BMI View: We remain bearish on the European building materials market as conditions for firms continue to deteriorate in light of ongoing e urozone austerity. The sovereign debt crisis, lower domestic demand from peripheral countries, and tighter financing conditions are constraining our construction outlook for the region, and will continue to limit growth for the foreseeable future. Overcapacity, increasing production costs, and falling sales volumes have hit the bottom lines of producers since 2009, and we see no immediate end to these phenomena. Notable exceptions to this trend are Russia and, to a lesser extent, Turkey and we expect these outperforming markets to sustain high levels of demand over the medium term.
As the graph below illustrates, steel production in the eurozone is following a long-run downward trajectory, and we believe that this trend is likely to continue. Notably, however, production in countries outside the eurozone, largely Russia, is incrementally bolstering output. It is our view that the production levels of the two sub-regions will soon reach parity.
Saying this, we highlight that these positives will be counterbalanced in the medium term by ongoing weakness in the eurozone economy, a view highlighted by the poor performance of steel majors over H112. In July, Europe's largest steel producer, ArcelorMittal, slashed its forecast for European steel consumption, with the company now posting a 3-5% contraction for the fiscal year. This is broadly in line with the World Steel Association (WSA)'s deteriorating global outlook for consumption - the organisation believe that global consumption will rise just 3.6% over 2012, a slump from the 5.6% experienced over 2011.
|Steel: Output Slump As Eurozone Eclipsed By Rest Of Europe|
|Europe - Crude Steel Production, '000 Tonnes|
We expect building material prices to remain under significant pressure for the remainder of 2012 as demand remains muted, while efforts to curb capacity continue. We believe that heavy public spending cuts and ongoing weaknesses in the majority of the eurozone's housing markets will inhibit a sustained recovery. In terms of supply-side costs, although we are witnessing a significant fall in the global price of iron ore, we believe that this will be largely offset by the elevated price of oil and chronic overcapacity.
With this in mind, it is our view that an ongoing decline in the consumption of building materials will have a negative impact upon total European output, as firms look to streamline their operations. On the back of lower-than-expected second quarter earnings, the Swiss based cement giant Holcim Ltd announced that a "leaner and more efficient" structure for its European operations, which over H112 experienced a 75.8% year-on-year (y-o-y) decline in operating profits - attributable to elevated costs of energy, transport and inputs, as well as the strength of the Swiss franc.
Holcim reported that sales volumes in the region were down 4.1% y-o-y, with Spain, Italy and Bulgaria suffering the steepest declines. In an effort to reduce Southern European capacity, Holcim cut employees at its Spanish plants by more than a third in July. Following the closure of its Pontassieve plant in June, Italcementi plans to end production at two further plants over Q312.
Western and Northern Europe also weighed heavily on Lafarge's H112 results, as total European turnover fell 7.5%. This decline was driven by Western Europe (10.8%), which experienced significant declines in demand from Greece and Spain. Italcementi noted a 24.9% y-o-y fall in cement and clinker sales volumes in Italy. Although Heidelberg noted sales volume increases in Germany and the Nordic region, lower shipments to the UK and Netherlands significantly hit the firm's margins.
We believe that the increase in German demand may be attributed to a notable uptick in residential starts off the back of boom in house prices. However, we currently believe that this growth lacks the potential to constitute a significant uptick in German construction activity and therefore see demand tapering off over the long run.
Overcapacity will also remain a serious problem in the steel industry. According to the director-general of the WSA, Edwin Basson, the European slump has left the region with a surplus capacity of between 30mn and 40mn tonnes per annum. In August, reports suggested that, of ArcelorMittal's 32 European blast furnaces, 10 were temporarily offline. Two of Mittal's Belgian furnaces have been taken out of service permanently and, according to reports, inefficient plants in Florange, France and Eisenhüttenstadt, Germany are also being scrutinised. In October 2011, the steel giant 'idled' plants in Germany, France, Poland and Spain.
|Cement: Emerging Europe Key To Long-Run Growth|
|Selected European Countries - BMI's Cement Forecast - Consumption, % Y-O-Y Growth|
A notable trend in our regional forecast continues to be the widening gap between conditions in the Eurozone and those of peripheral European states and CIS countries. Indeed, we expect that a gradual regional recovery will be likely be driven by emerging European markets, but note that a recovery will be subjected to significant headwinds. Government spending in Russia and Turkey will bolster demand over the medium term, yet low levels of public and private investment will stymie growth across developed markets for the foreseeable future.
Turkey - for whose construction sector we forecast robust 6.25% y-o-y growth - became the world's largest exporter of clinker and cement in 2010 and strong domestic demand off the back of large-scale infrastructure investments should sustain long-term consumption growth - our forecast posts a growth of 3.6% per annum between 2012 and 2015.
Russia will continue to solidly outperform the region. Holcim reported a 22% y-o-y rise in clinker and cement volumes in H112, and a 33% uptick in prices over 2011. Indeed, it was due to a 70% uptick in demand from Russia that offset the decline in HeidelbergCement eurozone sales volume in H112. We expect this strong growth to be sustainable over the coming years due to relatively decent construction activity - we are forecasting real growth for Russia's construction to reach 3.5% and 4.5% over 2012 and 2013 respectively.
We also note that the rise in demand from central and eastern European countries will not be uniform. Markets in Poland and Ukraine will continue to suffer from weak construction activity in the aftermath of the 2012 UEFA Football Championship - Polish demand for cement dropped 19.4% y-o-y in June.
|Domestic Cement Prices, % Variance (2011/12)*||Clinker & Cement Volumes, % Variance (2011/12 +/-)|
|*Calculation based on local currencies. (1) Weighted average like-for-like. Source: Holcim|