Jul 2009 Financial News

The Caribbean Cement dilemma - to manufacture or not

Jul 03, 2009

I have been following with some interest the recent tribulations of Caribbean Cement (CCCL), as they seek to justify imposing CET on imported cement. In contrast there are others against the CET, arguing that the 2006 experience of bad cement from CCCL almost shut down the construction industry and should never be allowed to happen again.

This argument is compelling, remembering the reports of the negative effect on the local economy and lost growth opportunities at a time when the world was booming.

CCCL argues that since 2006 they have invested heavily in productive, storage, and quality control capacity resulting in a very small chance of any recurrence. They also posit that they are capable of supplying 100 percent of market needs and further that the imported cement is nothing but dumped product, which we can remember had a debilitating effect on the dairy industry, eventually causing it to basically shut down resulting in lost production and employment.

The experience of the dairy industry should not happen again. Even more recently Goodyear made a decision to close its manufacturing operations and concentrate on imports, as much cheaper tyres were being imported. One of the questions therefore is when it is necessary to protect an industry, and the answer lies in looking at the net effect on the economy.

In considering this I spoke with the persons at CCCL, to get some numbers to do some analysis on CCCL's benefits to the Jamaican economy. So for transparency's sake I am declaring that the numbers are from CCCL and that I hold a small amount of shares. But what is important is the logic of the arguments, and numbers can always be verified.

My interest in this issue is because of the apparent interest in removing the CCCL blemish we have on our record of declining manufacturing in this country. I see for example in the Gleaner (June 25, 2009) where the president of the JMA, Omar Azan, is quoted as defending Jamaican patties against imported patties because of its positive contribution to the Jamaican economy. Based on this argument I would expect therefore that is in favour of the protection of CCCL also, which would mean he is working not only on behalf of his members but in the interest of the Jamaican economy.

First I want to look at the arguments against the duties on imported cement:

1. CCCL is perceived to cause the shutdown of the construction sector in 2006. The fear is that this situation could recur. We need to consider, however, if this is still justified. CCCL has invested US$177 million in its production facilities, which has the capacity to produce more than the market demand. In fact the increase in inventory in 2008 over 2007 on CCCL's audited accounts supports this argument. CCCL has increased its export of cement, demonstrating excess capacity.

2. Another argument is protection of fair competition. This was the same argument forwarded publicly for the dairy industry, and may have been the case for tyre imports. The result is that we now have no dairy industry and no manufacture of tyres, and no doubt would have lost much employment and are at the mercy of the producers overseas who can export inflation to Jamaica, causing further pressure on the foreign exchange rate. We see also the massive import food bill because of our lacklustre performance in agricultural production.

3. Some argue that the profits are paid out to the overseas parent company. In fact the last dividend payout made by CCCL was in 2005 (as reflected on the audited accounts), which means that the money would either be reinvested in the company or is in the cash reserves.

There are also some compelling arguments for supporting CCCL's position. These can be summarised as follows:

1. When I looked at the audited financials it is obvious that in order for the plant to keep open it has to produce a minimum amount, else it may not make sense keeping it open. This I surmised from the rising inventory even when sales are falling, which means that below a certain level of production adds greater per unit costs. If sales continue to decline then the plant may reach a point where it has to scale down considerably, leading to the following:

a. Unemployment, as layoffs would of course be the prudent decision (the unemployment would not only be at the plant but throughout the island at various distribution channels etc); and

b. Increased costs of cement to the market

2. Information I received from CCCL showed that they pay out annually $2.8 billion in salaries, $3.4 billion in purchases, collect and pay $1.3 billion in GCT, and $500 million in statutory payments. Any significant disruption in operations could see these economic benefits being cut significantly, which could add to the economic and fiscal challenges we face. CCCL employs some 439 persons of which 242, or over half, are in production. The logical decision for a company like CCCL is if production falls below covering variable costs then it would obviously want to shut down its production facility and concentrate on importations alone, similar to Goodyear and Nestle. This would mean a minimum job loss of 242 persons in addition to the significant reduction in demand for electricity, thus negatively affecting GDP.

3. One other option available to CCCL of course is to increase exports, and dedicate most of its production to exports. What will happen, though, if something goes wrong with the imported cement, which is also a real possibility as we do not know about the reliability and quality standards of the overseas facilities? The fact is that CCCL could not easily re-channel its goods back to the Jamaican market and even when done it may be at a premium.

4. My understanding (CCCL information) is that every tonne of imported cement demands US$100 to be sent abroad, while every tonne of CCCL cement produced results in US$25 being sent abroad. This means that if the 720,000 tonnes CCCL sold into the market were imported it would mean an additional US$54 million being sent abroad per annum.

I think the arguments on both sides have merit and again must say I have only got information from CCCL and not the other side. The arguments for maintaining our manufacturing sector are compelling, as the head of the JMA has argued. The Minister has correctly stated that one cannot, without merit, impose restrictions on imports, as the world moves towards freer trade (although at times it seems it's just Jamaica).

What we must do, however, is ensure that imports are at a justifiable price and not just a price to close down CCCL or any other manufacturer and then we suffer future price rises, as with the dairy industry. We have to also ensure, particularly in this case, that the quality of the imports and the production facilities meet certain minimum standards. I also am wary of us losing a local industry in a product such as cement, as when China and the other emerging economies start to grow at rapid rates again we might find ourselves in a very long line waiting for cement.

The minister has his work cut out for him, as CCCL also needs to justify the claim that the 2006 problem will not recur. Once this is satisfied, however, I would support the JMA head's argument to protect the local industry as in the case of patties. I welcome arguments from the other side as debate is necessary to arrive at the best solution for Jamaica.

Source: Jamaica Observer
http://www.jamaicaobserver.com/magazines/Business/html/20090702T220000-0500_154683_OBS_THE_CARIBBEAN_CEMENT_DILEMMA___TO_MANUFACTURE_OR_NOT_.asp
Article by: Dennis Chung
03-07-09