Laying the groundwork for brighter prospects

Local tile companies are on the lookout for brighter prospects as the post-war boom gets set to increase growth and give international exposure. Following are excerpts from a research report compiled by Nuwan De Silva of Asia Research for Asia Securities:

Investor synopsis

Currently the local tile cluster is estimated to worth circa Rs. 20 b per annum with 6-7% averaging growth rates over the past few years. Of the tile cluster 70% is contributed by floor tiles with an estimated production of 12.5mn Sqm and a value of circa Rs. 14 b.

With the expected turnaround in the land and property sector on a high geared economy, the demand for tile related products are expect to increase in due course. Further, with the expected influx of Foreign Direct Investments together with circa 8.5% GDP growth prevalent in the country, the spending on construction related activities has seen a hike over the past few months.

Presently the Sri Lankan tile cluster is on a low base with the per capita tile consumption only at 0.6Sqm in comparison to developed countries like Europe which averages 5-6 Sqm per person

Currently 40% of the production cost is attributable towards the energy cost which acts as a critical factor for the industry whilst they consume over 1,170 metric tons of LPG per month.

Sitting on a post war scenario, infrastructure investments in the country has improved drastically with over US$ 1,200 m being spend on transportation and a further circa

Lanka Walltiles dominates the local wall tile sector with a market share of 55% whilst imported tiles from the European and Asian market compete for the second place. In the floor tile sector Royal Ceramics dominates the local market with a circa 35% market share followed by Lanka Tile’s 25% market share.



Ceramic tiles industry

With the man’s desire to create living spaces which were user friendly, durable and colorful, tiles came to life during an era before 4,000 BC. Beautiful tiled surfaces have been found in the oldest pyramids, the ruins of Babylon and the ancient ruins of Greek cities. Since then the tile industry has boomed and spread across continents over time to become a highly competitive cluster.

The tile industry is a capital intensive trade with a requirement of a working capital cycle of at least 7.5 months of sale and where location of plant usually abide the source of raw material, which include china clay, feldspar, flint and talc.

The factories also have a continuous operation cycle of circa 10.5 months each year whilst only being closed for renovation and upgrades once per annum. Further the energy costs have a major impact towards the sector with 40% of the cost of production being made up of fuel cost for firing the kiln.

Due to the new technology present in the market and large economic size, the initial capital costs remain high, making it hard for the new entrants to break into the industry. Further the need to store a diversified range of products and long credit periods to the distributors drives the industry working capital requirement higher.

Total world exports of ceramic related goods were circa US$ 35 b in which tableware, kitchenware and porcelain contributed circa 10% whilst ornamental ceramics and glazed tiles recorded US$ 2.3 b and US$ 9.7 b respectively with a total world production of over 6,900mn Sqm per annum in 2008. For the Sri Lankan manufacturer, China (with 46% export market share) and Italy (which accounts for 33%of glazed tile exports) acts as the biggest direct export competitor.



Local tile cluster

In 2003 under the aegis of the Ceylon Chamber of Commerce, Sri Lanka Ceramics Council (SLACC) was formed to implement a unified industry wide strategy. The above council’s 25 members represent manufacturing firms, raw material and energy suppliers, government and academic agencies and R&D institutions; whilst membership dues, symposia and training programs provide funding for the council.

Even though Sri Lanka’s ceramic industry boasts a history dating back couple of centuries the modern ceramic industry was originally the result of significant tax and investment incentives provided by the government in the 1970s.

Over time the ceramic industry’s competiveness was compromised due to the high cost energy charges, expensive imported inputs and inefficient production. In addition Sri Lankan companies faced difficulty in tapping the high end international market due to the underdevelopment in the local tile sector and ongoing labour difficulties.

Currently the local tile cluster is estimated to worth circa Rs. 20 b per annum with 6-7% averaging growth rates over the past few years. Of the tile cluster 70% is contributed by floor tiles with an estimated production of 12.5mn Sqm and a value of circa Rs. 14 b. The rest is contributed by the Walltile market with an estimated production of 5mn Sqm per annum or Rs. 5 b an year. Yet Sri Lanka only holds a circa 0.2% share of the global market share.



Key factors affecting the Sri Lankan ceramic industry

The growth in demand for housing is a primary indicator of the ceramic sector growth together with the rate of construction approval. Since the initial cease fire period in 2004 the housing and commercial construction approvals have seen a decline due to the artificial land and property prices together with the height of war and uncertainty in the island.

With the land and property sector in a turnaround period together with the economy in high gear the demand for tile related products are expected to increase in due course. Further with the expected influx of Foreign Direct Investments together with circa 8.5% GDP growth prevalent in the country, the spending on construction related activities has seen a hike over the past few months.

During 2010 Sri Lanka was elevated to a middle income emerging market status by the International Monetary Fund whilst receiving a major world recognition when it was ranked the 8th fastest growing economy in the world by Economist Intelligence Unit (EIU) of the United States.



Strong income to shoulder industry growth

With a low inflation rate (5%) prevailing in the high performing economy, country’s per capita disposable income is expected to show healthy growth increasing the purchasing power of consumers. Particularly, Western and Southern provinces which generated 60% of the national GDP whilst recording the highest per capita income levels in the country have acted as the epicentre for the demand for tile products. These two provinces accounted for 70% of the tile industry sales.

The inward remittances remained strong in 2009 even in the face of global economic slowdown. Private transfers mainly consisting of workers’ remittance inflows grew by 14% to US$ 3.3 b in 2009 and projected circa 8% of national GDP. This would further fuel the tile sector incline through the expected derived demand. Further, with the real wages in the country improving together with the masses perceiving tiles to be associated with quality and affluence, we expect the demand for the products to improve strongly with the Central Bank estimating the per capita GDP to reach US$ 4,000 by 2014.

Presently the Sri Lankan tile cluster is on a low base with the per capita tile consumption only at 0.6Sqm in comparison to developed countries like Europe which averages 5-6 Sqm per person, Brazil (2.5Sqm per person) or the tile manufacturing giant China which has a per capita tile consumption of 2Sqm per person. With the economic growth and budding investments, averages in tile consumption would be boosted consequence to the rising income levels. Source: Ceramic Tile and Stone Consultants



Land and property sector driving demand

The land and property sector which suffered during the war tone era saw a drop of 48% in real estate activity during 2006 to the 2nd quarter of 2008. Further during 2009 due to the climax of the civil war, approvals fell to an all time low of 1638 and 277 for housing and buildings respectively.

With the interest rates stabilising at a low base of 12% together with the circa 5% inflation rate a strong foundation is being built for future development. Further with the construction and manufacturing sector acting as a leading indicator to the economy, together with the expected developments in the land and property sector the tile industry would have a positive impact in the years to come



Infrastructure development; boost to the industry

Since the end of war, infrastructure investments in the country has improved drastically with over US$ 1,200 b being spend on transportation and a further circa US$ 1,500 b on power and energy projects over the years. With heavy investments in infrastructure islandwide the land value in the country is appreciating together with higher constructions taking place. Therefore, developments in amenities tend to build a strong foundation for the tile industry for future developments.



Fuelling energy costs

Currently 40% of the production cost is attributable towards the energy cost which acts as a critical factor for the industry whilst they consume over 1,170 metric tons LPG per month. It is estimated that the increase in cess for LP Gas by Rs. 13.12 per kilo effective 1 September 2010 would push costs by over Rs. 15 m per month for one heavy user and impose additional burdens for some of the seriously struggling companies.

Further, with the oil prices based on Saudi Aramco in the rise ceramic and other related industries fear that the overall industrial gas would increase by a high margin. In the past gas and oil prices in Sri Lanka was on par with highest prices seen in the world market making it hard for the local producers to compete in the global arena. The Ceramic Council of Sri Lanka (CCSL) together with the glass manufacturers has planned to lobby concerns against the sudden increase in duty and the long term impact to the sector.

At present the price of LP Gas remains at US$ 652 per ton but Sri Lankans pays circa US$ 800 per ton due to the cess of US$ 131 per ton. Thailand being one of the main regional competitors pay only Rs. 35 per kg whilst in Bangladesh it is at Rs. 18 per Kg where as in Sri Lanka companies pay over Rs. 95 per Kg making production cost extremely high comparative to the regional competitors.



Clay inputs

Tile industry consumes large quantities of clay. Although there is an abundant supply of high quality ball and china clay in Sri Lanka, mining restrictions prevailing in the country act as a barrier in acquiring required quantities. Illicit clay mining in the rural districts are also taking place which has a negative impact on the larger producers.

Currently circa 20% of the production cost of ceramic tiles is arrived through raw material expenses. Even though the clay is easily available, the transportation cost and the escalation of attendant fuel costs adversely impacts the industry at the point of obtaining raw material. Further, it is said that in the early 2000’s Sri Lankan annual ceramic production included 10,000 metric tonnes of Kaolin, 25,000 tonnes of ball clay, 20,000 tonnes of feldspar and 5,000 tonnes of quartz which has doubled over the years up to now.

Lanka Ceramic, the parent company of LWL and TILE has the largest raw material reserves controlling the largest mining operations in the island. Furthermore, Royal Ceramics has also acquired land reserves to be utilised in the future whilst currently few regionally located independent miners also participate in supplying raw material.



Strong rupee against global markets

Currency valuation has a dual faced impact on the tile industry. Currently the strong Sri Lanka Rupee would have a positive impact on importing fuel making it a bit cheaper to the industry. Yet in the competitive global tile market the strong rupee hinders the demand for tile products due to the comparatively higher pricing levels.

Further with the continued recession in USA and Europe together with the reduced spending on the housing sector, export sales declined 13%YoY and 16% YoY in value and volume respectively, forcing the industry to look for other alternative markets.



A competitive oligopoly

The tile sector in Sri Lanka which shows signs of an oligopolistic market is a highly competitive industry. The oligopoly consists of key listed manufacturers namely Royal Ceramics, Lanka Tiles and Lanka Walltile which contributes for a major portion of the tile market.

The floor tile market size is estimated to be circa 10.8mn Square meters in 2007 whilst the wall tile market is estimated to be approx 6.1mn square meters. Lanka Walltiles dominates the local wall tile sector with a market share of 55% whilst imported tiles from the European and Asian market compete for the second place.

In the floor tile sector Royal Ceramics dominates the local market with a circa 35% market share followed by Lanka Tile’s 25% market share. The rest of the market’s demand is mainly supplied through imported floor tiles by China, Italy and other Asian countries.



Conclusion

With the Sri Lankan tile manufacturers working at full capacity and poised for expansion the tile industry is positioned to grow whilst distributing the generated high income among the participants. Turnaround in the land and property sector propelled by the post war market sentiment will shoulder the tile industry growth with the higher demand generated in the construction sector.

Further, the Government’s initiative in infrastructural developments throughout the island had made Sri Lanka an investor paradise in the region. Therefore the strong momentum in economic growth together with the infrastructural developments has been attracting foreign investments while a healthy inflow of FDIs is expected in the near future.

The ceiling on home loans and the low cost financing together with the stabilised inflation in the country act as a catalyst for the strengthening of the sector. With the Government imposing heavy taxes on the imported tile related products the local ceramic industry has being safe guarded from foreign threats. Yet an immense amount of low quality ceramic tiles are been imported to the country at a lower cost hindering the market whilst eating into the market share of the local producers.

With the current protectionism acts carried out in the industry the local manufactures have a competitive advantage against the foreign competitors. Further, we believe that construction industry together with the tile sector acts as a leading indicator of economic growth in a specific region.

Yet Sri Lanka is still in its development and rehabilitation stage after the war whilst paving a sturdy foundation for an accelerated economic growth. With the positive sentiment prevailing on the Sri Lankan economy which is backed by the emerging prospects and the strong macroeconomic stance tile sector is poised for growth together with the high geared economy.