Part of being an investor is latching onto trends and investing early on. As a new investor what do you need to know about investing in the cement industry? The construction sector in East Africa is booming as governments splash huge sums of their budgets on infrastructure development. This coupled with strong economic growth in the past 2 years and a vibrant property sector would make you think the Kenyan cement stocks are in the investor’s sweet spot. If the recent announcements are to go by then this is not the case as Bamburi reported a 23% drop in end year 2010 profits and East Africa Portland Cement (EAPC) recently reported a 41% drop in half year earnings, the only company left standing is is Athi River Mining (ARM) posting a 23% rise in profits in end year 2010. The question to ask: Is the Kenyan Cement industry’s best years gone by? Let’s investigate.
1. Competition
Unlike in the past where the Kenyan cement sector was dominated by only 3 players namely Bamburi, EAPC and ARM, the past year has witnessed the entrance of new competitors such as Mombasa Cement which triggered turf wars resulting in a drop in cement prices. More companies such as National Cement from India plan to set up shop this year in Kenya. The end result of all this is overcapacity unlike in past years when cement demand was higher than supply and since cement is a commodity influenced by supply and demand, price undercutting is the best way to capture market share. The best way to measure the effects of competition on Kenyan cement stocks is to look at the turnover of our listed cement stocks.
Turnover in Sh Billions
2010 2009 2008
Bamburi 27.9 29.9 27.4
ARM 5.9 5.3 4.6
EAPC 9.4 8.1 7.2
From the above we can clearly see Bamburi’s market share has come under some pressure.
2. COSTS
Energy costs constitute about 38% of the production costs at cement factories. The recent surge in crude oil prices and the prevailing drought has resulted in a surge in electricity bills. Coal prices have also risen globally due to low output from hydroelectricity. Unlike in the past where the cement companies used to pass on electricity costs to consumers or turn to coal to reduce their electricity costs, cement firms this time around will find it difficult to pass on costs to consumers due to competition and the surge in coal prices on the international markets.
Let’s look at Energy as a % of production costs
2010 2009 2008
Bamburi 27 24.9 37.8
ARM – – 39
EAPC 37 53 43
From the above we can see Bamburi is the most efficient firm compared to its peers. However this advantage will cease once the others catch up on efficiency.
3. Expansion/Strategy
A. Bamburi is well diversified through Kenya and their Ugandan Hima plant. They have commissioned a new plant in Kasese, Uganda which is set to increase capacity. Biofuel constitutes about 20% of energy costs.
B. ARM-subsidiaries in South Africa, Tanzania and Kenya plus a new factory in Tanzania set to produce 1.2 million tones per year of cement.
C. EAPC-it is the least diversified, shifting to bio-fuels and coal to increase efficiency. Recently converted their troublesome Yen dominated loan to other currencies.
4. KEY FINANCIAL RATIOS
a. Operating Margins
This is calculated as the Net Margin=net profit/revenue. It shows how much each Sh earned by the company is turned into profits.
Operating Margins % 2010 2009
Bamburi 18.8 18.3*
ARM 13.3 12.6
EAPC -3.1 22.2**
*minus their once off sale of their stake in ARM
**Includes a once off revaluation of their investment property. From above we can see that Bamburi has the highest net margins and thus the most profitable cement firm in Kenya, this is owed to their high level of efficiency.
b. Return on Equity
Calculated as ROE=Net income/shareholders equity.It shows a firm’s profitability, basically it tells how much profits it generates for funds from its shareholders.
ROE % 2010 2009
Bamburi 24.5 26.2*
ARM 17 15.6
EAPC -5.1 30**
Yet again Bamburi comes on top but as Bamburi’s ROE declines, ARM has been growing its ROE in double digits, indeed Bamburi shows signs of a company that has reached its maturity while ARM is in a growth mode.
c. Cash flow per Share (CFPS)
CFPS measures a firms financial strength and sustainability of its business model.
CFPS % 2010 2009
Bamburi 20.8 17.6
ARM 1.05 1.9
EAPC 10.5 16.7
e. Debt to Equity
Debt to Equity % 2010 2009
Bamburi 21.6 13.6
ARM 62 52
EAPC* 35.8 26.6
*Has a Sh 3 Billion Yen loan which was recently converted to other currencies.
CONCLUSIONS
With increased capacity, competition and energy costs we expect the margins to come under pressure.
ARM-we place a HOLD recommendation on the stock, despite increased volumes from its Tanzania unit which will translate to more sales, increased competition, energy costs and high interest rates will slow down the growth momentum, at a PE of 23 its trading at a premium to its peers.
Bamburi-we rate Bamburi cement as ACCUMULATE due to its high level of efficiency and expected increased capacity from its Ugandan unit.
EAPC-we rate it as a Speculative Buy due to the company’s change in strategy, they recently changed their Yen loan to other currencies and have been shifting to more energy cost saving initiatives such as coal, all this might push the stock out of loss making territory.
The author Davis Mika is an accomplished writer on all things investment. Find more of his insights here