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Indian cement sector: The landscape has changed - Views on News from Equitymaster
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Indian cement sector: The landscape has changed
Jan 9, 2009

The cement story was in the limelight during CY07. The stocks scaled higher as the Sensex marched northwards. The optimism around the cement sector was built by the then booming real estate and construction sectors. However, cement being a sector linked to economic growth it witnesses typical phases of the economic cycle – peaks and troughs. Not surprisingly then, with the start of the CY08 the tide started turning. The first blow: The Government in order to control inflation banned cement exports at the beginning of the CY08. The countervailing duty on cement was reduced to nil. The move was directed towards increasing supply of the commodity domestically and containing rising prices of cement. Ban on exports, however, did not significantly impact the industry as a whole as exports hardly account for 5% of total cement dispatches. But favouring imports badly hit players in the northern region. India imported cement from Pakistan. Cement being a bulky commodity, it is difficult to transport it across regions. Hence, imported cement could only cater to the demand of the northern region. Imported cement accounted for almost 30% to 35% of market share in the northern region. This resulted in few cement majors reporting dismal growth numbers within the region.

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    Upcoming capacities: Meanwhile, the industry had started building capacities. The planned projects started to commence operations. The industry has added over 20 MT of capacity in CY08 taking the total industry capacity to over 200 MTPA. The upcoming capacities started catering to the unfulfilled demand and in turn led to softening of cement prices. As the capacities started becoming operational cement prices stabilized. In some parts of the country, like the northern region few industry leaders revised prices downwards by Rs 3 to Rs 5 per bag to boost volumes. Moreover, slowing demand may have also exerted downward on prices.

    Costlier raw material prices: While realisations were cooling off, supply was increasing and in the north players were uncompetitive in comparison to imported cement. As a result, costs pressures refused to abate. Even though oil prices cooled off, the benefits of the same were partly offset by depreciating rupee and the need to import coal on account of poor coal linkages. Cement is a fixed cost intensive industry. Declining profitability, escalating costs, slowing volume growth forced ACC, the oldest cement manufacturer, to go for a planned shutdown of one of its unit in Himachal Pradesh on a temporary basis.

    Credit crunch: It was believed that rising inflation and interest rates will slow down the economy a wee bit and the global economic slowdown which has been the result of the subprime crisis will drive out capital that flooded Indian markets in CY07. The return of real estate prices to their fair value squeezed profitability of the real estate majors especially the ones who had lined up huge expansion plans on the basis of the high property rates. All this raised concerns about ability of these players to stick to their repayment schedule. Considering the global financial meltdown, financial institutions in India tightened their credit norms. They were reluctant to lend to sectors such as real estate and construction projects on account of fear of increasing bad assets. Cement being a key construction material, deferment of planned projects impacted volume offtake. Thus, apart from upcoming capacities, slowing demand pressurised realisations.

    Credit crunch has impacted cement directly too. Slow growth in volumes and evaporating pricing power has started to impact cash flows of the cement manufacturers. Few of them have deferred their plans to expand capacity on account of credit crunch and block of capital on account of stock piling. Slowing demand resulted in stock piling, which in turn resulted in delayed cash inflows. Even payment against stock sold on credit got deferred as builders and dealers deferred payments. This resulted in longer credit repayment cycle in the short term.

    FY09 outlook...
    Subdued volume growth:
    The overheated real estate sector has cooled off now. Considering the financial turmoil witnessed globally, financial institutions have tightened their credit norms. This cautious stance has led to a credit crunch and the same has impacted upcoming projects. On account of general economic slowdown and these issues, the demand for cement has moderated. The industry is expected to grow at 7% per annum as against earlier estimates of 8% to 10%.

    Vanishing pricing power: The Cement Manufacturers’ Association of India (CMA) has estimated cement consumption to go up to 241 MT by FY12 considering 10% growth in cement demand. This level of demand growth would require new capacity to the tune of 80 to 100 MT. On a conservative basis, capacity additions announced till date will add up approximately 40 MT to 50 MT to the existing capacity (over 200 MT in CY08), the bulk of which will come on stream from FY09 onwards. The same has started taking place. But at the same time, economic slowdown has scaled down growth in consumption. This will further pressurise cement prices, which were expected to cool off with upcoming capacities.

    Can sail through: The cement industry landscape has changed. The Indian cement sector is relatively consolidated than what it was 10 years ago. While in 1995 the top 5 cement manufacturers in the country accounted for 26% of industry capacity, now almost 40% is controlled by the top 4 players. Consolidation has helped the industry enjoy pricing power. Even if there is a supply glut, the situation is less likely to be severe as compared to the past. The cement majors and most of the players have low gearing. Further, with improved cash flows many players have set up and have planned to set up captive power plants, cement plants based on efficient fuel and alternative fuel technology. These moves are expected to help companies within the sector to contain hike in costs if not reduce them.

    Our view...
    While the near to medium term growth prospects have been impacted by the economic slowdown, the long term growth story remains intact. This is mainly on account of government initiatives in the infrastructure and housing sectors that are likely to be the main drivers of growth for the industry in the long run. Further, the government’s recent moves such as infusing capital, lower interest rates for new home loan disbursals, plan to increase infrastructural funding etc., is expected to limit the impact of the slowdown. However, execution and implementation is the key.

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