Peru government initiatives to diversify local industry

Traditional exports, principally metals, have helped make Peru one of the fastest growing Latin American economies over the last decade. However, falling commodities prices have taken their toll on export revenues and GDP growth. The focus of the Ministry of Production (PRODUCE) in recent years has, therefore, been on diversifying the Peruvian economy and providing greater added value to production. Under the leadership of Minister Piero Ghezzi, PRODUCE has set the target of returning Peru to 7% growth rates through private partnerships that will develop the country´s secondary and tertiary industries. However, in the first five months of 2015, GDP from the industrial sector amounted to $9.8bn, a 2.6% decrease on the previous year.

Partnership

The central pillar of government policy is the National Plan for the Diversification of Production (Plan Nacional de Diversificación Productiva, PNDP). The plan has established working groups consisting of key private and public sector individuals in the industries that the government deems to have significant potential for future growth. However, the sectors chosen highlight the country’s dependence on primary industries: forestry products and aquaculture are the two most established groups, while the other two are textiles and creative industries.

Non-primary manufacturers fared poorly in 2015. Following a 1% drop in 2014, non-primary manufacturing decreased by 4.2% in the first five months of 2015, according to data from the National Society of Industries (Sociedad Nacional de Industrias, SNI). From January to May 2015, 52 of the 93 branches of industry defined by the SNI experienced a contraction.

Food & Drink

The biggest segment of Peruvian industry is the food and beverage business, which accounts for 42% of sector GDP. Having shrunk 9.1% in 2014, the sector bounced back in 2015, growing 6.5% from January to May. One of the country’s biggest firms, Corporación Lindley, a local beverage producer known for the emblematic Inca Kola, continued to invest heavily in 2015. Construction began on two new distribution warehouses in Lima, and in September 2015 the company inaugurated its $200m bottling plant in Pucusana, to the south of the capital. Earlier in the same month the firm received $760m for the sale of 47.5% of its shares to Mexico’s Arca Continental, the world’s third-largest bottler of Coca-Cola products. The fusion of the two companies will create an operation with combined sales of more than $5.4bn, according to Lindley representatives.

Elsewhere in the sector there was less activity. “At present investors in the Peruvian food and beverage industry are cautious,” Alvaro Delgado, executive adviser of the SNI, told OBG. “We have seen a slowdown in growth as companies wait to see how the 2016 presidential elections play out.”

Textiles & Clothing

Peru has a long tradition of producing clothes and garments for local and international consumption. According to the SNI, the sector accounts for around 5% of the country’s manufacturing output and provides employment to 460,000 people, as well as 1.2m indirect jobs. The country also has a comparative advantage in that it is home to high-quality materials such as pima cotton, a fine cotton that rivals Egyptian cotton for comfort, and alpaca and vicuña wools. However, the industry finds itself fighting a battle on two fronts. Firstly, higher wages make Peruvian products less competitive than Asian products in key export markets. Secondly, manufacturing for local consumption has come under pressure from the entrance of foreign fast fashion companies in recent years (see analysis).

In the first eight months of 2015 the Peruvian garment industry shrank 10% compared to 2014 figures. The mainstay of the export industry – shipments of cotton t-shirts, polo shirts and baby clothing – is in decline. The country exported $603m of clothing to the US in 2014, down from a peak of $839m in 2006. The dire economic situation in Venezuela, traditionally the second biggest export market, has also led to dwindling sales, although in recent years Brazilian demand for cotton products has increased, according to Marina Mejía, president of SNI’s apparel commitee directorate, a PRODUCE working group on textiles production.

Productivity

One of the key challenges for the sector will be to increase productivity in a very fragmented industry. Of the country’s 46,000 textile companies, 94% are classified as micro-companies, with just 0.5% defined as medium or large scale. Looking ahead, Peru’s small, fragmented industry appears to have two options open to it. The first is to focus on quality goods for export. “Due to its advantages in labour costs, competition from Asia and Africa has grown both in the US and European markets,” Ana Maria Chavez, general manager of Textimax, a Peruvian company that makes clothing for international brands and has its own clothing brand, told OBG. “This has increased pressure on the Peruvian textiles industry to invest in research and development to enhance its competitiveness.”

The other option is to improve efficiency and seek to enter the supply chain of fast fashion brands operating in the country. “It’s a matter of companies knocking on the doors of the top firms,” Mejía said. “But first we need to make our production more efficient and speed up delivery times. Peru has great skilled labour with experience of producing products for brands such as Hugo Boss and Calvin Klein.” For its part, the working group will focus on introducing more flexible labour protocols and ensuring the expansion of the country’s pima cotton production in the agricultural sector.

Construction Materials

As new buildings, roads and mining projects continue to be built across Peru, domestic construction materials companies encountered very different fortunes in 2015. Steel firms were hit by low prices and increased imports from China (see analysis). In comparison, the cement industry remains in good shape. There was record production of 10.7m tonnes of cement in 2014, while the first nine months of 2015 showed a 3% drop in production year-on-year (y-o-y), to 7.59m tonnes, Stable prices and cost-cutting measures have benefitted companies. The country’s biggest producer, Unión Andina de Cementos (Unacem), posted a profit of $55m in the first three quarters of 2015, having reduced operating costs by 5.7%. During the same period the firm also invested $63.6m, primarily in its Condorcocha and Atocongo plants, which will see a total of $367m in investment between 2014 and 2018. Cementos Pascamayo also had a successful third quarter in 2015. Following the opening of its Piura cement plant, which will have a final capacity of 1.6m tonnes per year, the company turned a $16m profit in the quarter, an increase of 36% y-o-y.

The sector has seen significant international mergers and acquisitions activity in recent years. In December 2014, two major overseas acquisitions were made by Peruvian firms. Unacem purchased French firm Lafarge’s Ecuadorian operations for $517m and Cementos Yura – part of Grupo Gloria – acquired a 98% stake in Sociedad Boliviana de Cementos, a Bolivian company, for $300m.

Foreign funds are also set to enter the construction sector. In January 2015 Chinese firm Jidong Development Group announced its intention to purchase Cementos Interoceanicos, a local firm developing a 1.6m tonne-per-year plant in the Puno region. In May 2015 Colombia’s Cementos Argos revealed that Peru and Chile were the next targets in an international expansion plan that has already seen the firm spread throughout Central America and the Caribbean.

Metal Mechanics

Peru’s mining, fishing and energy industries create strong internal demand for metal products. The country is home to a handful of companies that mass produce products, including steel wire and trolleys for the mining sector. However, one of the great success stories of the Peruvian industrial sector since the early 2000s has been the growth of a cadre of companies that design and produce made-to-measure metal products for Peru’s mining and infrastructure projects. The entrance of international engineering firms drove the industry to develop high-spec products with international quality certificates.

The construction of the Talara refinery was supported by a large volume of local products. “In the good times the sector generated annual revenues of $1bn and provided 50,000 direct and 200,000 indirect jobs,” Humberto Palma, president of the Association of Private Metal Mechanic Companies of Peru (Asociación de Empresas Privadas Metalmecánicas del Perú, AEPME), told OBG, “However, the sector´s fortunes are tied to investment and since 2012 we have seen strong annual declines of 10-15% per year.” In 2015 the segment began to focus its operations in other sectors, looking more at transportation and construction.

Retail

From 2006 to 2013, strong and sustained growth in consumer spending was at the heart of the country’s region-leading GDP figures. During that eight-year period – with the exception of 2009 – private consumption grew at annual rates of 6% to 8.9%. “The retail industry has been the second-fastest-growing sector of the economy over the last decade, after construction,” Oscar Chávez Polo, a senior economist for the Lima Chamber of Commerce (Cámara de Comercio de Lima, CCL), told OBG. “The primary resources sector has been one of the slowest-growing sectors, but the development of major mining and infrastructure projects has improved Peruvians’ expectations of the economy and boosted consumer confidence.”

However, the reverse is also true. Lagging slightly behind the fall in prices for Peru’s main commodity exports, the retail sector has slowed of late. Since the beginning of 2014, consumer spending has decelerated slightly, with growth for the first two quarters of 2015 coming in at 3.4% and 3.3%, respectively. “The Peruvian retail sector has seen the effects of deceleration over the last year, as the sector’s performance is closely related to the country’s economic strength,” Edgardo Vargas, CEO of Celima-Trebol Group, told OBG.

Class Action

The rise in Peruvian spending is tied to the rapid expansion of the Peruvian middle class. Definitions of social classes are notoriously contentious. However, using the World Bank’s simplified model for Latin America – which classifies the middle class as individuals with daily incomes of $10-50 at 2005 rates – 40.1% of Peruvians were in the middle class in 2014, the last year for which data was available, up from just 16.4% in 2004. Although a further 1.2% of the population earns more than $50 a day, the growth of the middle class has been the basis of total wage growth in Peru and thus the cornerstone of retail spending. Between 2010 and 2014 total wages grew an average of 10% per year, from $32.5bn to $47.7bn.

To Market

Roughly 40% of sales in the formal retail sector are made in supermarkets. “One of the biggest advantages formal companies have is that they can provide the necessary guarantees to ensure product quality,” Juan Correa, general manager of Tottus, told OBG. “This is especially important in segments of the food retail sector.”

The supermarket segment is dominated by three companies. Local firm Supermercados Peruanos (SPSA) has 103 outlets in the country split between its main brands, Plaza Vea, Vivanda and Mass. The other two players, Cencosud and Tottus, are Chilean. Cencosud has maintained its 86 supermarkets under its Wong and Metro brands without adding new stores from 2012 to 2015, while Tottus has added 14 new supermarkets since 2012 and now has a total of 47 nationwide.

One of the most striking aspects of the segment is the predominance of the capital. Lima has a total of 157 supermarkets in 2015, compared to 79 in the rest of the country. Between 2013 and 2014 total sales in Peru’s supermarkets increased 9.5%, to $3.65bn. Although decelerating slightly in 2015, growth remained robust. In July 2015 the supermarkets and department stores segment registered sales revenues of $501m, up 5.2% y-o-y.

Chilean firms also have a notable presence in the department store market through brands Saga Fallabella, Ripley and París, part of the Cencosud group. The local competition comes in the form of Oechsle, the retail arm of Interbank Group. In 2014 total sales in department stores reached $1.75bn, accounting for 18% of the overall retail market. Following annual growth rates of between 12% and 20% from 2010 through to 2013, Scotiabank estimate growth for the segment at 3% in 2015.

In terms of consumer habits, roughly a quarter of sales in the combined supermarket and department store sector go towards food, and another quarter is spent on clothing. The next largest segment is domestic appliances, a sector that continues to grow rapidly. In July 2015, $90m of white and brown goods were sold, a 14.6% y-o-y increase.

Some groups are also adapting their business models to focus on budget options for lower-middle-class customers. In 2014 and 2015 Tottus opened branches of its new budget supermarket, Hiperbodega Uno, at three locations on the outskirts of Lima. “Hípermercados Tottus, part of the Falabella Group, has diversified its strategy through the entrance of a new format of store called Hí per-bodegas Precio Uno,” Jessica Rodriguez, a retail analyst at CCL, told OBG. “These supermarkets do not require warehouses and sell a high proportion of the group’s own-brand products.”

Hardware & Appliances

Department stores would appear to be Peruvians’ go-to option for electronics and white goods purchases. PRODUCE groups hardware stores and domestic goods into the same segment, sales of which have grown far slower than those of department stores. In July 2015 the segment grew by 2.7% compared to the previous year. Hardware stores accounted for 38% of the total $190m spend in these stores, with domestic appliances adding a further 35%.

The continued boom in real estate and construction has opened up major opportunities for furniture companies, however. Furniture sales grew more than 40% y-o-y in July 2015, but the segment is the smallest in the hardware and appliances group, accounting for 3.1% of total sales.

Mall’s Good

With 2.3 shopping malls for every 1m inhabitants, Peru falls short of the Latin American average of 3.4 and its penetration is less than half that of Chile, which has 5 malls per 1m inhabitants, according to data from the Peruvian Shopping and Entertainment Centres Association (Asociación de Centros Comerciales y de Entretenimiento del Perú, ACCP). Recent developments indicate that country is catching up fast. From 2000 to 2010 an average of 7.8 malls were inaugurated each year, and there are expected to be 78 malls in operation at the end of 2015, up from just eight malls at the end of 1999.

Visitor numbers increased at an average annual rate of 15% between 2012 and 2015, and spending in malls is expected to reach $7.9bn in 2015, up from $2.5bn in 2009. Nevertheless, with macroeconomic indicators weakening, 2015 was a year of taking stock for many mall owners. In recent years, local chain Real Plaza has built 17 malls, mainly outside of the capital, often inaugurating several each year. In 2015 the firm did not open a new project, although it has two major Lima malls, Real Plaza San Isidro and Real Plaza Cuartel San Martín, scheduled for completion in late 2016. The ACCP estimates that total investment in malls fell to $350m in 2015, down from $417m in 2013.

Stimulus

In anticipation of weaker consumer demand, the Ministry of Economy and Finance ( Ministerio de Economia y Finanzas, MEF) announced a $1.6bn stimulus package in April 2015. Among the measures introduced were tax offsets for workers and the extension of a decree permitting fuel prices to fall in line with world energy prices, freeing up funds to spend on other goods. “We are taking the necessary steps to ensure we reach budget targets, provide appropriate fiscal support and make people aware of ways to raise their spending power,” said Economy and Finance Minister Alonso Segura on unveiling the package.

Outlook

The diversification of the Peruvian economy is often discussed but hard to implement. PRODUCE’s strategy of building a partnership between the private and public sectors through the creation of working groups is a worthy one that has already produced results in the forestry and aquaculture segments. However, with Peru committed to opening its economy to free trade, developing the country’s manufacturing sector, from textiles to metal mechanics, will be more challenging. Labour rates cannot compete with those in lower-cost Asian markets, so Peru must innovate to provide products of the highest quality.

Peruvian retailers look set to take stock and focus on maximising revenues rather than rushing to open more floor space. The days of double-digit consumer growth may be a thing of the past, but medium-term growth of between 3% and 4% in 2016 presents attractive prospects. While per-capita incomes remain low by regional standards, recovering commodities prices are expected to support the retail sector’s long-term potential.