Lacking local construction activity, domestic cement demand contracted five per cent in 2007 and another 6.9 per cent in 7M08, and is anticipated to drop further in 4Q08. There are several reasons why further decline is expected. First, a weak Business Sentiment Index (BSI) signals sluggish construction activities. Second, the current flooding will further weigh on cement demand in the quarter.
Finally, the investment expenditure in the government’s 2009 budget will not be enough to offset the subdued cement demand from the private sector. For the full year, domestic cement demand is forecasted to drop five per cent.
Though BSI picked up a slight 0.6 points MoM to 41.5 points in July, the figure is still below the average in 2007 of 43.4 points and far below 50.0 points, indicating poor business sentiment. Looking ahead, the index is likely to show a sideways downtrend, weighed down by the unclear political scene and deterioration in external factors resulting from the global economic slowdown. As local cement demand typically moves in tandem with BSI, cement sales volume is poised to remain stagnant for remainder of this year.
Should current flooding worsen, it will be another adverse factor to cement sales in 4Q08. Based on our analysis, though fourth quarter construction activities typically revive QoQ after the rainy season, it does not recover in exceptional years when severe flooding takes places. This is seen in the fourth quarter cement demand trends which picked up in 2001, 2003-04, but dropped in 2000, 2002, 2005-06, pulled down by severe flooding throughout the period (reflected by the damaged to infrastructure exceeding Bt5.0bn). As the damaged areas take time to drain out, existing and potential construction would be postponed, and the rebuilding of the infrastructure might gradually occur in late fourth quarter to first quarter.
Currently, 36 provinces have flooding. Though the amount of damage done to the infrastructure hasn’t been tallied yet, the damage to agricultural areas has already jumped to 2m rai, slightly higher than the 1.7m rai seen in 2005. Thus, it can be implied that the damage from 2008’s flooding will be comparable to what was seen in 2005, and also implies weaker demand for cement during 4Q08.
Based on the government’s budget expenditure of Bt1.8trn for fiscal year 2009 (October 2008-September 2009), the budget allocation for investment rose only 1.7% YoY, while fixed expenses and principal repayment increased 11 per cent and 40 per cent YoY, respectively.The unexciting-scale of investment won’t be enough to offset the subdued cement demand from the private sector, implying inactive demand for the sector. Note that the mega projects are still far in the future and the bidding process for the first mass transit lines will take place in late 2008, so demand for cement from the projects wouldn’t begin until 2H09 at the earliest.
In 7M08, export cement sales volume plummeted 9.6 per cent YoY, in-line with forecast of a 10 per cent YoY decline. Export volume is expected to continue to drop at this pace for the rest of 2008 as Siam City Cement (SCCC, Bt167, OP) slashed its 2008 export volume by around 2-3mn tons after closing two kilns (accounted for 10-15 per cent of Thailand’s cement export volume). The economic slowdowns in the US and EU should have minimal impact on the cement export volume as the exposure of Thailand’s cement export to these areas is less than four per cent, and major cement export destinations are still in Asia (South Asia 40 per cent, ASEAN 37 per cent, and the Middle East of 6.8 per cent).
Though production costs are still high, cement prices are likely to rise further, as producers can pass costs on through their selling prices despite facing contracted demand. Nevertheless, cement prices have risen over 20.0% this year, so it will be harder to raise prices by such a high magnitude. Hence, cement prices are expected to increase only to match rising costs rather than jump sharply. Net-net, we see the negative impact of shrinking sales volume overshadowing the sustainable margins, implying that bottom lines will be hurt.
Peer comparison: SCCC is top pick
Among cement groups, SCCC is preferred for a few reasons. First, the company offers a striking dividend yield of more than eight per cent per annum, providing downside protection for the share price. Second, it is set to deliver the best margin in the industry. While others maintained or expanded their export sales, which contribute poor margins (export cement prices are around 30 per cent below domestic prices), SCCC cut its export volume in 2008. Third, SCCC’s 4Q08 earnings would be better YoY as its 4Q07 earnings were quite low, pulled down by the compensation expenses for employees of Bt150mn due to the kiln closures. Finally, though the cement outlook is not that good, it is still far better than the outlook for the chemical industry, which is weighed down by slower global demand (capped sales growth) and the start up of new supply from 2009 onward (pressure margin). Thus, a pure cement player like SCCC would be in a better position than its peers.
Note that Siam Cement (SCC, Bt134, N) and TPI Polene (TPIPL, Bt3.50, U)’s earnings exposure to their chemical units are 50 per cent and 15 per cent, respectively.
Despite falling for the last seven consecutive quarters, domestic cement demand is poised to continue downward in 4Q08, due to the negative signals from the weak BSI, the current flooding, and the government’s minimal investment budget. Though margins are still at a healthy level, it won’t be enough to offset the deterioration in sales volume, implying weaker bottom lines. Thus, the sector is downgraded to Underweight from Neutral. SCCC is top pick.