increasing future unutilized capacity. It does tend to seem as if the industry may be gradually, albeit inadvertently, digging its own grave. A proverbial David vs. Goliath scenario seems to be developing where the larger players like Lucky, DG Khan, Bestway, Pakistan Cement, etc. may cause a few smaller (especially those not expanding) cement

9

manufacturers to struggle for existence, or eventually sell out operations to one of these large producers. However, within the group of large producers, we could have an interesting scenario in itself, where the local cement industry’s big boys, Lucky and DG Khan, are likely to be given a tough time by the international veterans like Orascom and Bestway.

Capacity Expansion cycle:
The capacity expansion cycle in cement industry is governed by following factors: • • • • Cement industry being a commodity industry provides very few barriers to entry. Positive demand and profitability outlook attract new entrants until profitability is affected. Industry went through two such capacity addition cycles during 90’s. However, current capacity addition cycles is the largest as industry capacity will be increased from 20.045mn tpa in FY05 to 43.9mn tpa by FY08. • These factors indicate that although it is considerably easier for a new entrant to enter into the business with regards to the conditions. But the staggering amount of investment required makes in quite a difficult task.

10

Capacity addition cycles in the industry

Mn Tpa 45 40 35 30 25 20 15 10 5 0 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06E FY07E FY08E FY09E FY10E

45% 40% 35% 30% 25% 20% 15% 10% 5% 0%

Capactiy

Increase in Capacity (RHS)

Capacity expansions are targeted at domestic markets:
The research made on our part has shown following indications with regards to capacity expansion in cement industry of Pakistan: • • • Capacity expansions are largely concentrated in the northern zone Capacity in the northern zone will grow from 14.7mn tpa in FY05 to 33.8mn tpa by FY08. Concentration of expansion projects away from sea routes indicates these projects are targeted at domestic markets.

11

Further more, we have also researched on the region wise industrial capacity so that to present a conclusive picture of cement concentration in Pakistan. Northern Region Industry Capacity Market Share y-o-y Industry Capacity FY05 FY06E FY07E FY08E FY09E 14.336 18.006 28.215 32.363 34.243 74% 80% 77% 77% 78% 8% 26% 57% 15% 6% 5.086 4.388 8.227 9.663 9.663 26% 20% 23% 23% 22% 1% -14% 87% 17% 0% Southern Region Market Share y-o-y

Demand and growth:
We expect domestic demand to grow at 13% Capacity growth rate (CAGR) during next five years. But certain other factors will also affect the growth of cement industry as well. These are as follows: • • • • • Backlog in development activities Strong DGP growth Housing sector growth Government Development Expenditures Earthquake Rehabilitation

12

•

Announcement of large dams

Backlog in developmental activities will help in such a way as the Cement demand remained stagnated during 90’s owing to lack of development activities. And if we conduct a comparison of per capita consumption between Pakistan and India we can find out that demand of cement in Pakistan with respect to its geographic size has stagnated. Per capita consumption was 73kg during FY97 in both countries. Consumption in India during FY05 was 115kg/capita whereas ours was 95kg/capita. Our consumption is low compared to region countries and world average and so our per capita consumption may well remain below world average in the medium run.

Kg/Capita

130 120 110 100 90 80 70 60 50

Pakistan

India

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

13

Kg/Capita 600 Per capita cement consumption 500 530 470 400 World Average 300 375 300 200 100 0 50
Ban gla des h

625 560

1095

95
Pak ista n

115
M ala ysi a Chi na Ind ia Iran UA E USA EU

Effect of GDP:
Following effects of GDP will govern the growth of cement industry in Pakistan: • • • Higher GDP growth has positive impact on cement demand Cement demand growth rate was double the GDP growth rate in last three years GDP growth is expected to continue to have same positive impact on demand growth FY02 Real GDP Growth Domestic Demand Growth Cement/GDP growth 3.1% -1.1% -0.36 FY03 4.8% 11.8% 2.46 FY04 6.4% 14.2% 2.22 FY05 8.4% 18.2% 2.16 FY06E 6.5% 15% 2.30

14

grow: Housing demand to grow:
Following indications have showed a considerable demand of cement in Pakistan: • • • Housing projects consume roughly 40% of cement demand Currently 0.3mn houses are built annually against demand of 0.5mn Low interest rates, post 9/11 remittances’ inflow, and real estate boom have helped housing sector growth • Easy mortgage availability and announcement of low cost housing schemes will determine housing sector growth in the long-run.

Government’s development spending shall continue to rise due to:

• • •

Government development expenditures count for one third of total cement consumption Increase in development expenditures has helped cement demand to grow at very high rates Increase in PSDP- as announced in Medium Term Development Framework 2005-10 - will help cement demand to grow in the country

•

Infrastructure development in a region triggers private development projects having even positive impact on cement demand

15

Govt.’s spending: Govt.’s development spending:
Mn PKR 35 30 25 20 15 10 5 FY06E FY07E FY08E FY09E FY10E FY00 FY01 FY02 FY03 FY04 FY05 Bn PKR 700 600 500 400 300 200 100 -

Domestic Demand

Development Expenditures (RHS)

demand: Earthquake rehabilitation to boost demand:
After the earthquake of October 8th, the demand for cement rose tenfold due to the rehabilitation and developmental programs. The conditions that constitute this growth due to earthquake are as follows: • • • • • • Earthquake losses are estimated at USD 5.2bn Reconstruction work will boost construction material demand Some portion of development expenditures will be allocated to this project Reconstruction work is expected to generate cement demand of 4mn tons over next 3-4 years Positive impact on demand will be much more evident from 2HFY07 onwards. Cement manufacturers in northern zone will be the main beneficiaries of this demand growth

16

dams: Demand generation from large dams:
The demand for cement will also increase due to following observations: • • Construction of four large dams will generate demand of 3.7mn tons as construction activities start Our estimate does not include demand generation from Skardu-Katzarah dam as its feasibility study in not yet completed. • Extent of demand generation will depend on size of dam, type of dam, and extent of relocation/resettlement activities required. • Bhasha dam will generate maximum demand as it is RCC concrete dam whereas other dams being Earthfill/Rockfill dams will require less cement for their construction. • Resettlement activities for Kalabagh dam will generate maximum demand as it is located in a highly populated area.

17

dams: Cement demand generation from large dams:
Dams Munda Bhasha Kuram Tangi Capacity Dam Type Relocation Persons Households1 Cost2 USD Bn MAF 1.3 Rockfill 1,000 101 1.2 7.3 RCC 23,700 2,833 6.5 0.9 Earthfill 11,000 1,111 0.22 6.1 Rockfill 120,000 16,667 6.1 6 Rockfill 49,300 6,847 5 160,000 19,753 Kalabagh Akhori Katzarah

Estimated Cement Usage -Construction -Resettlement Mn Tons Mn Tons 0.30 0.002 1.35 0.055 0.25 0.022 0.99 0.325 0.30 0.134 0.385

1. Number of households except for Bhasha is calculated based on average persons/household as mentioned by Population Census Organization 2. Cost of Kuram Tangi dam is converted to USD based on PKR 60/USD parity. (Original cost PKR 13.241bn)

18

markets: Competition in export markets:
With regards to the competition in export markets, we have observed following behaviors of cement industry in Pakistan: • • • • Cement exports started in FY02 to Afghanistan that is still a major market Iraqi market can become a potential target after peace is restored India and Iran are the major competitors for Pakistan in the Middle Eastern region Upcoming capacity expansions in Iran and other GCC countries will create tough competition for Pakistan • Export prices are presently touching USD 75/ton in the exports market, however they are likely to come down as new capacities comes online

overcapacity: Problems of overcapacity:
Overcapacity situation in local market is due to: • • Cement industry has grown at 31% CAGR from capacity of 20mn tpa to 43.9mn tpa by FY08 Current wave of new capacity expansions have reduced capacity utilization rates despite demand growth of 13% CAGR • We expect capacity utilization levels to decline to 60% in FY07 and 56% during FY08.

19

markets: Oversupply situation in local markets:
Mn tons 50 45 40 35 30 25 20 15 10 5 0 FY01 FY02 FY03 FY04 FY05 FY06E FY07E FY08E FY09E FY10E 60% 55% 50% 80% 75% 70% 65% 90% 85%

Sales

Capactiy

Capacity Utilization (RHS)

situation: Problems of oversupply situation:
Following problems might arise with the oversupply situation in cement industry: • Lower capacity utilization will reduce benefits of economies of scale. High leverage will also adversely affect profitability of new plants • • • New plants will gain market share at the cost of older players which are not undergoing expansion Large idle capacity is will create panic in players This may result in price wars in the coming years

20

players: Idle Capacity of various players:
FY06 DG Khan Fauji Lucky Maple Leaf Pioneer Attock Industry Average 10% 12% 12% 10% 10% 6% 17% FY07 39% 27% 39% 37% 38% 37% 41% FY08 39% 30% 43% 42% 40% 42% 45%

strategy: Financial Obligations will determine price strategy:
Level of financial obligations will play key role in determining pricing strategy for manufacturers. Players with higher debt obligations will have greater incentive to cheat from current cartel arrangements and as the Financial and depreciation costs were PKR690/ton in FY04 that will increase to PKR1260/ton during FY07. Similarly, at 60% capacity utilization level, financial obligations/ton (current maturity + interest expenses) will be PKR 298/ton for Pioneer and PKR 1158/ton for Maple Leaf cement during FY07. And an increase of 10% in capacity utilization level declines financial obligations per ton by 14%. And if capacity utilization levels are increased to 70%, financial obligations will decline to PKR 256/ton for Pioneer and PKR 998/ton for Maple Leaf cement

21

years: Price reductions are likely in the coming years:
This observation is mainly due to following factors: • • • • Cement industry is currently enjoying historically high prices, margins and utilization rates Historically, lower capacity utilization rates have resulted in price wars among manufacturers Effect of capacity utilization levels will start to decline from 1QFY07 Lower sales volume and high leverage due to expansion will create problems for players to meet debt obligations • • • This is likely to trigger price wars as players will try to gain market share Price wars will lower margins creating further problems for players We expect price reduction of 10% in FY07 and 5% in FY08

22

Conclusion:
Consolidation is needed for industry stability because of following observations that we as a group have made: • • • Cartels are unstable by their nature. Industry needs one or two dominant players for long-term sustainability in prices and profits Top four players command 35% of market share in the industry that will be increased to 46% in FY08. • • World norm is that top four players have more than 60% market share Consolidation process will be needed to increase market share of larger players rather than going for capacity expansions • • We may see acquisitions in the industry as the industry goes through overcapacity cycle Acquisitions were made at EV/ton of USD100-130/ton in India excluding GACL acquisition that at EV of USD193/ton.

23


				
DOCUMENT INFO
Description: Are you looking for assignment and term reports? then I can make your assignments and term reports. Please email me for further details: Email: umair_sheikh2002@hotmail.com
Umair Sheikh Umair Sheikh BBA and MBA Education
About Hi, Are you looking for assignment and term reports? then I can make your assignments and term reports. Please email me for further details: Email: umair_sheikh2002@hotmail.com Thanks.