Building Blocks: The Bright Future of Colombia's Cement IndustryPublished: January 03, 2012 in Knowledge@Wharton
Colombia is poised to be the next Latin American growth story, ripe with opportunity for foreign investment. Heavy industries, particularly infrastructure, will be the big winners, as Juan Manuel Santos' government looks to enact new reforms that will modernize the economy. Much like a house, the foundation for the new Colombia will be built upon the cement industry. The bulk of infrastructure spending will be directed toward transportation (primarily roads) and housing, whose key input product is cement. Within Colombia, the cement industry is dominated by three key players: Argos, Cemex and Holcim.
For international investors interested in Colombia, three themes seem to dominate their general perceptions of the country: the illicit drug trade, security concerns and tourism. However, these themes, all interrelated and paramount to achieving sustainable growth and political stability, are not the key obstacles to the country's economic development. Colombia's most crucial requirement for success is to promote and execute its new infrastructure development plan -- in particular, the development of a robust and effective transportation network as well as affordable housing for its growing population.
Within Colombia's transportation network, the mode most in need of development is land transport -- in particular, rail and roads. Unlike most other Latin American countries, Colombia is comprised of four key economic centers: Bogotá (the capital), Medellín, Cali and Barranquilla. (Cartagena, the fifth-largest city, is focused primarily on tourism.) An extremely frail network of roads and highways currently connects these principal cities. With regard to housing, the growing middle class has caused real estate prices to increase steadily. In addition, increased economic prosperity has shifted the spotlight to social welfare and affordable housing, as 45.5% of Colombia's population lives in poverty, and 75% of the population lives in cities. As Edgar Ramirez, vice president of planning and market development at Cemex Colombia, noted: "Colombia currently faces an approximate quantitative housing deficit of 1.3 million and a qualitative housing deficit of 2.5 million for a total deficit of 3.8 million. The deficit is expected to grow despite the housing currently under construction." The qualitative housing deficit is a measure that looks to capture the differences in construction quality.
Pioneering a New Mini-plant Design
Often used interchangeably, cement and concrete actually denote different substances. Portland cement, the key element in the manufacture of concrete, is made from a combination of iron, calcium, silicon and aluminum in predetermined, specific proportions. It is so named by its inventor, Joseph Aspdin, for its resemblance to a stone from the quarries on the Isle of Portland near the British Coast. From the original mixture, clinker (an intermediate product) is made from a heating and mixing process that eventually produces cement after further burning and grinding. Cement, when combined with water and aggregates (typically sand, gravel or crushed stone) forms concrete, which is ideal for constructing roads and buildings.
Cement consumption in Colombia is based on market dynamics specific to the country. According to the leading Colombian manufacturers (Argos, Cemex and Holcim), approximately 70% of the cement is consumed in bags and about 30% is consumed in bulk (a granel). In comparison, the U.S. consumes about 95% of its cement in bulk (typically sold to concrete and ready-mix manufacturers) and only 5% in bags. In addition, ready-mix concrete in bags, which is quite popular in the U.S., has not yet proven viable in Colombia due to its shorter shelf life vis-à-vis bags of cement. Concrete consumers in Colombia (for up to medium-sized projects) will purchase the aggregates, additional building supplies and cement in bags (usually the last purchase) over a period of time, mixing the concrete only when all the materials have been amassed and construction is ready to begin. This group and low-income consumers are constrained by the relatively short shelf life of pre-mixed dry concrete and its higher retail price.
Small and independent contractors in Colombia are already accustomed to purchasing bags of cement and mixing concrete at construction sites on their own, which leads to quality-control issues during construction. To guarantee quality concrete for smaller projects while still allowing contractors to consume cement in bags, Cemex, for example, is pioneering an innovative new mini-plant (miniplanta) design that will allow contractors to continue purchasing bags of cement. The proportions of cement, water and aggregates will be monitored to ensure that the resulting concrete mixture is of the highest quality. As Ramirez noted, "for larger construction projects, cement producers either set up mixing facilities at the construction site or deliver ready-mix concrete in trucks to the construction site as needed."
Breaking Down Colombia's Cement Producers
According to Martha Quintero, manager of Bogota's marketing and distribution department for Holcim Colombia, cement consumption in 2010 was approximately 9.5 million metric tons, and concrete consumption was approximately five million cubic meters. The three largest producers are Cementos Argos (4.3 million tons of cement and 1.9 million cubic meters of concrete), followed by Cemex Colombia (3.4 million tons and 2.0 million cubic meters) and Holcim Colombia (1.5 million tons and 1.0 million cubic meters). Together, the three produce more than 95% of the total output. Cementos Argos, headquartered in Medellín, has a national presence throughout Colombia. It is also the only one of the three largest players that is locally owned through Inversiones Argos, which, in turn, has a complex cross-ownership structure with Grupo de Inversiones Suramericana and other local businesses and pension funds.
Holcim Colombia focuses on the market in and around Bogotá, which represents approximately 40% of the national cement consumption and 60% of Holcim's production. According to Tomas Uribe, head of investor relations at Cementos Argos, "Argos has an installed capacity of approximately 8-9 million metric tons of cement and represents approximately 51% of the total installed capacity in Colombia at nearly 16 million metric tons." Cemex Colombia's installed capacity is approximately 4-5 million metric tons or 31% of the market. Other, smaller players in the market account for the remaining 5%. Cemex Colombia markets two brands of cement as a result of the acquisitions it made when it entered the market: Sanper, which is available mainly in and around Bogotá, and Diamante, which is available nationally. Lastly, Holcim Colombia represents 13% of the market, with an installed capacity of approximately two million metric tons.
However, competition on a national scale is limited primarily because of high transportation costs and the weight of the cement and derivative products. Despite the obstacles to competition on a national scale and the particular consumption dynamics present in Colombia, cement and concrete are expected to experience healthy growth rates in the near and medium terms. According to Ramirez, "cement typically grows at 1.1-1.3x the GDP growth rate and concrete grows at 1.5x the rate of growth of cement." Colombia's expected real GDP growth rate is 5.0% for 2011 and 2012, as indicated by José Darío Uribe, Governor, Banco de la República Colombia, in his June 2011 presentation. Therefore, cement is expected to grow 5.5%-6.5% and concrete is expected to grow 8.25%-9.75% in 2011. Nevertheless, as Ramirez was quick to note, "Cemex Colombia's sale of cement grew 11.1% during the first quarter of 2011 (January 1st to March 31st)," indicating that 2011 will be a good year for the cement and concrete markets.
Roadmap to a Better Transportation Network
Heavy rainstorms at the beginning of 2011 caused major flooding and devastating damage to Colombia's fragile network of roads and highways. As a result, US$14 billion in resources have been allocated this year for repairing and developing infrastructure. The damage literally caused cities to be cut off from each other and isolated, inconveniencing the general population and adversely affecting the competitiveness of Colombian products in the international market due to elevated transportation costs. In addition, even during the dry season (typically between May and September), roads -- often with only one lane -- are congested with trucks that limit the average speed to 30 kilometers per hour (kph). During holidays, the average speed can fall to 20 kph.
It is no surprise, then, that, according to Colombia's Ministry of Transportation Investment Plan, of the 99.3 trillion Colombian pesos (US$ 56.3 billion) destined for transportation investments over the next 10 years, more than 56%, or 55.9 trillion pesos (US$31.6 billion), will be invested in highways and roads. Furthermore, more than 34%, or 19.2 trillion pesos (US$10.8 billion), will be invested over the next five years in highways and roads. Inevitably, the concentration of infrastructure investments in roads will create a strong demand for rigid (concrete) and flexible (asphalt) paving systems. However, understanding the differences between these two systems is also important to explain why Colombia's current network of roads and highways has deteriorated and remains susceptible to flooding.
As Ramirez noted, currently, 90%-95% of Colombia's roads are constructed with asphalt, which is cheaper than concrete (by a factor of three) and benefits from not being subjected to value-added taxes. Nevertheless, the useful life for asphalt roads is only three-to-four years, whereas roads constructed with concrete can last, on average, 10 years. Quintero, however, pointed out that it is not easy to simply build all new roads with concrete under a rigid paving system. Much of Colombia's geography is marked by mountain ranges, and the underlying tectonic plates continue to shift. According to Quintero, "Building any road with concrete or asphalt requires extensive technical and environmental impact studies that at the end of the day will still indicate using asphalt in certain regions that are highly prone to geological movements."
Corruption continues to create a huge obstacle to the successful development of Colombia's infrastructure. For example, many of the companies that produce asphalt (a petrochemical-based product) are owned by, or have ties to, local or national politicians. Second, winning construction contracts through public auction has long been plagued by bribery, where the lowest bidder does not necessarily win or, even worse, revises costs upward after winning the contract. In addition, the law governing the auction process, "La ley 80 de contratación pública" (Law 80 of public contracting) for construction contracts provides winning bidders with anticipos (up-front payments) to start construction. As highlighted in the article, "La caída del Grupo Nule"("The Fall of Grupo Nule"), that appearedin the September 2010 issue of Semana, the Nule brothers and their cousin Guido were finally exposed for their corrupt practices of winning contracts and living off the up-front payments in a pyramid-like scheme while completing, at best, only part of their projects.
Nevertheless, Colombian President Santos has made infrastructure a pillar of his government. To that end, a new revision of the concession and public auction law is expected at the end of 2011, and changes to the law are expected to be retroactive. Furthermore, Santos has made battling corruption another focus of his government. Construction companies have taken note, and projects that were just begun or are about to begin have been delayed as further technical and environmental studies are conducted to ensure that the appropriate standards are met. Although 90% of the current pipeline for road construction will use the flexible paving system, it is expected that the newer projects will use more concrete where appropriate, which will be a further boost to the cement industry.
High Demand for Housing
The 2005 Colombian census revealed a shortage of approximately 1.3 million homes in the country. Since then, the deficit has continued to increase, currently approaching approximately 2.4 million homes, according to estimates by the Global Property Guide. This shortage does not mean the housing market in Colombia is struggling. On the contrary, the market continues to perform well, with average housing prices rising 9.25% in 2010. However, similar to other developing countries, Colombia is not producing housing fast enough for its growing population. Each year, approximately 285,000 new households are created, but only around 145,000 new homes are built. In other words, the shortage increases by 140,000 units per year. According to Martha Pinto de Hart, the executive president of the Colombian Chamber of Construction (CAMACOL), "The current government has an ambitious plan to build one million homes over the next four years, which will require an investment of about US$43.5 billion, 70% of which will be housing solutions for low-income families."
Despite a crisis in the real estate market in other parts of the world, housing prices in Colombia continue to rise. A peaceful transition to a new president and a positive economic outlook for the country have contributed to the healthy market. In March 2011, the country's credit rating improved to investment grade, opening the gates for significant foreign direct investment in the housing market.
In developing economies, the housing sector often makes up a significant portion of the cement industry's revenues. With a strong performance from the housing sector anticipated, the Colombian cement industry is expected to thrive. The industry recognizes its dependence on housing for its growth and has taken action to assist low-income families in purchasing homes.
Cemex developed a program called Patrimonio Hoy (Worth Today), which provides support to lower socio-economic classes to encourage and ease the financial constraints of home ownership. Following the initiative's success in Mexico, Cemex brought Patrimonio Hoy to Colombia. The program seeks to reduce the Colombian housing deficit by encouraging low-income populations to save in order to pay for housing. It organizes low-income families into self-financing cells that facilitate and expedite the typical home-building process. Families served by Patrimonio Hoy gain access to credit, enjoy better living conditions and learn improved savings behavior. The primary challenge for social housing policy now is preparing the urban land for the construction of housing in all price ranges. As Ramirez noted, "With 2.5 million people in need of housing, Cemex continues to explore public housing projects that could provide more options to low-income individuals. They are searching for the right mechanism to counter both the housing shortage and the approximately 800,000 low-income individuals who currently reside in shanty towns."
The housing demand in Colombia will remain strong due to the country's solid economic outlook in terms of growth and inflation and the initial elevated deficit. The building sector's growth is predicted to be an average 10% annually for 2011 and 2012. According to BBVA Research, building permits are at high levels, and mortgage interest rates are at historic lows, encouraging home ownership. In the coming years, housing prices and costs will continue to increase moderately. In fact, even when the cost of cement decreases, housing prices remain constant -- evidence of sufficient demand in the market place. Cement sellers in Colombia predict an increase in their prices toward the end of 2011 due to increases in the costs of production and distribution associated with the strong rainy season. This is yet another reason to expect rising prices in the housing industry.
Colombia has a large low-income population and, since 60%-70% of cement consumption is "do-it-yourself" construction, pricing is the most important factor for consumers. Ramirez pointed out that "there is little-to-no brand loyalty -- consumers purchase the most inexpensive brand within a 700 peso margin per bag." Furthermore, the lack of a developed market for more convenient (but also more expensive) premixed bags of cement reflects the importance of price to the average Colombian consumer.
This consumer sensitivity to price has made cement the most popular building material in Colombia because cement structures are relatively inexpensive when compared to those built from other materials. In addition, the Colombian government's commitment to infrastructure development and repairs to existing infrastructure over the next four years will create significant demand for cement. The growth of the housing sector will contribute further to cement industry sales.
Based on the growth of these indicators in Colombia as well as improved credit and economic indicators, all signs point to strong growth in this industry.
This article was written by Jordan Brock and Julian Lautersztain, members of the Lauder Class of 2013.