After already seeing a couple of weak years with domestic cement demand declining 5.0% in 2007 and 10.9% in 11M08, according to a report by KGI Securities, consumption is anticipated to continue to head south and drop another 10.0% YoY in 2009. Poor investment sentiment, coinciding with the weak economy, would cap private investment activities, thereby pressuring local cement sales. Nevertheless, KGI do not expect cement demand to plunge 42.0% as was seen in 1998, as the low base for local cement sales after volume contraction in 2007-08 and the acceleration of the government’s budget disbursement would prevent a deep contraction in cement demand this year.
In November 2008, Business Sentiment Index (BSI) reached an all-time low of 34.4 points, down 3.9 points MoM. In the near future, BSI might increase following the easing in local political tensions after the new coalition government was set up. Nevertheless, it’s unlikely to edge up significantly as the market is now concerned about the global economic slowdown. The rebound in BSI should be below the average of 43.4 points in 2007 and 42.7 points in 2008 and far below the 50.0 points that indicate poor business sentiment. Therefore, domestic cement sales growth is poised to be weak in the coming quarters.
The outlook for private investment, consisting of residential, commercial, and industrial sectors, is entirely bleak. For the residential sector, poor demand ahead and the high level of unsold units means new supply is expected to decline. For the commercial sector, though expansion plans are still set to continue, they will be quite a bit lower than in the past due to cuts in consumer spending amid the economic downturn. Lastly, for the industrial sector, Thailand’s political uncertainty and the global economic woes would lead to a further delay in new investment. All of these would hit domestic cement demand. Economist expects private investment growth to drop to 2.1% in 2009 from 4.2% in 2008.
During the various transition periods of changes in the government, budget disbursement from the total investment budget in fiscal year 2008 (October 2007-September 2008) dropped to 78.6%, down 1.8ppts YoY. Under the new government, though the investment budget disbursement is set to accelerate from the low base last year to alleviate the economic downturn, total budget allocation for investment is minimal at only Bt400bn, up only 1.7% YoY, implying an insignificant impact to cement demand. Besides, the mega projects are still far in the future and cement demand from the mass transit lines won’t begin until late 2009 at the earliest. Economist expects public investment to rise to 5.5% in 2009 from -2.2% in 2008.
Despite the trivial increase in public investment and acceleration in the government’s budget disbursement, the lack of private investment would be the issue to pull down local cement sales. From KGI’s study, domestic cement sales are more dependent on private investment than public investment. Domestic cement sales volume growth has a high correlation to private investment of 0.71 and a low correlation to public investment of 0.48.
Though the major reason for more than 10.0% drop in Thailand’s cement export in 2008 was the slashing of cement production by Siam City Cement, dwindling demand from the global economic woes would be the main factor pressuring cement exports down 15.0% in 2009. In contrast to volume contraction for only SCCC in 2008, export volume reduction would be seen by all cement producers in 2009. So far, Thailand’s cement export destinations have minimal exposure to the economic recessions in G-3 countries (Europe, US and Japan) with the proportion of exports at less than 4.0%. Nevertheless, Asia, which accounts for more than 80.0% of Thailand’s cement export market, is also undergoing economic slowdown. This, in turn, would lead cement export volume to dip.
Some might be concerned that cement margins will be hurt if cement prices drop at the same pace as coal costs. However, this is very unlikely. From KGI’s study, cement price growth has a negative correlation to local cement demand growth of -0.75, while it has no correlation to the change in coal costs. For example, in 1998, cement prices jumped 26.9%, while domestic demand dipped 42.0% and coal costs dropped 15.6%. In 2005, cement prices dropped 7.3%, while domestic demand ticked up 6.5% but coal costs fell 10.3%. During the downturn, cement producers attempted to maintain their margins to alleviate the negative impacts of volume contraction, whereas, during the upturns, cement producers could sacrifice their margins in exchange for higher sales volume. Even though coal costs dropped around 60.0% from the peak in July 2008, cement prices remained stable throughout the period. Looking ahead, if cement prices remain at this level, after gradually increasing since late 2007 to mid-2008, it would imply cement prices will grow YoY. This should be a positive factor for cement margins.
The continued drop in cement volume amid stable fixed costs suggests cement margin will be hurt. The industries utilization rate declined to 60.1% in 2008 from 70.7% in 2006, similar to the drop in utilisation rate after the 1997 financial crisis in 1998-99. As cement volume is expected to continue to drop in both the domestic and export markets next year, the cement margin would be pressured further.
Net-net, the positive impact from the stable cement prices while coal costs decline would be counterbalanced by the negative effects of the drop in capacity utilization rates. This implies sustainable cement margins. Nevertheless, a contraction in sales volume would surpass the healthy cement margin, implying weaker bottom lines.