Long-term returns: Despite the ongoing challenges of weak infrastructure, there are reasons to be optimistic about the future

As manufacturers scour the globe for new growth opportunities, few markets offer greater long-term potential than Nigeria, which boasts an enormous domestic population, plentiful feedstock and limited market penetration. Current business conditions, however, including sky-high operating costs and cheap unregulated imports, make it difficult for industry to survive, much less thrive. As a result, those manufacturing firms that have already laid foundations in Nigeria are in it for the long run. Indeed, the growth they have seen to date – in spite of limited electricity, minimal infrastructure and weak human capital – should mean they can expect to see a significant rise in returns as conditions gradually improve.

RECENT SUCCESS: The total value of Nigeria’s manufacturing sector increased 7.55% in 2012, reaching N761bn ($4.8bn) at current base prices, up from N634bn ($3.9bn) in 2011. According to reports from the Central Bank of Nigeria (CBN), key drivers of growth were the cement industry, non-metallic segments, and the food and beverage industry, which saw increases in production of 17%, 9.1% and 8.8%, respectively.

Yet the 2012 uptick belies what many manufacturers describe as a difficult year, with a deteriorating security situation, floods in the north-east, and continued infrastructure challenges. Some fast-moving consumer goods (FMCG) firms reported decreased demand. “The last 12-18 months have been tough,” said Christos Giannopoulos, CEO of PZ Cussons, a British FMCG manufacturer that has operated in Nigeria for 125 years. Slumps in manufacturing are no anomaly in Nigeria. The government is now allocating more resources to manufacturing, but the country remains dependent on hydrocarbons profits and has traditionally invested little in industrial production beyond the oil and gas industry. Manufacturing reached a peak in 1981, contributing about 10% of GDP, but has since fallen noticeably. In 2012 manufacturing comprised just 4.6% of total GDP. For the last two years, capacity utilisation has hovered around 1990 levels. “Companies have been closing,” said Vassily Barberopoulos, chairman of the Manufacturers Association of Nigeria, Oil and Gas Local Content Group (MANLOC), and managing director of Nigerian Foundries. On the upside, however, “the survivors are growing”. Barberopoulos pointed to potential in the food processing and fabrication segments, along with opportunities in downstream activities in the oil and gas industry.

STABILITY: While the challenges facing the sector are clear, existing producers have largely managed to establish a strong presence in a rapidly growing market that has tariff-free ties to a sub-region of around 300m people. Furthermore, the last few years of stable macroeconomic policy has been a boon to producers borrowing on international markets. Currency risk has been reduced with inflation holding steady, at around 10% after years of fluctuating. “Given the challenges of doing business in Nigeria, failure rates for manufacturing are significant,” George Onafowokan, managing director of Coleman Wires & Cables, told OBG. “This risk has deterred some investors from manufacturing in Nigeria; however, this just means that the market for many industries is generally far from saturated and opportunities are still available for new entrants “.

GOVERNMENT POLICIES: Given the need for the country to boost job creation, improve per capita income, slow import growth and reduce exposure to commodity volatility, the federal government has launched new initiatives to promote industrialisation and secondary activities. A globally competitive manufacturing sector is integral to the government’s Vision 2020 plan, the development document with a stated goal of transforming Nigeria into one of the world’s top 20 economies by the year 2020. In 2012, the Federal Ministry of Trade and Investment (FMTI), the agency responsible for developing policy and programmes to promote growth, launched the Nigeria Industrial Revolution Plan (NIRP), which aims to increase the manufacturing sector’s contribution to GDP from 4% to 10% in the next four years. The FMTI is working with the Standards Organisation of Nigeria (SON) to reduce sub-standard imports from about 80% of the market to 30%, and is forming a committee of industrial representatives to enact a new tariff regime. The 12-member committee is tasked with proposing duties to raise capacity in sectors prioritised by the government, which include agribusiness, solid minerals and petrochemicals.

Additionally, the FMTI has partnered with the Federal Ministry of Power (FMP) to improve electrical supply specifically by expanding foreign direct investment in the sector. “To ensure an increase in power supply, we are working with the FMP to ensure that 10 industrial cities in the country have at least 18 hours of uninterrupted power supply by first quarter of [2014],” Olusegun Aganga, the minister of trade and investment, told local media in early 2013. In addition, the ministry is offering a tax credit of 30% on business investments in infrastructure.

REINVIGORATION: The Nigerian Export-Import Bank has also stepped up financing to support manufacturing in four specific subsectors; food and beverage, wood and wood products, steel and processed alloy, and plastic and rubber. According to local media, the bank has budgeted N42bn ($265m) to support an estimated 6% of the manufacturing sector’s financing needs until 2015. However, the government still has an uphill battle to reinvigorate the industry after years of underinvestment and mismanagement. Nigerian manufacturers emphasise the remaining challenges – first and foremost the high operating costs attributed to lack of infrastructure. Consider, for example, the mining segment. “In a new mining operation the return on investment can be up to three to five years, taking into account the capital intensity of the industry and the lengthy exploration phase,” Alabi Oluwaseyi, chief geologist, managing director and CEO of Terralords, told OBG. “The majority of Nigerian investors are looking for more short-term income, deterring a lot of investment in this untapped industry.”

WEAK INFRASTRUCTURE: In the first quarter of 2013, electricity generation fell by 3.1% compared to the previous quarter, and reduced the index of industrial production by 0.9%, according to the central bank.

At around 5000 MW, Nigeria’s installed generation capacity is well below the country’s power demands. On par with a small European city and with less than the supply available to New York City, Nigeria’s limited power grid is the largest constraint to industrial growth, in the view of most manufacturers. Generating reliable power supply through diesel generators adds about 30% to operating costs for local industry.

Furthermore, navigating non-existent roads or congested ports, supplying and sanitising water, all present extra costs to Nigeria’s producers. None of this is new, however. In a 2008 survey of 124 Nigerian manufacturers, the UN Industry Development Organisation (UNIDO) found that nearly 60% of respondents cited physical infrastructure as the biggest challenge facing their business. Nearly 70% of respondents also cited power shortages as the primary cause of their idle capacity. The issue of electricity is so intrinsic to doing business in Nigeria that many manufacturers do not even find it worth talking about.

But there may be some hope on that front. The government is moving forward to fully privatise the power sector, including an ongoing break-up of the current state-owned utility firm, the Power Holding Company of Nigeria (PHCN), and in 2012 signed memoranda of understanding with a number of companies to improve electricity generation. South Korea’s Daewoo and Germany’s Siemens have each committed to generating 10,000 MW of electricity. Two French companies will invest about $200m in the transmission network, and a Canadian firm will manage the Transmission Company of Nigeria for three years. At the end of September 2013, the government ratified the sale of PHCN’s 10 distribution companies and four of its five generation companies. The sale of all 15 companies is worth some $3.3bn. Additionally, the US EXIM bank will loan $1.5bn to Nigeria’s power sector. Reform is likely to be slow, but any improvement will be significant. “The challenges aren’t just about not having power, but once we do, it will solve a lot of problems. It will reduce costs by 30%,” Barberopoulos told OBG.

FISCAL CONSTRAINTS: Adding to high operating costs is the price of finance and the country’s “multi-taxation” regime. Respondents to the 2008 UNIDO study on Nigerian manufacturing cited access to credit as the second-biggest challenge to local operations. While blue-chip firms may be able to access slightly more competitive rates, commercial lending rates in Nigeria go as high as 23-24%, stifling expansion of small and medium-sized enterprises and forcing successful businesses to find alternative routes to capital.

Furthermore, some 20-30% of survey respondents used personal cash reserves, borrowed informally, or obtained supplier credit. Nigerian Foundries, for instance, buys specialised steel plates on credit from a European supplier at a rate of only 2-3%. Local firms are also seeking out international partners that can bring capital through joint ventures. Both PZ Cussons and Nigerian Foundries launched joint ventures in the last two years in which they paired their local knowledge with foreign capital and technical expertise.

SUPPLY CHAIN CHALLENGES: Local materials have high production costs and legally imported materials face high tariffs. In the 2008 UNIDO survey, manufacturers cited the cost of both imported and domestic raw materials as a key concern.

“A major obstacle to investment in raw material processing is the fact that supply comes largely from the informal sector, which complicates procedures and is a significant turn-off for foreign investors,” Azikiwe Peter Onwualu, director general of the Raw Materials Research and Development Council, told OBG. Some inputs are simply not available locally. PZ Cussons, for example, currently imports about 80% of inputs for its consumer and white goods. Because the country’s four oil refineries are defunct, industries have to import petrochemicals products. In addition, Nigeria’s once thriving textile industry declined along with agriculture, and local cotton is no longer available. Leather from Nigeria is exported, refined abroad, and then reimported at a premium for local use. In some cases, manufacturing needs are trumped by other interests. “Mechanisation of agriculture is often underemphasised relative to fertiliser needs,” Didi Ndiomu, managing director of Nigeria Machine & Tool, told OBG. “There is a strong need for local manufacture of tractors – tractors that can work in this environment and climate.”

Also, the price of local inputs is inflated, largely due to the same operating costs that challenge end-product producers. Louw Burger, CEO of cassava processor Thai Farm International, described the high cost of securing cassava to local media in February 2013. “Transport in Nigeria is very expensive, and typically run by small companies – one-, two-, three-truck people, that are not especially reliable. With the unreliable transporters, you’ve got bad roads, as well as harassment by government officials on the roads,” he said. Indeed when discussing costs, manufacturers usually make reference to the high price of corruption or the federal government’s “multi-taxation” regime. According to a 2012 World Bank report, 80% of businesses in Nigeria paid bribes to government officials in 2011 to “get things done”. The informal payments required for permits, licences or utility supply are often sudden and unplanned for, the report said. Some 63% of formal firms and 72% of microenterprises said that laws were not applied predictably. In one example, Barberopoulos described attempts to locally source a specific coal made from coconut husks. The product should have been much cheaper than an import, but by the time each local authority got a cut of the deal, the coconut coal was three times the price of an import.

HUMAN CAPITAL: Less than 20% of manufacturers surveyed in the UNIDO study identified skilled labour as a principal constraint to Nigerian production. Moreover, while productivity in Nigeria is low, wages are priced to match. Labour taxes and contributions amount to about 10.8% of commercial profits, below the 13.3% average in sub-Saharan Africa, according to the World Bank’s 2013 “Doing Business” report.

At this point, Nigerian and other West African salaries are cheaper than those seen in China. “Universities and polytechnics aren’t great,” said Barberopoulos, “but we don’t hire for skills. We hire for potential.” With nearly 200m people, most of them young, Nigeria certainly holds a lot of potential. Both public and private players are investing heavily in technical and vocational education and training (see Education chapter).

CHEAP IMPORTS: High operating costs for local industry can make it difficult to compete with foreign producers, which may benefit from more efficient economies of scale, and firms can find import competition intense. Manufactured and semi-manufactured goods accounted for slightly more than 1% of Nigeria’s exports in the first half of 2012, according to CBN data. Oil sector exports accounted for 96.7% of total exports, with more than half of the remaining exports being agricultural produce. During the same period, finished goods accounted for 50% of Nigerian imports and industrial goods accounted for 37.1%. Furthermore, CBN figures only include legal imports and do not track the vast number of finished goods entering through the grey market. Manufacturers across the value chain, from textiles and mobile phones to steel and automotive, often complain that cheap, lower-quality imports cannibalise local demand. Over 45 years operating in Nigeria, Nigerian Foundries has commissioned numerous feasibility studies before expanding production to estimate the local demand for their products. When the firm expanded operations, local demand fell far short of what was predicted. It never reached even one-tenth of the feasibility estimates, Barberopoulos told OBG.

Nigeria’s once-thriving tyre industry shut down when the government reduced the 40% tariff on tyre imports in 2006. Before the tariff was dropped, the two local producers, subsidiaries of Michelin and Dunlop, controlled the Nigerian market, with a 25% and 35% share, respectively. The remaining 40% was met by imports. When the tariff was decreased, Michelin closed its Nigeria operations immediately.

Dunlop Nigeria Tyre and Rubber shuttered factories but did not sell its Nigerian facilities, hoping operating conditions would improve. In mid-August 2013, however, the company declared losses of N663.6m ($4.2m) for the third quarter of the year.

TEXTILES: The textile industry has faced a similar collapse in the face of imports. Once the second-largest textile producer in Africa, Nigeria had about 180 textile mills, and in 1991 it employed about 25% of Nigerians, according to a UN University report. The sector has declined over the last two decades, however, as cheap imports entered and local operating costs rose. In 2009 the number of mills had fallen to 25.

“The majority of textiles come in bulk from China and other Asian countries, leaving companies like CHA Textiles, with subsidiaries that manufacture in Nigeria to compete with them,” said Omoyemi Akerele, creative director of Style House Files, a fashion consultancy, and founder of Lagos Fashion and Design Week. In 2010 the government invested N100bn ($630m) as part of the Textile Intervention Fund, to provide loans to mills and rejuvenate the segment. The fund successfully increased capacity at textile manufacturers from 29% in 2010 to 52% in 2012, according to data from the Manufacturing Association of Nigeria. Indeed, the intervention was successful enough that workers began lobbying the government in early 2013 to increase the fund to N500bn ($3.15bn). Still, local textiles comprise just 12% of the Nigerian market, and the government is working to raise market share to 25% by 2020. The 20% tariff on imported textiles should allow local products to gain ground, but enforcement of duties, as in so many other sectors, is weak at best. “Nigerian textile manufacturing companies can compete with imports if a levy of approximately 20% can be imposed and enforced adequately at Nigerian ports,” Akerele told OBG.

GREY MARKET: Limiting imports through tariffs is only so effective, however. When the government attempts to restrict imports, manufactured goods come in through the grey market. For example, most imported tyres are categorised as truck tyres, which face a 10% tariff, despite actually being car tyres, which are subject to a 20% tariff, Dunlop’s Yinusa told OBG.

While exact figures are impossible to quantify, most industry experts agree that everything from steel rods and industrial cables to TVs and processed foods come in through informal channels. Some 80% of cars are bought on the grey market, said David Edwards, general manager at Mandilas Group, a conglomerate with interests in Toyota dealerships.

OPPORTUNITIES: Even as manufacturers eagerly anticipate reforms in bank lending or power generation, there are opportunities in the current climate. Producers surviving in Nigeria focus either on scale or quality, Barberopoulos told OBG. Mass-production industries such as FMCG are thriving and Nestlé and Proctor and Gamble (P&G), for example, have both invested in new manufacturing facilities over the past several years. Furthermore, both PZ Cussons and local industrial conglomerate Nosak Group recently expanded production into palm oil, a growing sector.

Specialised or high-quality products used as inputs for other finished goods can find buyers in the market, as manufacturers often cannot substitute inferior goods in factory production. Thus, Nigerian Foundries has succeeded in supplying specialised steel castings to local industrial clients. Coleman Wire Cables, which is planning a new $20m facility, meets demand for higher-quality medium-voltage cables, rather than competing with cheaper Chinese cable imports.

FOOD & BEVERAGE: The food, beverage and tobacco sector has been a particularly bright spot in Nigerian manufacturing, growing 60% between 2007 and 2011 to reach N230.7bn ($1.5bn) in 2012 (see analysis). In 2012 the industry comprised over 30% of the Nigerian manufacturing sector, with a number of large foreign-owned facilities. International giant Nestlé announced a $2.2bn investment in local operations, with the goal of tripling Nigerian sales in the next 10 years. P&G broke ground on a multibillion-naira factory, its second in Nigeria, in mid-2012. South African firm Tiger Brands recently purchased a controlling stake in Dangote Flour Mills, a producer of flour and pasta, and one of the country’s fastest-growing conglomerates. SAB Miller, the world’s second-largest brewing company, recently purchased two Nigerian brewing companies, Pabod and Standard. The food and beverage industry is among the most vulnerable to the country’s poorly-maintained distribution networks, exposed to a fragmented logistics sector and a high risk of spoilage, but it nonetheless benefits from limited fluctuation in demand and a market of more than 160m people. As incomes continue to inch up in line with headline growth, demand and purchasing power are set to grow.

AGRO-INDUSTRY: Recent private sector investment in palm oil may soon be bringing down the price of key industrial inputs. “There are a lot of players getting into palm oil refining; the huge demand-supply gap, of close to 2m tonnes, is driving the rush to invest in the sector,” said Alex Osunde, group managing director of Nosak Group, a local conglomerate that has invested in palm oil. PZ Cussons, for example, launched a joint venture with Singaporean firm Wilmar to develop a 50,000-ha oil palm plantation. In five to six years, the land is expected to produce about 300,000 tonnes of palm oil annually, a key ingredient in soap and other products. PZ Cussons will be able to reduce its imports from 80% of inputs to 45%. If the oil refineries come back on-line, the firm could reduce its imports to just 30%, Giannopoulos told OBG.

CEMENT: Nigeria’s cement industry has also been transformed over the last few years. In 2012 the sector grew more than 17% to contribute N79.9bn ($503.4m) to GDP, boosted by the increase in construction activity. Nigeria’s homegrown Dangote Cement – which is owned by the Dangote Group, one of the largest industrial firms on the continent – invested $6.5bn to increase production capacity in 2005-11. Lafarge WAPCO, a subsidiary of the world’s largest cement maker, doubled production capacity with the opening of a new plant in late 2011. As a result, domestic cement output rose from 10.5m tonnes in 2010 to 28.6m tonnes in 2011, allowing Nigeria to be self-sufficient in cement for the first time. UNICEM, another Lafarge joint venture, and Edo Cement Company, both announced plans for new cement plants in early 2013.

Cement manufacturers have battled the same challenges facing Nigerian industry as a whole. In late 2012, Dangote temporarily closed its Gboko plant when cheap imports flooded the region. The price of a 50-kg bag dropped from an average of N2000 ($12.6) to N200 ($1.26). In response, Nigeria’s minister of trade and investment raised tariffs, slowing imports. Thanks to increased demand and reduced imports, Dangote registered an 80% rise in net profits in the first quarter of 2013 and WAPCO posted a 20.64% increase in pre-tax profits in the same period. Dangote’s three Nigerian plants now have sufficient capacity to export to Ghana, and the firm has also announced plans to sell excess supply to a number of ECOWAS countries.

ELECTRONICS: Electronics manufacturing comprised only 4% of the country’s total manufacturing output in 2012, but with demand for such goods on the rise, the scope for local production is growing. While the economy has fluctuated, demand for electronic goods has remained healthy over the last few years both in terms of buffered goods such as mobile phones and income-sensitive goods such as televisions and laptops, according to Giannopoulos. Current demand for electronics has traditionally been well beyond local production capacity, offering opportunities to foreign firms.

According to local statistics, imported computers from Dell, HP, Acer and others dominate the PC market with 80% market share. But local original equipment manufacturers, such as Zinox Group, are making inroads into the industry by assembling imported parts and producing Nigerian-branded electronics. Founded in 2001, Zinox completed a new plant in May 2013 that will assemble laptops, desktops and mobile phones. Most Nigerian-made electronics, ranging from PCs to air conditioning units, are assembled domestically using imported parts. In mid-2013, General Electric launched a $1bn investment in a new manufacturing and assembly plant to produce gas turbines in the city of Calabar. Omatek Ventures, another local electronics manufacturer, announced plans in January 2013 to increase local capacity by 300%. The expanded factory will produce PCs and solar panels, and will allow Omatek to lease facilities to outside producers.

Additional original equipment manufacturers include Brian Technologies, Beta Computers and Veda Computers, which each assemble components and sell computers under individual brand names.

Speaking at the launch of Omatek’s solar technology production in March 2013, Florence Seriki, managing director of Omatek, joined with a number of local producers when she identified the lack of patronage for local products as a major challenge to the industry. However, the federal government is seeking to boost consumption of locally produced information and communications technology (ICT) products. To this end, in November 2012 it mandated that all federal ministries, departments and agencies purchase computers from local firms. The government is Nigeria’s largest purchaser of ICT, and could provide a huge boon to the industry if the policy is successfully implemented.

PETROCHEMICALS: With impressive oil and gas reserves, Nigeria has a great deal of potential to develop a thriving petrochemicals industry. Historically, flaring of natural gas, underperforming refineries and weak infrastructure have limited performance in downstream activities like chemicals, fertiliser and feedstock production. But a government push to increase fertiliser production to 8m tonnes annually by 2017 has attracted international firms. In 2005, for example, the federal government began a privatisation process and sold a defunct national urea plant to Notore Chemical Industries. The Japanese-Nigerian joint venture began production in 2009 and is now constructing a new power plant as a step toward boosting capacity at its facility.

Meanwhile, Indorama Eleme Fertiliser and Chemicals, a subsidiary of the Indian-owned Indorama conglomerate, has financing backing from a consortium including the International Finance Corporation, the African Development Bank and Standard Bank to construct a $1.2bn fertiliser plant in Eleme, Rivers State, that will have an annual capacity of 1.4m tonnes of fertiliser when completed in 2015.

Indorama took over the Eleme Petrochemicals Complex from the Nigerian National Petroleum Company (NNPC) in 2006, turning the facility into the second-largest producer of polyolefins in Africa. The existing plant comprises four processing facilities that make olefins, butane, polyethylene and polypropylene. The extension is set to add a nitrogenous fertiliser plant to the facility, which is due to be the single largest urea manufacturing complex in the world upon completion. In addition, the NNPC is also planning a petrochemicals plant, power plant and processing facility in Delta State, according to local media reports in March 2013.

METALS: The federal government is also working to promote the local metals industry, particularly steel. The steel and basic metal segment comprised 9% of Nigerian manufacturing in 2012, contributing N79.9bn (503.4m) to GDP, up from N70bn ($441m) in 2011. However, while local producers have a total capacity close to 1m tpa, the country’s plants currently operate below 50% capacity, thereby opening the market to importers. The Ministry of Mines and Steel Development (MMSD) puts the total quantity of imports between 500,000 and 1m tpa, with key sources being Ukraine, Brazil, Russia and Turkey.

Yet some private firms, which comprise the bulk of local capacity, are finding success. In April 2013, for example, African Foundries, an Indian-owned firm with a production capacity of 500,000 tonnes of steel billets, announced that it would begin exporting steel to Ghana, a first for a Nigerian-based producer. Its first commitment to Nigeria’s neighbour was 5 tonnes sent on April 27, 2013. The company’s current capacity, which the firm is looking to double to 1m tonnes, is processed at multiple furnaces, a re-bar mill and a structural rolling mill across three plants.

OUTLOOK: Producing under capacity and fighting cheap foreign goods, Nigerian industry is operating well beneath its potential. Years of neglect by the government have helped to entrench structural challenges to growth. However, the success of some local producers in the face of these challenges shows plenty of room for optimism about the sector’s long-term potential. The government is improving power generation, and that alone could be enough to kick-start growth.