Egyptian manufacturers continue recovery amid challenging environment

 

With a long-established presence of large-scale manufacturing capacity and a rapidly expanding domestic market, the industrial sector has long been a fundamental component of Egypt’s economy. With the combined potential of a population of nearly 100m and a central location between Africa, Europe and Asia that makes it well situated to service international export markets, the industrial sector has built a reputable manufacturing track record across an array of different segments.

Foreign Investment 

Because of the sector’s economic weight and its capacity to generate employment, the authorities have increasingly focused on expanding production and attracting more foreign direct investment (FDI). Although key industrial projects have long been based around the northern region and close to the Suez Canal, there have been increasing efforts to channel new investment into other regions, such as Upper Egypt, to help drive economic development across the country’s different governorates.

Expansion plans come, however, at a time of new challenges for the sector. Although the worst of the economic instability that arose after the 2011 uprising has subsided, domestic manufacturers have had to deal with a weaker pound, which lost over half of its value against the US dollar after the government floated the Egyptian currency in November 2016. This has brought challenges and benefits. “Many industries have been affected, both positively and negatively, by the flotation of the exchange rate in November 2016,” Mohamed Zein, director of consumer, health care and industrial research at Beltone Financial, told OBG. “Fertilisers, for example, are being heavily exported. Therefore, while the cost base of exporters expanded, revenue also did, and the impact of foreign exchange rate flotation was positive in some cases. Many other industries, food and beverages for instance, focus on domestic consumption and the effect of devaluation has been negative.”

Industry executives are hopeful that the benefits will outweigh the costs over time. “While many of the recent economic reforms are likely to have a positive impact in the long term, for industries that import raw materials, de-pegging the pound from the dollar has been a significant challenge. The benefits, however, will come from increased export opportunities,” Tarek Al Gioshy, CEO of El Gioshy Steel, told OBG.

Textiles are a another growing industry with significant opportunities to increase exports, Fadel Marzouk, CEO of Giza Spinning, told OBG. “Local manufacturing costs have decreased with the devaluation of the pound, and since cotton is locally produced, you do not have the same downside as industries that need to import source materials,” he said.

Sector Performance

It is in this context that the authorities are hoping to implement policies to accelerate the growth of the sector as a whole. Manufacturing segments accounted for 16.7% of GDP in 2018, according to the “Egypt Economic Report” published by Lebanon-based Bank Audi in February 2019. However, a broader view of the industrial sector, including both manufacturing industries and the country’s significant extractive sector, puts the overall value of industry at 27.8% of GDP. The sector’s share of total employment was estimated at 26% in 2017.

Although the 2011 uprising brought economic instability and likely delayed investment plans by both domestic and foreign investors, recent years have brought a degree of improvement. Indeed, Egyptian manufacturing industries have been able to post seven consecutive years of overall growth. In 2018 manufacturing expanded by 4.8%, an improvement on the 2017 growth rate of 2.1%. Notably, the petroleum refinery segment grew by 4.1% compared to a contraction of 3.1% in 2017. The remaining manufacturing segments, grouped by Bank Audi under as “other industries”, have also seen a fast turnaround in recent years, growing by 5% in 2018 compared to 3.7% in 2017.

The sector’s extractive segments, which include petroleum and gas extraction and mining, also experienced significant growth. The segment expanded by 7.7% in 2018, compared to a 1.8% contraction in 2017. Positive results were seen across the extractive sub sectors; petroleum production grew by 0.7% in 2018 against a 6.5% contraction in 2017, showing a promising recovery, while gas production expanded by 17.9% in 2018, compared to 2.1% in the previous year. Strong performance across 2017 and 2018 was fuelled by investment and development of recent gas discoveries. The third subsector, other extractive activities, grew by 3.1% compared to 3.4% in 2017.

Energy Supply

In the long term, expanding the sector’s value will be driven by energy supply and electricity generation. Although there was little investment in the power generation segment between 2011 and 2013, due to instability and lack of financial resources, the authorities have resumed their focus on securing additional production capacity.

The discovery of significant offshore gas reserves — including the Zohr offshore field discovered in 2015, which is estimated to have 30trn cu feet of gas — have changed the energy equation for the economy and, in particular, the industrial sector. Egypt had been experiencing a severe shortage in gas, which affected energy generation companies, gas distribution and industrial producers that used it as feedstock. The country had been importing liquefied natural gas (LNG) since 2015 to support its gas requirements as local production was insufficient to cover demand. However, in September 2018 the authorities announced an end to the import of LNG, and at the end of 2018 the Ministry of Petroleum announced that the country had achieved self-sufficiency in gas consumption.

Egyptian manufacturers continue recovery amid challenging environment

Improved energy availability has given industrial players the confidence to expand production. “We are seeing increasing operating rates for industrial manufacturers in the market. In terms of adding new installed capacity, it is slow, but it is coming,” Ahmed Hazem Maher, vice-president of research at Egyptian investment bank EFG Hermes, told OBG.

Under the current conditions, industrial expansion plans are likely to focus on non-organic growth, due to the higher costs involved with establishing greenfield manufacturing operations. To avoid bureaucracy and red tape, investors wanting to enter the sector or expand their foothold might initially opt to buy working factories as opposed to establishing new ones.

Oversight

Although the Ministry of Trade and Industry is the principal state body in charge of sector orientation, several other players also have a say in policy direction. The General Authority for Investment and Free Zones, affiliated with the Ministry of Investment and International Cooperation, operates as a one-stop shop for foreign investors entering the Egyptian market and supports international operators aiming to establish partnerships with local companies. Another important role is played by the Industrial Development Authority, charged with issuing operating licences for key industries such as cement and steel.

A new taxation regime, approved in August 2016 by the Parliament and implemented in early 2017, has influenced the business environment for industrial operators. The legislation eliminated the sales tax and included a value-added tax (VAT). For the first half of FY 2016/17, VAT was fixed at 13%, but this rate was raised to 14% in June 2017, while in November 2017 VAT was extended to apply to real estate leases.

Other measures were implemented with an eye to the country’s attractiveness for FDI. A new investment law, Law No. 72, was issued in May 2017 and allows investors a 50% tax break if they invest in underdeveloped areas across the country, as well as government backing to pay for the cost of linking up new projects with water and electricity access. Also included is a provision to allow investors to get back 50% of their investment on land acquisition if the new industrial project begins operations within a two-year window. Meanwhile, domestic materials production was strengthened by the passing of the Public Procurement Act in May 2018. This law prioritises products that include a minimum of 40% of domestic content in government tenders.

“It is important that regulations are created with a long-term view to business development, and that businesses are able to make plans and project earnings. This kind of clarity on the future environment is an important factor in the decision to invest,” Khaled Saad Mohamed, general manager of Zamil Steel, told OBG.

Improving the performance of the manufacturing sector will be essential to overcome one of the economy’s biggest obstacles: its dependence on imports. The government is trying to remedy the trade balance by encouraging exports as well as boosting FDI. Although investment remains largest in the traditional industrial sectors such as hydrocarbons, petrochemicals and fertilisers, FDI has accelerated in other segments like consumables. The results of these regulatory changes can already be seen. “The recent economic reforms directed towards making Egypt more competitive as a base for exports are beginning to pay off as investment, particularly in consumables, and food and beverages, is increasing,” Mohamed Shelbaya, general manager and vice-president of PepsiCo Egypt and Jordan, told OBG.

Industrial Zones

Development of the sector over the long term will require adequate space for new manufacturing capacity. In line with this, the authorities have been focusing on the establishment of industrial areas and free trade zones. One of the main areas of development was set up in 2015 near the Suez Canal as a means to capitalise on its strategic maritime link. The Suez Canal Economic Zone will offer a variety of port infrastructure as well as four different industrial zones catering for specific segments. The authorities also signed an agreement with Russia in 2018 to build a 5.25m-sq-metre industrial zone in Port Suez which will cost $190m and is expected to launch in late 2020 or early 2021 (see analysis).

Cement

Driven both by domestic and external demand, Egypt has been able to establish a robust cement industry. Continued expansion of production capacity has transformed the country into a significant regional cement producer. Between 2006 and 2014 total installed cement production capacity increased from around 30m tonnes per year to as much as 70m tonnes. Despite adequate capacity, production has at times been limited by insufficient energy supply.

The long-term perspective for the sector is directly linked to the expected expansion of construction and real estate development, with annual demand growing at around 6% per year. “Industrial growth is being spurred by increasing demand from the construction sector, whether for infrastructure projects or the development of the New Administrative Capital and other new cities,” Ahmed El Guindy, CEO and managing director of aluminium and glass manufacturer, and facade contractor AluNile, told OBG.

Sizeable urban development plans, such as the ongoing construction of a new capital city to the east of Cairo, are expected to drive consumption patterns over the coming decade. New investment in transport infrastructure will also help cement producers. “Typical road works in Egypt are done with asphalt and gravel, but the government is aiming to add cement into road building for the roads to last longer, so this will definitely also help cement demand as well,” Maher told OBG.

The cement industry had, as of 2017, an installed production capacity of around 79m tonnes, but only 53m tonnes of cement are consumed annually. “A pick-up in demand increases competition in the market, and this generally keeps prices down,” Maher told OBG.

New capacity has been coming on-line. A new 13m-tonne capacity cement production unit began operations in the first quarter of 2018 in Beni Suef, 120 km south of Cairo. The $1.1bn project was established by El Areesh Cement, which is owned by the Egyptian army. The new unit has six production lines. In February 2018 international media reported the existence of 5m tonnes of cement inventory on the Egyptian market. In addition to cement, other investments are helping to develop the construction materials market. In 2017 Egyptian Cement announced plans to establish a $332.4m building materials complex in the Sohag governorate in Upper Egypt.

Steel 

Manufacturers of steel have also experienced the demand created by an expanding construction sector. However, recent years brought difficulties due to the lack of adequate foreign currency supply necessary to import iron ore. This challenge, however, has improved since the pound was floated. Ezz Steel is the largest producer of steel in Egypt, with an output of 3.4m tonnes of rebar as well as an additional 1.1m tonnes of flat steel in 2017. Acting on complaints from domestic steel producers, the authorities implemented temporary anti-dumping duties on rebar imports from Turkey, China and Ukraine in mid-2017. At the end of 2017 the tariff was extended for five years.

Additional capacity is on the way. Al Gioshy Steel, which inaugurated a LE500m ($28.1m) steel rebar production unit in 6th of October City in January 2018, announced in December 2018 that it would invest an additional LE500m ($28.1m) to build a second production line set to be operational before the end of 2019.

Foreign players are also investing in additional capacity. Russia’s Metprom, has announced it will channel $249m into its steel production capacity in Egypt. The firm told Egyptian authorities it would invest $71m build a new wire and rebar production unit, while an additional €178m would go towards revamping its existing iron and steel factory in Helwan. In mid-2018 the Ministry of Industry and Trade reported that Chinese firm Sinoma International Engineering was aiming to invest $100m in a new steel plant with a capacity of 2m tonnes per year. However, further details for the project had not been released as of March 2019.

Infrastructure development offers further potential for the steel industry to expand. “Although Egypt imports ore and pellets, it has the advantages of geographic position and inexpensive gas. As gas production increases and transport infrastructure is improved, this will create opportunity for the steel industry,” Hassan Elmarakby, chairman of Marakby Steel, told OBG.

Consumer Goods

Because of the country’s large domestic market and growing population, fast-moving consumer goods (FMCGs) have long been a key component of the manufacturing and agro-processing segments. “Egypt is an attractive base for any consumables manufacturing not only due to its nearly 100m-strong population and current level of population growth, but also its logistics connections to growing markets across Africa and the Gulf,” Karim Salah El Din, general manager of Coca-Cola Egypt, told OBG.

Consumption levels have risen over the years, with the agro-industrial and food manufacturing segment accounting for annual sales of $22.2bn in 2017. A better link between the agriculture sector and manufacturing capacity is essential, especially in segments where Egypt already has a competitive advantage, such as the processing of fruits, juice and frozen vegetables.

Recent economic volatility has impacted local food manufactures. “FMCGs have experienced a tough cycle since the liberalisation of the exchange rate, with many of these companies raising prices by as much as 100% in 2017,” Beltone’s Zein told OBG. However, 2018 was a more positive year. “The increased economic stability of 2018 allowed for the growth of FMCG firms, particularly in essential product areas where rationalised consumer spending had less of an impact,” Naguib Mahfouz El Saeed, managing director of edible oils company Arma Group, told OBG. Despite the pricing challenges, the segment’s long-term prospects remain broadly positive.

Incentives for manufacturing will also help to expand local production and allow FMCG producers to increase export volumes to regional markets. To ensure continued growth, firms have had to respond to developing trends. “Manufacturers of consumer products have become more competitive with respect to exports, but have had to adapt by developing less expensive alternatives to compete locally,” Shelbaya told OBG.

Petrochemicals

Efforts to reduce the country’s high fuel import bills are translating into a number of key projects in petrochemicals. The use of the country’s natural gas reserves will also free up oil for a number of value-added activities. Petrochemicals account for roughly 3% of GDP and as much as 12% of industrial output. Government policy for the sector is implemented through the state-owned Egyptian Petrochemicals Holding Company, which is in charge of the implementation of the National Petrochemicals Master Plan. The strategy, which runs from 2002 until 2020, aims to attract $20bn in investment, establish more than 100,000 jobs, and enable annual output of $15bn in exports and domestic consumption.

In September 2018 Alexandria National Refining and Petrochemicals Company began testing production capabilities at its recently inaugurated octane unit. The plant was established at a total cost of $219m, and will be able to produce 700,000 tonnes of 92-octane and 95-octane fuel per year, as well as 38,000 tonnes of butane. The unit’s output will reportedly be directed towards the domestic market. In October 2018 an agreement was also made between the Suez Company for Methanol and Derivatives and the Arab Petroleum Investments Corporation to establish a 100,000-sq-metre methanol and derivatives production unit at Damietta Port, budgeted at over $35m.

“Egypt has significant potential to attract investment in downstream petrochemicals industries as the source materials are available locally. Manufacturing in this sector is important for localising the supply chains of many industries, which will allow companies to take better advantage of the competitive value of the pound,” Hany Halim, chairman of Al Ahram Plastic, told OBG.

Textiles

The textiles segment has long been an important aspect of Egypt’s industrial sector. While its performance dwindled in the aftermath of the liberalisation of the cotton industry in the 1990s, which subsequently saw companies struggle to secure supplies, concerted effort from both the government and the private sector in recent years has given the segment a boost. The flotation of the pound also provided investors with the opportunity to tap into a more affordable workforce. “Ready-made garments manufacturing is labour-intensive and will be one of the last areas to be impacted by automation because of the complexity of the task. Access to skilled labour at a competitive price is key to attracting investment,” Oussama Abboud, CEO of Kazareen Textile, told OBG.

Outlook

The industrial sector is likely to maintain an upwards trend over the medium term, although the economic situation may impact different manufacturing segments in the short term.

Industry will remain critical for job creation and regional development. Government strategies to expand production capacity into Upper Egypt are expected to improve employment options, and investment into road and railway links will also be critical to ensure that this manufacturing capacity can be developed with a close connection with logistics networks.

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The Report: Egypt 2019

Industry & Retail chapter from The Report: Egypt 2019

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