ARM Cement slides into the ICU as industry woes deepen

Athi River Mining factory

?Cement maker Athi River Mining (ARM) has sunk into the worst financial hole in its history. The firm's health has deteriorated so fast in the last one year in what saw it plunge from Sh2.8 billion loss in 2016 to a massive Sh6.5 billion last year, its biggest loss in over a decade.

Its auditors, Deloitte & Touche refused to issue an opinion on their financial statements on grounds that they are not certain that the company will still be in existence in the next one year, what accountants refer to as a going concern.

ARM Cement, which was started by the Paunrana family, has been in losses for the past three financial years.

The financial health of the firm, which is Kenya’s second largest listed cement maker, is so bad that even if all its assets were sold today, among them the factory, plant and equipment, it will not get enough money to pay off its debts.

The Deloitte auditor who signed off the report, a CPA F. Okwiri, says that the cement maker's current liabilities exceeded its current assets by Sh13.4 billion and has additional accumulated losses amounting to Sh2.9 billion.

"These conditions combined with the historical performance of the group indicate that a material uncertainty exists, which may cast significant doubts on the group's ability to continue as a going concern," the auditors said.

Analysts have described this situation as 'distressing' given that it is now surviving on overdrafts that more than doubled to Sh4.4 billion last year.

"The cement manufacturer’s liquidity ratio at 0.22 is distressing, indicating that the company can barely meet its immediate obligations - current liabilities (Sh17.2billion) outweighs current assets (Sh3.7 billion) by Sh13.5 billion,” research analysts at Standard Investment Bank (SIB) note.

The firm is now being accused by its auditors of many years for not being truthful in declaration of financial health and this made them withhold their opinion.

Auditors usually withhold their opinion if they feel that a company has not sufficiently disclosed a significant development that affects its ability to remain in operations through issuance of a disclaimer of opinion.

In other cases, where all information has been provided, auditors can give a qualified opinion or an adverse opinion depending on how perverse its problems spread.

"The summary consolidated financial statements do not contain all the disclosures required by International Financial Reporting Standards and the Kenyan Companies Act," the auditors said, warning that reading the summary of the financial statements is not a substitute for the full and detailed reports.

All efforts to resuscitate it and get it out of the financial intensive care unit it sunk into in 2015 seem to have hit a dead end. Unless a miracle happens, it is just a matter of time before it switches off its plant in Athi River for good.

It has made numerous changes to its executive suite with some as late as last week, to try and inject new ideas to help change its course.

To try to remain afloat, the firm sold off its non-cement business, Mavuno Fertilisers Ltd to Omya (Schweiz) AG and Pinner Heights Kenya Limited (related to the main anchor shareholder of ARM). 

The transaction, that was to be completed in January 2018, is valued at about Sh1.6 billion, but this appears to have been swallowed without a burp and is an effort that came a little too late.

Raw materials

Research analysts say that asset disposal is the most viable option now for ARM, and could involve a look at the Tanzania unit. "We think investors might have oversold the stock, despite its distress situation – but a solution has to be found soon for its key assets," SIB says in its latest report.

ARM is not sailing alone. Despite having thousands of acres of land to mine its raw materials from, State-controlled East African Portland Cement Company (EAPCC) is also in the red.

It saw a fourfold widening of its half-year losses to Sh969.7 million. Results for the six months of trading ended December 31, 2017 left the company worse off compared to a loss of Sh248 million in a similar period in 2016, with shareholders staring at the prospects of a sixth straight year without dividends. The firm, in which National Treasury owns 25 per cent stake and NSSF 27 per cent, has a negative working capital of Sh3.4 billion partly due to a bank overdraft of Sh1.1 billion.

Its outlook for the remaining six months of the year may not be so promising given the oversupply and slowdown of cement consumption in the country. Its revenues dropped by Sh660 million, which translates to 18 per cent in the half year period, to Sh3 billion. 

EAPCC is now looking at selling part of its 14,000-acre land to support its declining fortunes. "The company has enormous resources in the form of idle and fully mined parcels of land, the Board expects to be granted the necessary approvals to generate value from these idle parcels of land," the firm said in a statement.

Bamburi Cement, which is the only profitable listed cement maker in Kenya, has also been hit by the whirlwind blowing across the cement firms in Kenya, which has seen its profitability decline. 

The country’s largest cement maker by market share, which also owns Hima Cement Ltd in Uganda, saw net earnings drop by 67 per cent to Sh1.97 billion from Sh5.89 billion in the previous year in line with the company’s profit warning issued last November.

Bamburi, controlled 58.6 per cent by France’s conglomerate Larfage, saw its operating profit margin dropped from 21 per cent in 2016 to 11.8 per cent last year, the lowest in over 10 years. As a consequence, this pushed up its operating costs by 4.7 per cent at a time when companies were looking for ways to cut off excess fat to survive the storm. The board was forced to cut dividends by more than half in the financial year ended December 2017. 

The firm blamed its slide in earnings on a contracted market due to low sales. Its sales declined by Sh2 billion to Sh36 billion. 

"Cement demand declined last year and this significantly affected the industry. There was also overcapacity development, which though not very unusual impacted on firms that do not have staying power such as ARM. Bamburi remains largely debt-free and this gives it a better staying power in the market," Eric Musau, head of research at Standard Investment Bank (SIB) told Weekend Business.

The firm, largely owned by LafargeHolcim, has resorted to drawing from its cash reserves rather than taking debt, in order to finance its capital expenditure. This is in a bid to avoid similar pitfalls that are threatening to wipe off ARM from the market.

"Notably, the company has maintained below-industry-average gearing levels – a competitive advantage in a low price, highly competitive environment," analysts say.

The trouble in the cement business can also be attributed to a price war waged by new moneyed private players such as National Cement, Mombasa Cement and Savannah Cement.

However, since the numbers of these private players are not made public, it is highly unlikely that they have been unscathed by the turbulence in the cement industry, which is now threatening jobs and the viability of the sector.

Cement consumption contracted 8.2 per cent year-on-year last year to 5.8 metric tonnes with the construction sector adversely affected by the prolonged election period in Kenya, delayed large infrastructure projects, constrained access to credit for developers and a general slowdown in the individual home builder segment.

The woes in the industry will be complicated further once players complete their planned increase in capacity despite the current glut in the market that has resulted in over supply, forcing some players to operate their plant below capacity.

New grinding plants

Bamburi is increasing its capacity in Kenya and Uganda by 1.8 metric tonnes, National Cement added 1.2 metric tonnes per annum from February 2018 and Savannah Cement plans to double its capacity.

"Competition will remain intense as cement companies increase their capacities in an oversupplied regional market," SIB notes

The increase in capacity is also happening in the region. For example, Mbeya Cement completed its grinding plant in Tanzania in 2016 at the same time Dangote Cement was completing its 3 metric tonnes per annum plant.

In Uganda, Kampala cement also brought on board a new grinding plant. In total, the region is looking at eight new grinding plants that have added capacity in the last three years. There are more than 16 cement companies in the East African region each fighting for a piece of the action, five of whom are listed.

This is also promising a fresh round of price wars in a market where players are not just wounded but are struggling to limp to their next sale.

The industry is however counting on revival of consumption this year driven by the Jubilee Government’s agenda to increase housing by 1 million units in five years, as well as the second Phase of the Standard Gauge Railway (SGR) project to Naivasha and expansion of various ports.  

"Future market outlook remains positive with the unveiling of the Agenda Four initiatives by the national Government where affordable housing and manufacturing were among priorities,” EAPCC says in a statement to investors.

Administrative costs

"The company will continue with the ongoing restricting programmes covering both operations and financial aspects of the business. This is geared towards reduction of the high finance and administrative costs and stabilization of the value chain processes."

But it is ARM which will be the most bruised player in the region, having barely survived another price war waged by Dangote in Tanzania.

In an earlier meeting with this writer, the firm’s chief executive Pradeep Paunrana blamed its state of affairs on costly miscalculations it had made when it went into the Tanzanian market.

He said his firm was caught up in the battle between two cement giants -- Dangote and Heidelberg Cement -- that spilled over from West Africa.

"In West Africa, there are many overlapping countries where Dangote has moved into the traditional market of Heidelberg and Dangote’s strategy has always been to drop the price and hope for a market grab immediately,” he said.

But in Tanzania, it did not work out that way for Dangote because his plant is located at the bottom part of the country whereas the main market is in Dar-es-Salaam. Heidelberg plant on the other hand, which produces Twiga Cement is located in Dar, where ARM is also located.

So it had no transport costs. This left Dangote on the losing end of the cement price war. But he was not going to go down without a fight. Heidelberg kept on dropping the price from about $120 (Sh12,106) per tonne in 2014 to $100 (Sh10,088) by 2015.

By 2016, when CDC put in the money in ARM, the price had shrunk to $88 (Sh8,877) and by end of May 2017, it was down to about $60 (Sh6,053).

"This was a battle of giants and we were all affected. At $60 (Sh6,053), we are not making any money despite the fact that we were struggling with production because of lack of coal," Paunrana said.

The firm says the three main pillars of its turnaround are in restructuring its balance sheet, reducing its debt, but not at the cost of its shareholders. Many companies restructure their balance sheets when they are in financial distress.

In hind sight, Paunrana says the firm should not have built a big plant in Tanzania. "There were too many headwinds that created a perfect storm. But there is no point in regretting. CDC put in $140 million just last year. How could an army of experts from London also get it wrong? Nobody could predict this," Paunrana said then.

This type of business needs a lot of capital and a strong balance sheet that can help it weather the storm.

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