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ANALYSIS; Cement sector: Dancing on thin ice
In 2015, Indonesia’s cement production was among the top eight in the world and was second in Southeast Asia after Vietnam
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In 2015, Indonesia’s cement production was among the top eight in the world and was second in Southeast Asia after Vietnam. This fact is in line with the rapid investment from global giant cement corporations that invest in Indonesia and progressively increase production. Among the firms are Lafarge Holcim (Switzerland), Anhui Conch (China), CNBM (China) and Heidelberg Cement (Germany).
At the same time, large domestic players, such as Semen Indonesia and Semen Bosowa, are also following the trend and investing more on expansion of plants or clinker. It seems that all cement producers in Indonesia perceive the domestic market as a potential and highly attractive market due to increasing demand from the property and infrastructure sectors.
Therefore, to catch up with demand growth expectations, cement producers are boosting their production capacity through more capital investment.
Data from various cement producers in Indonesia show that national cement production capacities will almost double, from roughly 80 million tons in 2015 to around 150 million tons in 2017.
If we break down the figures based on area, there will be 39.5 million tons of additional cement production capacity in Java, 8.85 million tons in Sumatra, 13.9 million tons in Kalimantan, 7.5 million tons in Sulawesi and 2.4 million tons in Papua. Based on the same data, Java, as the heart of property and infrastructure development in Indonesia, is still expected to drive national cement sales.
However, hitherto the growth of the property sector has not yet recovered due to the weak economy. Hence in 2017, we expect the margin in the cement industry to be lower than the current level due to oversupply.
Current development of cement capacities in many regions in Indonesia is a result of strong demand growth from 2011 to 2012 due to the property sector boom. As for increasing demand for infrastructure, it started in 2015 when the budget allocation for infrastructure development grew 53.8 percent from the previous year. This situation led cement producers to anticipate a lack of capacity if demand increased continuously.
Unfortunately, investment in the cement sector is rather unique because plants should be constructed in a large capacity in order to reach a low cost per unit. Furthermore, when there is a lack of capacity in the industry, producers will race to invest in developing new plants. No producer wants to be one step behind the others. The Indonesian cement sector is precisely like this.
Theoretically, the graph above shows that the movement of cement capacity is stiff when there is a horizontal line, if there is no expansion over a period of time, while a vertical line indicates new production capacity expansion.
Thus, over time it will look like stairs, as illustrated in the graph below. In contrast, cement demand will be shown as a straight line over time. This leapfrog in capacity, which is presented as a vertical line in the graph, will lead to an excess supply of cement over a certain period of time until demand can fully absorb the production surplus.
The duration of the catching up period differs depending on demand and economic conditions at the time. High demand growth will certainly shorten the duration, while low growth will make the duration longer. After demand and supply match, the cycle will then be repeated upon signals from the market to increase production.
Based on our simulation, the duration of the catch-up period strongly depends on how fast demand grows. Our simulation shows that assuming that capacity is doubled within two years as planned, and with the assumption of 7 percent construction growth, cement production capacity can be fully utilized by 2032, or in 16 years.
If we assume that the construction sector represents the demand side for cement, then we will find that if construction grows by an average of 7 percent, then we may expect that the predicted double capacity of cement will be fully absorbed only by 2032.
If construction demand is eventually lower than 7 percent, the time required to reach full capacity utilization will be much longer. Note that construction growth in the last five years has been about 6.5 percent.
After reading that analysis, one may ask a logical question: why are most cement producers in Indonesia still eager to increase their capacity, given the imminent threat of oversupply?
Using the Herfindahl Hirschman Index (HHI) to assess market concentration or competition, we find that market concentration of cement has gradually decreased from 31.7 in 2012 to 30 in 2015. It means that cement industries are less concentrated than before because new players have entered and cut into existing players’ market share.
Therefore, in order to maintain their power in the market, some producers have chosen to increase their production capacity and try to win back their market share. As a result, if we analyze some listed cement producers, their profit margins have been decreasing since 2013.
However, not all cement producers suffer from lower market concentration. Cement producers in Sulawesi, Maluku and Papua have higher market concentration than those in other regions. They still control a high market share compared to other player.
Two big players in those areas are Semen Tonasa and Semen Bosowa. Nonetheless, this condition is temporary. One multinational cement producer that has invested in the eastern part of the country is Anhui Conch Cement, which started its development in Manokwari, West Papua. We predict that after 2017, it will constantly try to gain a bigger market share in Sulawesi, Maluku and Papua.
Hence, existing players in Sulawesi, Maluku, and Papua need to come up with new strategies to defend their market share, especially on how to increase their efficiency, particularly in production and distribution. High economic growth in these regions will attract all cement producers and affect market concentration. A price war can be expected in the near future.
As mentioned before, both property and infrastructure development play very important roles in the development of the cement sector. Based on its category of cement products, almost 80 percent of cement is sold in sacks and the remainder in bulk. Based on this information, we identified the property sector as the highest user of cement, because sacks of cement are used for property construction.
However, the 2016 outlook is bleak. The projections of almost all segments in the property sector are stagnant except for hotel construction. We expect to see a rebound in the property sector, with a demand growth in 2017 as a result of the central bank lowering interest rates to a single digit. Hence, we expect the move will boost consumers’ desire to buy property, since interest rates will be lower.
Therefore, for 2016, infrastructure development is still the key to boosting cement demand in Indonesia. Government commitment to execute various infrastructure projects provides hope for cement producers in Indonesia to survive the current market turbulence.
One thing that should be carefully watched is overcapacity, which can happen in the next 15 years. With production almost doubled from 80 to 150 million tons, the cement industry in Indonesia will face a challenging business environment. An oversupply of cement is very likely to happen, resulting in decreasing prices and lower profits.
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The writer is a regional analyst at PT Bank Mandiri
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