Colombia's industry and retail sectors hold expansion potential

Largely cut off from foreign investment during the 1980s and 1990s due to security concerns, Colombia developed a wide variety of local manufacturing businesses and brands. Companies such as drink maker Postobón, cement firm Cementos Argos or burger chain El Corral are household names in Colombia.

However, the opening of the economy over the last decade has forced local firms to compete with international imports. In addition, the rapid growth of the oil and mining industries has shrunk manufacturing’s importance in the wider economy. Having accounted for 14% of GDP in 2009, in the first nine months of 2015 the sector remained stagnant and its proportion of GDP shrank to under 11%. In 2015 the sector employed 13% of the workforce, up from 12% in 2014, according to the National Statistics Agency ( Departamento Administrativo Nacional de Estadística, DANE). Several sub-sectors continue to show promise, and the devaluation of the peso, improvements to infrastructure and the commissioning of a new refinery offer hope of an industrial rebound.

Incentives

Colombia is committed to free trade. At the end of 2015 the country had 13 trade agreements in force and a further eight under negotiation. For the most part the government shies away from an active industrial policy and from subsidising key industries. Incentives for manufacturers come mainly in the form of free economic zones, where companies pay a reduced 15% corporate tax and enjoy preferential trade tariffs, as well as a public-private partnership known as the Productive Transformation Programme (Programa de Transformación Productiva, PTP). The PTP, which focuses on 11 segments of the manufacturing industry, aims to bring private and public sector figures together to facilitate dialogue, promote national industry and encourage training and technology transfer. However, relatively high corporate taxes and labour and transport costs have eroded the competitiveness of Colombia. The increase in free trade agreements (FTAs) has also caused some multinationals to close down their Colombian factories and export to the country instead. In May 2015 US food company Mondelez closed down its plant in Cali to export from Mexico under the Pacific Alliance trade deal, a strategic path previously trod by car- maker Mazda, which closed its Colombian assembly plant to supply from Mexico.

Refining

By far the largest component of the industrial sector is the refining sector, which accounts for one-fifth of industrial output and 2% of total GDP. In the first 10 months of 2015 the refining sector shrank 5.1% due to the temporary shutdown of the Cartagena refinery, known as Reficar, as the final touches to its upgrade were put in place. In November 2015 the new refinery was commissioned. Two years behind schedule, the $8bn Reficar began production at a rate of 80,000 barrels per day (bpd) with a gradual ramp up to 165,000 bpd scheduled by March 2016.

Reficar is the most advanced refinery in Latin America, capable of processing the country’s heavy crudes and producing low-sulphur products. The conversion factor – the ratio of product produced per barrel of oil – will be boosted from 74% to 95% and derivatives will have 10 parts per million (ppm) of sulphur compared to 2400 ppm previously.

The refinery will have a significant effect on Colombia’s trade balance. In recent years the country has imported 1m barrels a month of diesel, gasoline and jet fuels. Reficar will make the country self-sufficient in such products – although lighter crudes will be required for mixing – and, after meeting domestic demand, exports of product are expected to reach 120,000 bpd. Investment bank BBVA estimates that the new refinery’s cheaper, locally produced fuels, combined with an expansion of total national refining capacity to 275,000 bpd, will boost Colombia’s industrial sector GDP by 2.6 percentage points and national GDP by 0.7 percentage points in 2016.

Cement

The two principal construction materials, cement and steel, have experienced diverging fortunes in recent years. While Colombian steel production has faced cut-throat competition from Chinese imports, the nature of the cement industry – whereby the producer’s proximity to end clients is rewarded – has seen the country’s main cement firms grow rapidly. DANE data shows that in the first 11 months of 2015 cement consumption in Colombia grew 6.1% on the previous year to fall just short of 12m tonnes. To date, this growth has been driven by the real estate sector, but the construction of major new infrastructure projects from 2018 to 2020 has spurred new investments that could significantly boost output.

The cement industry is dominated by three major players. Local firm Cementos Argos controls around half of the market while CEMEX LatAm Holdings (CLH), the international wing of the Mexican cement giant, accounts for a further 25%. Swiss firm Holcim has a 17% market share and the remainder is supplied by smaller regional firms. In recent years each firm has focused on organic growth. The centre of the country, demarcated as the triangle between Bogotá, Medellín and Cali, accounts for around 60% of total cement demand, and it is here that many of the $20bn worth of infrastructure investments are focused.

“The first wave of 10 infrastructure contracts, set to begin construction in 2016, will require 1m tonnes of cement,” Jairo Julián Agudelo, head of equity research at Bancolombia, told OBG. “Over the next five years the total demand from all infrastructure projects will be around 5m tonnes and that doesn’t take into account organic growth of real estate.”

Cementos Argos is set to expand its capacity by 3m tonnes through the construction of new units near to Bogotá and Medellín. CLH is building a new 1m-tonne facility near Medellín and expanding its capacity by 400,000 tonnes on the Caribbean coast. In September 2015 Spanish cement producer Cementos Molins announced that it would build a 1.35m-tonne plant in Antioquia in partnership with local construction firm Corona. The $370m investment is set to come on-line in time for the 2018 spike in cement demand.

The combined investments will take installed capacity to over 20m tonnes by 2018, but there appears to be little risk of oversupply, according to Agudelo. Firstly, 1.8m tonnes of Cementos Argos’s capacity comes from less-efficient wet-process technology that is likely to be squeezed out of the market by its dry-tech competitors. Second, cement mills in the centre of the country are already approaching full capacity. “In Medellín and Antioquia plants are working at above 85% of installed capacity,” said Agudelo. “The country has never seen an infrastructure programme like the current one and around 60% of projects are located close to Medellín, so I doubt we will see over capacity for the next five years.”

With the segment enjoying a bright outlook, Cementos Argos and CLH have performed strongly on the Colombian Securities Exchange. In the third quarter of 2015 Cementos Argos reported a 35% increase in revenues year-on-year (y-o-y) and a 63% growth of net profits to COP372bn ($136.9m). The firm has also become an increasingly important regional player, expanding across Central America and the Caribbean. While anti-monopoly law confines the firm to organic growth in Colombia, Cementos Argos has undertaken a series of acquisitions in the region and in May 2015 the firm acquired its first Puerto Rican asset, a cement terminal and distribution centre valued at $34m. However, the firm’s boldest moves have come in the US. Following the 2014 acquisition of a Florida cement company for $720m, it has a 6.6m-tonne capacity in the state, making it the second-largest cement producer in the south-eastern US. Cementos Argos is set to become a major player in the recovering construction sector in the US.

Steel

The country’s steelmakers have a great opportunity to benefit from the construction and infrastructure boom, though they face strong external competition. Colombia is home to five steel producers, the two biggest of which are Brazilian-owned. Acerías Paz del Río, owned by Brazil’s Votorantim, is the only vertically integrated company, controlling two iron ore deposits in Boyacá and Cundinamarca, and the country’s only blast furnace.

The other Brazilian company, Gerdau Diaco, owns mini mills (producing steel from scrap) in Tocancipa, Cali and Boyacá, while three smaller firms, Sidenal, Sidoc and Ternium, own mini mills in Boyacá, Cali and Manizales, respectively. All five exclusively produce long steels – such as rebar used in construction projects – while a number of smaller firms import flat steels and process them into finished products.

Long steel production has shown a small increase from 1.3m tonnes in 2013 to 1.4m tonnes in 2014, according to the Colombian Steel Producers Committee (Comité Colombiano de Productores de Acero, CCPA), a body of the National Business Association of Colombia. In 2015 the sector posted a healthy production of 1.42m tonnes. However, the influx of Chinese steel has depressed prices and prevented local firms exploiting the rapid growth in domestic demand. “Between 2005 and 2015 the apparent consumption of steel in Colombia more than doubled to 2.5m tonnes,” Camila Toro Dangond, director of the CCPA, told OBG. “However, this rise in demand has been met mainly by imports which reached 900,000 tonnes in 2014, and grew around 30% in 2015.”

Investment & Imports

According to the CCPA, Colombian steelmakers invested over $630m between 2010 and 2014 to improve efficiency, boost production and enhance environmental standards. However, unless they receive support from the country’s trade negotiation teams, they could be poorly placed to benefit from the coming surge in long steel demand – tipped to reach 1.9m tonnes by 2020 – spurred by infrastructure projects. In 2013 the Ministry of Trade, Industry and Tourism introduced safeguards for 200 days, raising tariffs on rebar, wire rod and four types of finished flat steel. However, only the safeguard on wire rod was maintained, with a tariff of 21%, while rebar tariffs fell back to their original 10%. Ultimately more will have to be done to stem the tide of cheap Chinese imports if domestic production is to grow. “The Chinese steel industry does not behave according to market conditions,” said Toro. “Between 2000 and 2013 China invested a sum equal to the combined GDPs of Colombia, Peru and Chile in its steel industry. Nearly 70% of global steel oversupply originates from China and its subsidised exports severely undercut producers in other countries.” Colombia is not alone. The impact of cheap Chinese steel is felt across global markets, and affected countries are likely to put pressure on the World Trade Organisation to make tough decisions in 2016.

Motor Vehicles

The motor vehicles segment faced two major challenges in 2015: the weakening of the peso and the reduction in tariffs as a result of international trade agreements. The number of new vehicles registered in 2015 fell 13.2% y-o-y to 283,380 units, the lowest level since 2010. Between 2002 and 2013 the automotive sector experienced an annual average growth rate of 13%, increasing from 100,000 units to 294,000 units. Rising incomes in the middle classes, combined with a strong peso and reduced import charges, made imported vehicles more affordable. However, over the course of 2014 and 2015 the peso declined 64% against the dollar, reversing this process. Among the sub-sectors most severely affected were commercial passenger vehicles, which saw a decline of 36% in 2015, and vans, which dropped 34%. Faring slightly better, car sales dipped 8% and light commercial vehicles 11%.

Assembly

The falling peso provided some respite for the country’s auto assembly firms. Only Renault and General Motors assemble vehicles in Colombia. During 2015 domestically assembled vehicles gained competitiveness and increased their market share from 31.7% to 33.8% of unit sales. The exchange rate is likely to provide only temporary relief, however. GM Colmotores is the biggest player with 24% of unit sales, but it sold 67,792 vehicles in 2015, a 17.4% drop on 2014. Renault fared better; its sales of 48,980 vehicles represented a 2% fall from the previous year.

However, the combined sales look paltry when compared with the 181,941 vehicles assembled in Colombia in 2007. The government’s commitment to free trade means that the sector will be pushed harder by cheap Asian imports in the coming years. In 2013 Colombia finalised an FTA with South Korea that would reduce tariffs on Korean vehicles – which then stood at 35% – by 3.5 percentage points each year for 10 years. In 2015, just a year into the treaty, Korea’s Hyundai and Kia sold a combined 45,981 vehicles in Colombia, according to figures from the Colombian Association of Motor Vehicles. Japanese firms Mazda, Nissan and Toyota sold an additional 45,009 units in 2015, a year in which negotiations for a Colombia-Japan FTA continued. Trade deals with the Asian countries are not the only threat, however. The signing of the Pacific Alliance was the crucial factor behind Mazda’s decision to leave Colombia and serve the country – tariff-free – from its larger plant in Mexico.

Drive On

The reduction in tariffs is good for consumers. In a March 2015 research report, BBVA forecast that sales would recover to 305,000 vehicles in 2016 on the back of stabilising prices and continued tariff reductions. Colombia is an attractive market for vehicle exporters due to its relatively large population of 47m and a low vehicle penetration rate of 100 per1000 inhabitants as of 2013, based on BBVA figures quoted in a study by Colombian think thank Fedesarollo. Brazil, Argentina and Mexico all have over 250 vehicles per 1000 inhabitants.

As a result, the Asian auto giants are investing heavily in their Colombian sales infrastructure to gain market share in a growing market. In March 2015 representatives of Japanese firm Subaru announced the firm would invest $15m in marketing and showrooms to boost sales 75% to 1000 units in 2015 with a goal of 3000 sales per year by 2020. On January 1, 2016 Hyundai began its contract with a new distributor for Colombia – Neocorp – a company distributing Hyundai vehicles in Mexico, Ecuador and Venezuela.

“In Colombia, as in the rest of Latin America, we are seeing automakers transfer their distribution contracts from local family businesses to international distributors,” Fernando Pardillo Antón, CFO of SK Bergé Colombia, which sells brands including Jeep, Dodge, Ram, Peugeot, Volvo and Chrysler, told OBG.

Sum Of Its Parts

The outlook looks less rosy for car assemblers and the parts industry. The automotive sector accounts for 4.1% of gross industrial production and provides 22,300 jobs, according to BBVA. However, the industry has failed to meet targets for national content. “When the assembly companies entered Colombia, most parts were imported from the US and the goal was to provide 30% of content from national industry, rising to 60% by 2015,” Tulio Zuloaga, president of the Association of the Automotive Sector and Parts, told OBG. “However, now parts also come from Mexico and Korea as well as the US and imports account for 85% of content.” According to Zuloaga, contraband is also a major challenge for local producers of parts. “Colombia used to have three domestic producers of sparkplugs. However, original German and Japanese sparkplugs were entering the country illegally not subject to taxes or tariffs. The companies couldn’t compete and had to close.”

Textiles & Fashion

The city of Medellín has a proud tradition as a centre of national textile production. Each year the city hosts the country’s premier catwalk event, Colombia Moda, and one of the continent’s largest textile industry exhibition, Colombiatex. However, in recent years, with regards to performance, the fashion and textile manufacturing segments have diverged. In the first 10 months of 2015 the garment industry grew 4.4% y-o-y while the textile industry fell 7.7%, according to DANE figures. Between 2004 and 2014 the Colombian fashion industry grew at an average annual rate of 4.2%, reaching production of $8.7bn, behind only Argentina and Brazil in the region. By 2017 ProColombia, which promotes Colombian exports abroad, estimates that the sector will be worth $9.9bn.

The country’s clothing manufacturers are boosted by a buoyant domestic market. In 2015 local sales of fashion products were expected to grow over 6% to reach $5.2bn. The fall in the peso has given a boost to local industry. According to ProColombia, sales of domestically produced underwear grew 10% in 2015 while imports fell by the same figure. “Colombia’s major supermarkets and department stores undertook a process of import substitution in 2015,” Rafael España González, economic director of the National Traders Association, told OBG. “For basic clothing they have imported less and found local suppliers.”

In 2013, citing deliberate under-valuation of clothing prices, the government introduced a tariff of 10% plus $5 for clothing imports with a value of $10 or less per kilogram. But that charge can only be levied on those imports that are formally registered. Similar to the auto parts sector, the clothing industry must compete with contraband products that circumvent tariffs. Industry associations estimate that 40% of all clothing sales are from smuggled goods.

Exports

Colombian clothing firms have also proved less effective at competing with Asian producers for international markets. In 2009 the country exported $600m of clothing to the US, but by 2014 that figure had dropped to $200m. In 2015 geopolitical issues also affected trade with two key export markets, with Venezuela shutting its land border and Ecuador – which uses the US dollar – introducing 45% levies on clothing imports. Total exports of clothing fell 4.7% in the first eight months of 2015, with Ecuador (down 35%) the worst performing market. In the first six months of 2015 Colombia exported $470m of clothing, but imported $1.2bn. With average labour rates of $2.50 per hour, compared to $2.20 per hour in Mexico and $0.60 per hour in Vietnam, according to Inexmoda, Colombia’s Institute for Export and Fashion, the industry may struggle to compete in international markets on a price basis. The future of the export sector appears to rest in developing niche products with value-added. Sportswear is a case in point, with Medellín firms producing high-tech fabrics with antibacterial properties, UV protection and intelligent fibres that mould to the athlete’s body.

Services

The service sector is one of the mainstays of the economy, accounting for 15.3% of GDP in the first nine months of 2015, growing 2.8% y-o-y during that period. Opportunities for growth exist in a number of segments. Despite the slowdown in mining and oil projects in 2015, services that can support the country’s extractive industries and infrastructure contractors still hold potential. “With around 80% of unexplored territory, international companies specialised in geology and cartography from Austria, Canada and Switzerland are seeing the potential in Colombia,” David Roche, managing director of Sigla, told OBG. “Additionally, the ambitious infrastructure programmes launched by the government have created an ideal environment for technologically backed companies to enter the market.”

Another area of potential is call-centres and business process outsourcing (BPO) operations. By the close of 2014 there were over 3000 companies working in the sector in Colombia with annual revenues of $5bn, over 1% of GDP. However, the sector could be just scratching the surface of its potential. “Given its high level of human capital and competitive cost structure, Colombia is a potential regional hub for customer service and BPO,” Helio Duenha, general manager of Bosch Colombia, told OBG.

Retail

Despite a slowdown in economic growth and the weakening of the peso, the retail sector posted solid y-o-y growth of 3.4% in the first 10 months of 2015. If the weak-performing vehicles and fuels segment is excluded, growth for the period was 7.1%. The best-performing sectors included hardware and home improvement sales (18.3%), alcoholic beverages and cigarettes (13.5%), cleaning products (8.9%) and white goods and furniture (6.7%). During the first three quarters of 2015 DANE records that the retail sector (including restaurants and hotels) contributed $14.7bn to the economy, or over 12% of GDP. “Surprisingly, the retail sector has not experienced a major slowdown in tandem with the Colombian economy,” said España. “In addition we have seen foreign firms enter the market with new business models.”

Increased competition has been seen in the sale of food and groceries. Although total sales grew 6% in the first 10 months of 2015, sales per square metre of commercial space have remained stagnant, according to España. Traditionally dominated by Medellín’s Groupo Éxito, which owns the Éxito and Carulla brands, the supermarket segment has been disrupted by the entrance of budget and discount options. One such chain, Tiendas D1, recorded sales growth of 15% in the first eight months of 2015, expanding its network to over 350 stores. In February 2015 Grupo Santo Domingo, one of Colombia’s largest holding companies, acquired a further 34.32% stake in the firm for $68.9m, taking its total holdings to 59%.

Meanwhile, Portuguese distribution and consumer goods firm Jerónimo Martins has focused the expansion of its Tiendas Ara supermarkets in secondary cities. By the end of 2015 the firm had 86 sales points in Colombia’s coffee region and around Cali with 40 more on the Caribbean coast. The group plans to invest $317m in the country between 2016 and 2020.

Outlook

It is fair to say that Colombian industries have reacted slowly to the realities of lower import tariffs and higher competition. For some sectors the outlook appears bleak, but in others the opportunity to export unique products is beginning to be understood. And while other Latin American economies stall as a result of weak commodities prices, the infrastructure programme set to pick up pace in 2018 provides a source of investment and increased demand.

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The Report: Colombia 2016

Industry & Retail chapter from The Report: Colombia 2016

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