Consolidation alone is not the answer; capacity must also shrink for the sector to look attractive
In the three years to 2013, China consumed more concrete than the US used in the 20th century, according to the academic Vaclav Smil. China’s economic growth has since slowed. Cement demand will never be as strong again. There remains, however, enough cement-making capacity in China to fill the peak appetite. If it is to earn positive economic returns, the industry has no choice but to shrink.
Chinese cement companies know this and believe that consolidation is the answer. The market may concur. On Monday, shares in West China Cement rose nearly 6 per cent on news that a sufficient majority of option holders had agreed to an acquisition by largest listed Chinese peer, Anhui Conch Cement. The deal should have the government’s blessing, too. Last week, the State Council reiterated its desire for a more concentrated industry. It wants the top 10 players to control three-fifths of industry capacity by 2020. This is even less radical than it sounds. HSBC points out that the top 10 cement producers already controlled 54 per cent of the market as of the end of 2015. Nor will mergers achieve what the industry needs most: outright reduction in supply.
Consolidation has already been showcased elsewhere. Last July European giants Holcim and Lafarge merged to become the world’s largest cement producer. Economies of scale did not spare the merged entity from having to announce a reduction in capex by November. Despite expected savings of $1.6bn by 2017, and anticipated improved pricing power, the maiden set of results highlighted the need to conserve free cash flow. HeidelbergCement has been faring far better. It has, at last, digested its own overblown 2007 acquisition.
Enthusiasts for a cyclical China trade might point to a near term pick-up from stimulus-led demand. Last week, the government said it would spend nearly 7 per cent of gross domestic product ($722bn) on infrastructure projects over the next three years. Construction activity has already improved as housing starts have rebounded. Yet supply is more than adequate to satisfy more demand. Fitch Ratings points out that clinker production capacity last year was 2bn tonnes, compared with output of 1.3bn. So, despite an increase in cement output of 13 per cent in the four months to April, prices over the same period actually dropped one-tenth. They look likely to keep sinking.
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