High consumption: Huge demand for cement as large projects get under way

The cement sector features characteristics common to so many markets in the country’s economy: short supply, mushrooming demand, Chinese imports and plans to boost local capacity. The importance of new domestic supply cannot be understated, as the government’s plans in the next five years include $40.5bn in spending on major projects in energy, housing, rail, roads and industry. Each will address a key economic constraint and each will, to varying extents, require cement to make it happen.

And as with many other economic activities in the country, geography and climate are major constraints that must be accounted for. Cement cannot be poured at temperatures freezing or colder, and a lack of awareness in the past among contractors has helped to keep demand high because some road fixes have not lasted more than a season or two, and building facades have cracked. Importing cement from China is difficult because domestic consumption has been high in that country but also because there is limited capacity on the one rail link in existence as of late 2012.

RISING IMPORTS: According to data from the National Statistical Office of Mongolia (NSOM), annual cement consumption reached 1.2m tonnes in 2011, and production reached roughly 425,000 tonnes, implying that roughly 66% of market demand is met by Chinese imports. However, as is common in Mongolia, statistics can differ. Unofficial statistics peg consumption in 2011 at 1.5m tonnes, according to the World Bank; the market share of Chinese cement is elsewhere often at 70% but rises as high as 90%, it found. Indeed, historically, local production had been sufficient to meet half of demand, according to the Ulaanbaatar-based market-research firm R2 Research.

Demand is widely expected to reach around 2m tonnes per year in the short-term – the World Bank’s research does not specify a projected year; however, local securities company BDS ec projected that to happen in 2012 for the Ulaanbaatar market alone. BDS ec’s research also sees a rise to 3m a year by 2015.

STEADY GROWTH: Although Mongolia’s mining boom in the past few years has had a profound impact on demand, the market for cement has been a steady grower for most of the current millennium. Compound annual growth was at 52% on average from 2002 to 2008, according to BDS ec’s numbers. Over that time, the year-on-year (y-o-y) average increase in production has been 30%, and the y-o-y average increase in imported cement 140%, according to Ulaanbaatar-based Frontier Securities. Annual rail delivery capacity is 2500 wagons, all of which have been accounted for by existing imports since 2006.

The side effects of this imbalance include frequent delays, which typically range between two and five weeks, in getting cement to construction sites, according to BDS ec. In a country in which the construction season typically lasts approximately six months, this can be a major obstacle to finishing a project. An additional problem in bringing in more cement is that Chinese railroads use narrow-gauge rails and Mongolia’s use wide gauge, which means one to two weeks reloading cargo, according to BDS ec. These constraints can lead to price spikes, such as in 2007 when cement prices surged 75% within the season due to 450 wagons being delayed at the border with China.

PRICING: Cement prices have been rising in line with the growing demand and increasing scarcity – on average tripling in the past five years, according to the World Bank. However, a blip in recent years can be explained by the global financial crisis and its impact on Mongolia. According to the NSOM data, a 50-kg bag of cement (M500) cost MNT6925 ($4.85) in 2011, up 19.4% from MNT5800 ($4.06) in 2010.

However, that was the highest recorded price since 2008, when the same bag cost MNT6496 ($4.55). The price dropped to MNT5327 ($3.73) in 2009 before beginning to rally once again.

Imported Chinese cement had typically cost more than local production until 2012. For the first half of 2009 the premium was at 48%, according to BDS ec, but narrowed until it flipped in January 2012, when local products cost 12% more. “From 2010, because of the bottleneck effect at the border of China and Mongolia, it is too risky for construction companies to rely solely on raw material supply from China,’’ according to BDS ec’s analysis. “The local concrete companies started to have more pricing power.’’ TRANSPORTATION COSTS: Costs to produce Chinese cement are almost equal to the cost of delivering it to Ulaanbaatar: $42 per tonne in comparison with $38 a tonne. The mark-up in China beyond production cost was pegged at $18 according to BDS ec, which implied a baseline price of $98 as of October 2012.

Should Mongolia’s domestically manufactured products continue to cost more, that implies strong margins and profit prospects for local producers, at least until more join the market and supply is no longer a concern, or until import capacity is increased.

As of late 2012 it was difficult to determine which catalyst would happen first. There are two more rail links to China in the works, both being built by Mongolian companies with coal mines near the border. These new rail links will run from those mine sites into the Chinese rail network, which leaves them of limited use for the cement industry, as end-users are to be found in Ulaanbaatar and second-tier cities and not clustered around the sites of two coal mines.

BETTER LINKS: Longer-term plans approved by the parliament call for an east-west rail line that could link the other two to the existing north-south railroad on which all cement cargo currently travels. There is also the potential for that existing line, which is part of the Trans-Siberian Railway, to be double-tracked.

Those plans, however, are inherently linked to Tavan Tolgoi, the vast coal deposit in southern Mongolia that requires rail capacity in order to exploit. Mongolia plans to form a multinational consortium to further develop Tavan Tolgoi – a group that is likely to include five governments and a private US company. This group is considered necessary in order to bring to Mongolia the expertise, capital, railroad capacity within China, and other ingredients needed.

Once a consortium is set, the mine’s state-owned parent company, Erdenes Tavan Tolgoi, plans an international initial public offering that will bring capital for the project and also possibly make raising capital easier for all Mongolians by improving to its international reputation and visibility on global markets. With these factors in mind, a difference-making boost to import capacity through railroad capacity could come as early as 2015, according to BDS ec’s outlook.

NEW PRODUCTION CAPACITY: In the meantime, local production capacity is ramping up. Indeed, according to Frontier Securities’ market study, the major domestic producers have a total installed capacity of 860,000 tonnes a year, but have been producing between only 330,000 and 380,000. Each have expansion plans that would add about 1m in capacity, bringing the total installed capacity to 1.68m tonnes.

Barriers to entry into cement production include the cost of building a plant, which Frontier pegged at $300m for a facility with 1m tonnes. In a country with a GDP of some $6.2bn, capital is likely to be a constraint until it becomes a more bankable investment destination, more likely to attract foreign direct investment and to be able to tap capital markets globally for more foreign portfolio investment.

One cement company on an expansion kick is Remicon JSC, which is publicly traded on the Mongolian Stock Exchange and part of the Hera Holdings conglomerate – one of several that have emerged as diversified leaders in Mongolia’s private sector. Remicon currently provides ready-mixed concrete in the Ulaanbaatar market, with a capacity of 150 to 200 cu metres an hour on that basis. The company’s production facility is only about 12 km from the capital city, and that provides it a competitive advantage over competitors, according to BDS ec, which began analyst coverage on the company shares in October.

Remicon CEO E. Munkhsaikhan told OBG the company’s plan is to add a second line that will double production, and also to operate a mobile plant to expand its coverage beyond Ulaanbaatar. This facility can be packed up and moved a few times a year, and the company aims for it to locate first in Choyr, a town 250 km south of Ulaanbaatar on the railroad line.

Not all of that extra capacity will hit the market, however – Remicon told BDS ec’s analysts that its plans call for internal use of 80,000 tonnes of its expanded annual capacity of 180,000 tonnes. Several other cement producers do the same. Asia Pacific Investment Partners, a Hong Kong-based conglomerate focused on the Mongolian economy, has emerged as a leading developer and owns a cement factory as part of its strategy of vertical integration.

Another market impact could come from Aizawa, a Japanese firm that produces frost-proof concrete. It opened up a manufacturing facility in Mongolia that will reach full production in 2012, according to local media reports, and should its technology prove popular that could help lengthen the building season.

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The Report: Mongolia 2013

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