Colombia - Acerias Paz del Rio Steel Project

R ESTRICTED Report No. TO-376a This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION APPRAISAL OF THE ACERIAS PAZ DEL RIO, S. A. STEEL PROJECT COLOMBIA June 17, 1963 FIlE COPY Department of Technical Operations  CURRENCY EQUIVALENTS Principal Selling Rate: U. S. $1 = Pesos 9. 00 Free Rate - June 13, 1963: U.S. $1 = Pesos 10.15 All tons are metric tons  APPRAISAL OF THE ACIRIAS PAZ DEL RIO, S.A. STEEL hROJECT (COLoirIBIA) TABLE OF CON'TENTS Paragraphs SUINARY AND COCLUSIOS . . . . . . . . . . . i-xii I. IN1TRODUCTION . . . .. . .. . . .* . . . .* 1-10 II. THE COMPANY . . . .. . . . . . . . 11-53 History and Financial Structure . . . . . 11 - 24 Properties . . . . . . . . . . . . . . . 25 -30 Production and Sales . . . . . . . . 31 -35 Marketing . . . . . . . . . . . . . . . 36 -37 Management . . . . . . . . . . . . . . . 38 -41 Labor . . . .*. . . . . . . . . . . . . . 42 -45 Financial Position and Earnings Record . . 46 - 53 III. THEiMARKET .. . . . . . . . 54-62 Market Prospects . . .. . . . . . . . . 55-56 Protection and Competitive Position . . . 57 - 60 Price Control . . . . . .. . . 61 IV. THE PROPOSED ROJECT . . . . . . . . . 63-88 Description of the Project . . . . . . 63 - 67 Materials, Services and Power . . . . 68 - 75 Construction Cost Estimates . . . . . . . 76 - 79 Construction Schedule . . . . . . . . . 80 - 85 Procurement . . . . . . . . . . . . . 86 Engineering Services . . . . . . . . . . . 87 Benefits from the Program . . . . . . 88 V. FINAMCING PLAN AND FINANCIAL FORECASTS. . . 89-102 Financing Plan . . . . . . . . . . . . . . 89 - 94 Financial Prosoects . . . . . . . . . . . 95 - 102 VI. PROTECTIVE ARRANGl&SNTS . . . . . . . . . . . 103-105 VII.. ECO:i-I:IC JUSTIFICATION . . . . . . . . . . . 106-109 VIII. CONCLUSION . . . . . . . . . . . . . . . . . 110  TABIE OF CYi CT'Th - rs (Cont Id) ANNEKES 1. List of Equipment and Properties 2. Recent Financial Statements of the Company 3. The Market for Steel in Colombia and the Prospects for Acerias Paz del Rio . Cost Estimates 5. Construction Schedule 6. Earnings Projections 7e Cash Flow EstirLates 8. Summary Balance Sheets 9. Assumptions for Financial Forecasts IAPS 1. Colombia 2. Belencito - Paz de Rio District'  APPRAISAL OF THE ACERIAS PAZ DEL RIO. S. A. STELL PPOJECT (COLLi MA) SjvmAPRY AlD CJ'i I !7L _;S The Bank has under consideration a loan of $30 million equivalent to finance the foreign exchange cost of thg major ;ortion of thc proposed project of P.cerias Paz del hlo, -.h. ii. Acerias Paz del Rio, S.A., operates the only fully-integrated steel mill in Colombia, located at Belencito about 160 miles northeast of Bogota. Production during 1962 amounted to 126,000 tons of finished prod- ucts and consisted of heavy structurals, rails, merchant products and wire, Except for some minor items, the company produces all of its raw material requirements. Proven recoverable reserves of iron ore, coal and limestone are in excess of thirty years' requirements at the current rate of consump- tion. iii. The company is the successor to a quasi-governmental corporation established in 1947 by the Colombian Government to construct and operate a steel mill. Construction of the rmll and related facilities was begun in 1951 and regular operations started in 1955. Foreign exchange financing was provided in part by suppliers and in part by the government, while local currency requirements were provided mainly by the government, in the form of loans and equity investment. By December 31, 1962, the company had become substantially free of debt (largely by application of the proceeds from the sale of new stock to debt repayment) and 79% of the companyts authorized cormnon shares had been transferred from the government to private investors, iv. In 1949 the Bank's general survey mission to Colombia reviewed the feasibility studies for the mill and recoRmended against its construction at that time. In 1955, at the request of the government, another Bank mission made a stud-y of the Colombian steel industry. This mission concluded that, if management were improved, further investment would be justified in order to rationalize the newly-constructed mill, provided that it could be included in an overall investment program tha-t was consistent with the internal solv- ency and external stability of the country. In 1958, in accordance with the Bankts recommendations, the company engaged a firm of consulting engineers to make a study of its operations and to assist it in prepcring an expansion program. In Nay 1959, after examining a preliminary report from these con- sultants, the Bank informed Paz del Rio that it would consider lending for the proposed program provided certain specific conditions were met. The company agreed to these conditions. The final report of the consultants was submnitted to the Bank in early 1961 and in the suimer of that year a Bank mission went to Colombia to appraise the proposed project. Because of various delays, another Bank mission returned to Colombia in 1962 and, with the assistance of John I'iiles & Partners (London) Ltd., consultant en- gineers, who have been retained by the company to engineer the project, agreed with the company on a revision of the proposed scheme. In April 1963, another Bank mission went to Colombia to review the financial via- bility of the project.  ii V. The scope of the proposed project does not encompass the construc- tion of any new basic iron and steel-making facilities. The project is designed to make possible maximum utilization of the existing plant and fuller use of raw materials and scrap and to broaden the range of the company's finished products. Completion of the project is expected to result in an increase in annual output of finished products from 126,000 tons in 1962 to 220,000 tons by 1968 (including 67,000 tons of flat products which the company did not produce in 1962), a reduction in unit costs and an improvement in product quality. Work is already in progress on certain parts of the project. vi. The total cost of the project, including renewals and replacements, is estimated at the equivalent of U.S.$58.7 million of which U.S.$30.8 million represents foreign exchange requirements (including interest during construc- tion) and U.S.$27,9 million local currency costs. In addition, the equivalent of U.S.$4.5 million will be required during the period 1963-67 for additional working capital and other purposes. vii. Internal generation of funds by the company is expected to be more than adequate to meet all requirements for local currency funds. To take care of any unforeseen contingencies, however, the company has arranged for a Col$100 million bank line of credit to be available over the next five years. In addition, the company will bear the foreign exchange costs of that part of the project already under construction. Thus, the Bank has been asked to consider making a loan to cover the balance of $30 million of the foreign exchange required. The financing plan is sound: interest and debt services would be covered at least three times. viii. As a result of completion of the project, it is estimated that the company's earnings (before interest, taxes and supplementary depreciation) would rise from Col$17.4 million in 1961 (earnings during 1962 were adversely affected by a 4S-day shutdown of the bla3V furnace for relinfing}) to, ar. e8ti.. mated Col$78.8 million in 1968. Return on the book value of the total invest- ment would increase from 3.2% in 1961 to 8.2% in 1968. This rate of return, though not as high as that attained by many industries in Colombia, is, never- theless, acceptable, especially when the project is viewed as an interim step in the company's planned expansion. ix. Conservative market forecasts indicate that the proposed investment program is amply justified. It is estimated that the total demand for steel in Colombia will rise from the present level of about 275,000 tons of finished products per annum to an average of around 400,000 tons per annum in 1967-71. In this period, Paz del Rio's share in the market for the products it now manufactures is expected to amount to 70% (as compared with 72% in 1961) and its share in the market for flat products is expected to amount to about 37%. x. The Government of Colombia follows a policy of protecting domestic manufacturing through import duties and import restrictions. Industrial products which are manufactured in the country can be imported only after  iii certification by domestic producers that they cannot satisfy the demand. In addition, the Colombian import tariff affords the domestic steel industry pro- tection which, for the bulk of the products currently manufactured by Paz del Rio, amounts to 25% to 30C of the c.i.f. cost of imports landed at Barranquilla. xi. In view of the government's protective policy, the competitive position of Paz del Rio vis-a-vis imports was carefully studied. Because the company's cost accounting system does not yield adequate unit cost information and its prices do not truly reflect the cost of capital in the sense that they produce only a small return on investment, it is not possible to evaluate the competitive position of individual items produced by Paz del Rio vis-a-vis imports. However, based on the principal selling rate of exchange for the peso of Col$9/U.S.$1, delivered prices on Paz del Rio's products in the Bogota region where more than half of the company's sales are effected would be competitive with those of similar imported products were import duties to be reduced to an average of l151 of the c.i.f. price of imports delivered in Bogota. As a result of the reduction in unit cost of production and the greater concentration of sales in the Bogota region which are expected to follow completion of the proposed project, the company's competitive position will be considerably enhanced. xii. On the basis of the arrangements set out in paragraphs 103-105, the project provides a suitable basis for a Bank loan of $30 million equiva- lent for a term of 15 years, including a five-year grace period.  I. lj'n'DUCTION 1. In 1942, largey ao a result of the difficulties that Colombia had experienced in securing steel after the outbreak of the second World War, the Colombian Government began to explore the feasibility of establish- ing a domestic steel industry based on iron ore and coal resources that were knowm to exist in the country. The American Rolling Iill Company (APLCC) which was engaged to study the project recomnended against it in 1944. However, the Governmentts interest persisted, and in 1947 a quasi-governmental corporation was established to construct and operate an integrated steel mill and related facilities. In early 1949, the hoppers Compary, Inc., which had been retained as consultants, repor-ted that an integrated steel imill with an annual capacity of 190,000 tons of finished products could be operated profitably. Belencito, about 160 miles northeast of Bogota was selected as the site of the proposed steel mill, and prelii,inary work was begun. 2. In the second half of 1949, when tlhe Bank's first general survey mission went to Colombia to assist the Government in for-rmiulating a development program for the country, the proposed steel plant was one of the priority projects submitted for its consideration. After careful review, the mission recomimended against its construction at that time. In the mission's opinion, the profitability estimates were unrealistic since the cost estimates for the proposed 190,000 ton plant (and for a sim.aller plant proposed as a possible alternative by Koppers) appeared far too low. iore important, however, the mission concluded that the limaited demand for steel in Colom^bia and the distance and absence of rail connections between Belencito and all centers of steel consumption in Colombia except Bogota made the establishment of an integrated steel plant premature. 3. The Colormbia Government, however, considering a domestic steel industry essential for the economic development of the country, decided to go ahead. It authorized the company that had been established to carry out the project to arrange for foreign exchange financing with suppliers. The Government guaranteed these loans and supplied the bulk of the locE:l currency funds required. Construction of the mill and related facilities was begun in 1951 and regular operations started in 1955. 4. When operations began, all facilities required for a completely balanced steel mill had not been installed. Loreovor, there was some question as to whether, even if properly balanced, the plant would be large enough in scale for economic operation. 5. In 1955, when a Bank mission went to Colombia at the request of the Government to assist in preparing a progra;. of public invest.ment, the mission was asked, in addition, to manke a special study of the Colombian steel indus- try and to recormend what steps should be taken to place the industry on a sound footing and to develop it further. The mission concluded that if the necessary investr;ent could be included in an over-all investment program that would be consistent with the internal solvency and external stability of tColoLbia, Paz del rio's facilities should 'be expanded, provided, however, that  - 2 - the company had first carried out a number of recomn:endntions made by the mission. The most important recommendations lrere that (i) Paz del Rio should employ experienced rmanagenent consultants, (ii) the studies and engineering designs for the proposed expansion prograni. should be prepared by qualified consulting engineers and (iii) the company stock then held by the Government should be transferred to private hands. 6. In June 1958, accordingly, Paz del Rio engaged the Koppers Company to rake a comprehensive study of its operations and finances and to assist it in preparing an expansion progran. In Mv,ay 1959, after studyiv: a preliminary report prepared biy the Koppers Company, the Hank informed the Government and Paz del R'io that it would consider lending for the proposed programl, provided that: a) The company would enter irto a satisfactory management contract with a qualified fir.. with a view to strength- ening management; b) A satisfactory program would be worked out to accelerate the transfer to private hands of stock held bx.r the Govern- ment; and, c) The projected investment, together with improvement in the manageii.ent, would enable the company tc become a profit-making enterprise within a reasonable time. 7. T'he company agreed to these condit-ons. The hoppers Company was engaged by Paz del Rio to act as tecl-nical and management consultants and to assist in preparing a revised expansion program. As a result of measures taken by the Government the transfer to private hands of stock held 'oy the Government proceeded rapidly (See paras. 13-21). The project which was developed was designed to balance the facilities at the mill and thus enable the cor.pany to obtain the highest profit rate obtainable fro. the existing investment within a reasonable period of time. 8. The Koppers Conpanyts final recoymmendations on the proposed ex- pansion programr were subrmitted to the Bank in early 1961. In the summer of that year, a 'Bank mission went to Colombia to study the project. Because of various delays, a Bank mlssion returned to Colombia in the autumn of 1962 to miake a further appraisal of the project. There, with the assistance of John 11iles C Partners (London) Limitecl wno had been retained by the company to engineer the project, the Bank mission agreed with the company on a revision of the 1961 project to m.eet conditions then existing in Colombia, anticipate prospective market demand and lay the ground wlork for possible future expansion. In April 1963, another Dank mission went to Colombia to review the financial viability of the project. 9. The revised project is not intended to expand the basic iron and steel making capacity of the plant. It is aimed mainily at: (i) balancing facilities at the mill to mnake possible raximum utilization of existing plant;  -3- (ii) increasing utilization of raw materials and scrap; and (iii) broadening the range of the comoany's production to include flat products in addition to the structurals, rails, merciaant products and wire to which its output up to now has been limited. The project is designed to bring about an increase in the company's annual output of finished steel products fron the 126,000 tons produced irn 1962 to about 220,000 tons (including 67,000 tonis of flat products which the company did not produce in 1962), a reduction in unit costs and an improvement in product quality. The project has also been designed to provide the most economical basis for possible future expansion and as such includes the installation of some excess capacity in anticipation of future expansion. 10. The following appraisal of the program is based on Koppers' 1961 report, recomriendations made by John Miles & Partners (London) Limited, in 1962, the results of the investigations of the Bank missiorn in 1961, 1962, and 1963, and information supplied br Acerias Paz del Rio, S.A. II. THE COMP