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Strong construction sector growth will support Saudi cement makers

By Yazad Darasha
25 December 2011

Construction contracts worth SAR 95 billion (USD 25.33 billion) were awarded in Saudi Arabia during the third quarter of 2011, more than the combined value during the preceding two quarters and a 104% increase over the third quarter of 2010.

Growth in the Saudi Arabian cement sector is expected to ride a construction boom that will see a significant shift from private sector-led demand in 2011 to government-led demand in 2012, a key bank has said.

At the same time, concerns about supply are likely to lead to strong pricing support, according research released by NCB Capital . The potential demand-supply imbalance could become particularly acute in the western region, where demand is expected to be high.

Construction contracts worth SAR 95 billion (USD 25.33 billion) were awarded in Saudi Arabia during the third quarter of 2011, more than the combined value during the preceding two quarters and a 104% increase over the third quarter of 2010.

The total value of contracts awarded during the first nine months of 2011 was 125% higher than the same period of the previous year.

"Although delays in major projects are the norm, based on conversations with cement buyers, we believe 2012 should see good progress in major projects which will support demand. Feedback from cement players indicates that demand in 2011 was largely private sector-led, indicating that government demand is yet to come and should support the sector in the coming few years," said NCB Capital analyst Farouk Miah.

Cement sales over the first nine months of 2011 were 12.6% higher than in the same period of 2011, according to data compiled by Jadwa Investment . The volume of imports of construction goods through the ports between January and July was 8% larger than in the same period of 2010.

With the government committed to a substantial house-building program over the next few years, construction should remain one of the fastest growing sectors.

Expansion Delays
Concern has been expressed, however, that Yanbu Cement and Southern Cement have been unable to tie up subsidized fuel from Aramco to run their expanded lines. This puts into doubt whether or not these new lines and the additional 4.5 million tons of capacity will be able to commence commercial production on time in 2012.

In October 2011, Yanbu announced it halted production at its first, second and third lines in order to save fuel for trial operations at its new fifth line. Next month, Aramco said it would continue to fulfill its fuel supply agreement with Yanbu and that the cement producer did not notify it in advance for extra fuel for its fifth line.

"Based on our discussion with Aramco, we believe the area of debate is the supply of crude for new lines from existing companies as well as new companies. In the long term, we do not expect lack of fuel to be a significant concern given the government's aim to quickly progress with construction activities in the Kingdom," Miah said. "However, if this issue is not resolved quickly, this could cause supply issues in the coming 12 months."

Price Inflation
A question-mark over supply could lead to price inflation. According to an Arab News report, contractors in Madinah have said that the price per bag of cement at the retail level has risen to SAR 23 from SAR 15. They said that in addition to skyrocketing prices, there was a scarcity in supply at both the wholesale and retail levels.

"From our conversations with market participants, we believe a government-imposed factory price limit of SAR 250/ton for type 1 cement and SAR 260-SAR270/ton for type 2 cement implemented several years ago has never been formally removed," Miah said.

"We believe around 70% of total cement used in Saudi Arabia is of type 1 form with the more specialized forms being able to charge higher prices. Although the implementation of these price limits recently has not been stringent (several firms charged average prices above these levels in 3Q11), significant and persistent prices above these levels may not be possible for fear of the government clamping down on cement companies.

"In addition to the factory price, there is an additional SAR30-SAR40 fee which the distributor/transport company charges, leading to a possible price of over SAR300/ton for the end consumer. Thus, a possible scenario could be continued good demand growth which is coupled with constrained supply, although prices will be limited by the ceiling set by the government," the analyst added.

Earnings Growth
Higher demand coupled with increased prices would mean higher earnings for cement producers. Revenues of the nine listed cement companies increased 24% on-year to SAR 2.11 billion during the third quarter of 2011. Gross income grew 27% to SAR 1.12 billion. The sector's gross margin expanded 1% on-year to 53% during the quarter.

The sector's net income increased 27% on-year to SAR 982 million during the third quarter, with the net margin expanding by 0.9% to 46.5%.

NCB Capital expects cement companies to show good profit growth in the fourth quarter of 2011 due to a combination of strong growth in sales volume and steady prices. Total revenues are expected to increase 19% to SAR 1.972 billion, gross profit to grow 25% to SAR 1.098 billion, and net income to expand 30% to SAR 1.003 billion.

"We expect year-on-year sales growth to slow in 2012," Miah said. "For sales volume, we expect YoY growth of domestic sales at covered stocks of 5% against the 9% expected for 2011. For revenue and profitability, we expect the stocks under coverage to record growth of 4.6% and 5.3% respectively against the 13.8% and 18.7% expected in 2011."

Miah said this slowdown is due in part to the very strong numbers and thus a high base in 2011, as well as the larger companies using up their inventories of clinker, which should stop any significant inflation in prices in 2012.

© Zawya 2011