Egypt's expansion plans bode well for industry sector despite challenges

With a market of 92m consumers and growing, Egypt is a natural fit for manufacturing industries. An estimated 1.2m Egyptians work in textiles, for example, and the plastics sector alone provides 500,000 jobs. Egypt is also home to energy-intensive industries such as cement, steel and petrochemicals manufacturing. As a result, the sector spans a diverse range of activities, largely led by the private sector, that stretch from building materials and downstream processing, to long-running textile factories, and competitive food and fast-moving consumer goods (FMCG) segments.

Yet the government hopes to further expand, and its goals for the sector are ambitious. Manufacturing accounted for about 16.6% of the country’s GDP in 2015, with medium-term plans to create 3m jobs and increase its share to 25% by 2020, in part through the development of new industrial zones (see analysis).

Industry and manufacturing are mainstays of the Egyptian economy with its share of GDP in 2015 nearing levels last seen in 2011 – before the onset of political instability. Sector growth was 2.9% in FY 2015/16, compared to 4.8% in the previous period. However, this figure includes oil and gas, which saw output decline. Manufacturing itself grew at a rate of 5% in FY 2015-16, compared to 5.6% a year earlier.

State Role

In addition to the Ministry of Trade and Industry, several government bodies are involved in the sector. They include the Industrial Development Authority, a licensing body within the ministry, and the General Authority For Investment and Free Zones (GAFI). The latter operates a one-stop shop for permitting and licensing procedures for foreign investors, and a matchmaking service for those looking for a local entity to partner with. GAFI is also responsible for establishing a land bank to ease the process of site acquisition for foreign investors.

Meanwhile, the General Authority for Supply Commodities works with raw materials with regulated prices, such as wheat and foodstuffs. Subsidised items account for approximately a fifth of total food expenditure for lower-income Egyptians.

Challenges

The sector still faces challenges, however. For the past several years, industrial consumers have borne the brunt of the country’s natural gas shortage, with the state prioritising supply to the power sector and households (see analysis). The biggest consumer, the cement industry, is in the midst of converting to coal to make up for shortages in feedstock.

However, in the long term Egypt bodes well as a foreign direct investment (FDI) destination for energy-intensive industries, as two major new gas fields are scheduled to enter into production, and exploration activities continue to be successful for upstream companies (see Energy chapter).

Currency instability and continued downward pressure on the Egyptian pound remained an issue throughout 2016, contributing to a shortage of US dollars and increased use of parallel markets, where access to foreign exchange was more expensive. “While there are opportunities for local production, for products that require imported base materials it is a challenge to get the forex necessary, while the low value of the Egyptian pound means that affordability is now a concern,” Mahmoud Bdeir, president of Sipes Quality Paints, told OBG. In late 2016 the floating of the Egyptian pound caused the currency to lose around half of its value against the dollar and triggered rising inflation; however, early 2017 is starting to see the Egyptian currency stabilise.

Import Competition

Trade policy is another hurdle for manufacturing growth. Egypt’s free trade treaty obligations mandate less protectionism for domestic auto assemblers, for example (see analysis). Additionally, foreign manufacturers of 23 separate lines of goods are now required to register with the General Organisation for Export and Import Control in order to access the market, with eight of the lines involving foods. Products from unregistered facilities will not be granted customs clearance. Chinese import competition is also increasing, prompting the government to erect barriers. In April 2015, then minister of trade and industry, Mounir Fakhry Abdel Nour banned all Chinese-made imitations of traditional Egyptian handicrafts. “In the current market, manufacturers in Egypt can compete with China on production cost and on quality. New manufacturers in Egypt face challenges, however, especially in terms of the cost of land and the length of the building approval process,” Ahmed Bahaa, CEO of MB Engineering, told OBG in 2016. While dollar shortages impeded imports for much of 2015 and 2016, the flotation of the pound in November 2016 has also created short-term pressures.

New Reforms

One of the biggest policy changes on the horizon is a new taxation regime, in which the current general sales tax will be scrapped in favour of a value-added tax (VAT). In August 2016 the Egyptian Parliament approved the new tax, and implementation is set for February 2017. Businesses with a turnover of LE500,000 (equivalent to $26,500 as of December 2016) or higher are required to register with the Egyptian Tax Authority within 30 days of passing. The VAT is set at a rate of 13% for the first part of FY 2016/17 and then will be raised to 14% as of July 2017. There are some concerns over the potential effect of VAT on the industrial sector. “The introduction of VAT will affect industry, although the fear is that it will benefit the informal sector more then it will help raise the overall quality of Egypt’s industrial sector,” Mounir Shehfe, chairman of Shehfe Casings, told OBG.

Other recent tax changes are aimed at boosting incentives for FDI, such as the presidential decrees in 2015 that capped the tax rate at 22.5% and suspended capital gains taxes for two years. One of the investment laws from 2015 added flexibility by allowing the Industrial Development Authority (IDA) to provide a temporary six-month operating licence to new ventures outside the food and pharmaceuticals segment. The permit can be renewed for another six-month period before a permanent licence is required.

Customs laws are also earmarked for reform. Egypt’s bureaucratic procedures at ports of entry are frequently cited as a top cause of delays. The first step has been to increase options for electronic submission of selected documents. A future restructuring plan will aim to streamline and shorten the overall procedure and combat smuggling.

Cement

Egypt is a key global cement producer, with a current capacity of 70m tonnes of clinker a year – far higher than current consumption. Output reached about 44m tonnes in the first 11 months of 2015. As of 2015 the cement segment was worth LE60bn ($3.2bn) in annual economic activity and contributed about 3.7% of GDP. The largest producer is Suez Cement, which accounts for more than 12m tonnes of overall production capacity. Foreign producers include French company Lafarge and the Italy-based Italcementi.

The era of capacity addition may be over in Egypt, as a round of new licences on offer met with minimal interest in 2016. The IDA made 14 new production licences available but received only three applications. However, one company is set to expand; South Valley Cement announced in May 2016 that it will invest LE1.5bn ($79.5m) to double its capacity from 1.7m to approximately 3.4m tonnes per year.

The cement industry presents a challenge for Egypt because of its immense energy needs. It accounts for 59% of total primary energy consumption among heavy industries and 46% of natural gas consumption. As a result, the natural gas shortage in recent years has reduced industry margins, reflected in the available quarterly earnings reports of listed producers. South Valley Cement reported 2015 earnings of LE71m ($3.8m), down 53% from LE151.2m ($8m) in 2014. This continued into early 2016. Arabian Cement reported earnings of LE34.2m ($1.8m), down 40% from the same period of the previous year. Although more gas supply is on the way from domestic sources, the state approved the use of coal in generating facilities in April 2014 to help reduce the impact of withdrawn subsidies and supply disruptions. Early returns suggest that shifting to coal – which could result in imports of up to 9.2m tonnes – will improve profit margins. Suez Cement, while converting to coal power, reported a profit margin of 27% in the first half of 2016, up from 22.5% in the first half of 2015, driven in large part by the cheaper cost of coal. By May 2015 the IDA reported that 90% of facilities were planning to make the cost-saving switch.

Steel

Steel production in Egypt was near its historical high before currency woes struck the sector in the latter half of 2014, forcing mass shutdowns at some facilities and production at low capacity at others. Production in June 2015 was 330,000 tonnes, less than half of the record high of 684,000 tonnes in June 2014.

A primary challenge in the industry is importing dollar-denominated iron ore, which exposes manufacturers to significant currency risk. For Ezz Steel, Egypt’s largest producer, about 75% to 85% of the cost of production is denominated in dollars, according to research from Cairo-based Prime Securities. “Industrial companies that depend on imported raw materials are now facing an additional obstacle as a result of the current exchange rate,” Anwar El Hout, general manager of GLC Paints, told OBG.

As with cement, feedstock is also a challenge due to the cuts in subsidies for end-users, which in 2014 saw gas prices for heavy industry jump by anywhere from 30% to 75%. Given the supply shortage, Egypt is speeding up plans to liberalise downstream gas supply and will allow private investment in distribution in the coming years (see analysis). Nonetheless, local firms continue to enjoy an edge in the domestic market, as Egyptians continue to buy 80% of their steel from local producers, despite the fact that locally produced steel is typically more expensive than imported alternatives, even after an 8% import tariff is factored in.

Food & Goods

FMCG are an important element of the industrial sector in the country given its young and growing population. “Much of the food sector is dominated by informal production and sales, but there is growing demand for industrialised products, and this is driven by the overall population growth,” Yasser Abdul Malak, CEO of Nestlé Egypt, told OBG.

Within the agri-business segment alone, GAFI counts 6471 companies with the sector employing 30% of the country’s total workforce and holding LE11.7bn ($620.1m) in capital. The segment contributed 15.7% to Egypt’s GDP, and its market value was estimated at $29.2bn in FY 2015/16 and is expected to increase by 2.1% annually through to 2020. Primary export products include cheese, processed sugar, aromatic oils, juices and concentrates. A majority of the segment’s output is sent to Arab and European countries.

Consumption trends are changing in Egypt, with the fastest growth in FMCG sales currently found in the poorer governorates of Upper Egypt. Expansion there, at an annual rate of about 40%, compares with 10% to 15% in the more mature markets of Cairo and Alexandria. “There’s been a transfer of wealth to the south through workers sending home significant remittances, and companies are now investing in distribution networks in Upper Egypt,’’ Hany Genena, head of research for Beltone Securities, told OBG.

Pharmaceuticals

Another key area in Egypt is drug manufacturing, which extends back to 1939, with the founding of the Misr Company for Pharmaceutical Industries. Currently, Egypt accounts for 30% of pharmaceuticals output in the MENA region, and is considered the largest market in terms of growth capacity and expansion in the next five years.

According to GAFI, there are 1458 companies currently active in the sector. The market leader in terms of domestic manufacturing is the Egyptian International Pharmaceuticals Industries Company (EIPICO), a publicly traded company on the Egyptian Exchange.

Generics play an important part in public production, with state-owned holding company Holdipharma accounting for one-10th of the market by value. Multinationals also play an key role in the country, with GlaxoSmithKline, which has a 9% market share, pledging to invest $34.1bn in Egypt’s pharmaceuticals industry. In July 2016 the company announced plans to build a $5.1m manufacturing plant in Cairo.

Domestic consumption, driven by the country’s demographic trends, has increased, with expenditure on health care rising to $14.21bn in 2015 from $13.88bn in 2014, according to GAFI. Drug prices in Egypt are regulated by a cost-plus formula that allows a profit margin of 15% for products considered essential, 25% for non-essential, and 40% or more on over-the-counter options. The Ministry of Health and Population has regulatory oversight and sets the country’s pricing formula.

Petrochemicals

Egypt’s petrochemicals output has grown significantly in the past two decades. Total production was expected to reach 5.34m tonnes in 2016, up from 3.43m tonnes in 2015. However, the overall market share of domestic production remains fairly limited, in spite of annual growth of 6%.

State-owned Egyptian Petrochemicals Holding Company (ECHEM) was created in 2000 and is the main arm through which the government executes its National Petrochemicals Master Plan. The overall plan includes building 24 plants with 50 production units, valued in total at $20bn. The sector is expected to reach a capacity of 15m tonnes per year by 2022, bringing in more than $7bn in revenue and creating 100,000 jobs in the process. It is predicted that the stream of new gas discoveries will help reduce feedstock availability concerns before the end of the decade.

Further initiatives under the plan include the construction of an ethylene plant and derivatives complex in conjunction with the Egyptian Ethylene and Derivatives Company. ECHEM and Sidi Kerir Petrochemicals Company, another state-owned producer, will each have a 20% stake in the endeavour, and when it reaches full capacity, likely in 2018, it is expected to produce 460,000 tonnes of ethylene, 400,000 tonnes of polyethylene, and 20,000 of butadiene. Early indicators suggest that the output will be earmarked primarily for domestic use, with that of Sidi Kerir slated for export. As in the FMCG sector, there has been interest in initial public offerings from petrochemicals producers. The Egyptian Propylene and Polypropylene Company announced a plan to offer shares by mid-2017 and will use the capital to double its production capacity.

In addition to petrochemicals, Egypt has an established fertiliser industry, which produces phosphate-and nitrate-based fertilisers, mostly for domestic consumption. With eight plants producing 10m tonnes per annum, a burgeoning export market appeared due to an excess of supply; however, gas shortages have temporarily impacted the fertiliser segment. “Fertiliser production has suffered because of the lack of gas, but new discoveries should help boost production by 2017 or 2018,” Mohamed El Danaf, chairman and CEO of Helwan Fertilisers, told OBG.

Textiles

Egypt has the region’s only fully vertically integrated textiles industry, from cotton cultivation to spinning, weaving and producing ready-made garments. The sector is important for job creation, employing 1.2m Egyptians, and is roughly 90% owned by the private sector. As of early 2015 GAFI counted 4594 companies in the sector, 196 of which operated from export-oriented free zones. The resilience of the sector is largely attributed to Egyptian cotton, which is among the most popular varieties worldwide. Textile exports account for 14% of all non-petroleum goods and are largely oriented towards the US, which buys 53.5% of exported ready-made garments, according to GAFI. Much of this output is produced in Qualified Industrial Zones (QIZs), which the US has encourage and which Egypt has at least 15 of. Producers in QIZs enjoy duty-free access to US markets as long as 35% of the product was manufactured in the zone. In Egypt the zones are used almost exclusively for producing textiles. QIZ exports in 2014 were valued at $824.2m, of which $816.7m came from spinning, weaving and garments. In the long term Egypt would like to encourage further investment in textiles. The Readymade Garments Export Council of Egypt aims to boost exports from $2.5bn in 2015 to $10bn by 2025, and the National Strategy for Textile Industries includes a plan to train 500,000 workers.

Electronics

Electronics manufacturing has been tapped as an area of high potential, with several global leaders eyeing Egypt, both for its large market of consumers and as a gateway to supplying other African markets. South Korea’s Samsung Electronics chose Egypt and South Africa for its first two manufacturing facilities on the continent, citing economies of scale. LG, another South Korean giant, announced a plan to manufacture washing machines by expanding existing operations from a facility located on the Cairo-Alexandria Desert Road, although the firm has announced that concerns about exchange rate instability could cause a revaluation of the plan (see analysis).

In addition to consumer electronics, Egypt could also emerge as a hub for manufacturing renewable energy equipment. The country signed a $9bn deal with Germany’s Siemens in 2015 to build 16.4 GW of new electricity generation capacity, including 2 GW from wind. The deal, which Siemens called the largest order in company history, involves Siemens building its own blade manufacturing facility near Ain Sokhna, as it could require up to 600 new turbines. Plans for free zones around the Suez Canal include pursuing more of this type of manufacturing (see analysis).

Outlook

Egypt’s industrial sector features a compelling attraction for long-term investment, in that it has consumers, low-cost labourers and can offer a gateway to the growing African middle class. Short-term obstacles remain, however, starting with the Egyptian pound’s struggle to stabilise against major international currencies and continued instability in gas supply; yet the goal of long-term growth remains the key priority.

 

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The Report: Egypt 2017

Industry & Retail chapter from The Report: Egypt 2017