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Cement: Will the price rise be benign?

Mar 2, 2010

In the recent budget, excise duty on cement has been rolled back partially. This is likely to exert upward pressure on cement prices. The price per bag of cement has accordingly been hiked across the country by Rs 10 to 12 per bag. This is highest ever price rise historically witnessed by cement industry on a pan India basis. This hike also factors in the increase in cost of diesel that would in turn increase cement manufacturing cost. Thus, increase in operational cost would be offset by this price hike. Hence, we do not foresee any substantial change on the operating margin front (upwards or downwards). While the cement manufacturers unanimously decided to raise cement prices, cement still remains a cluster story. The regional story would unfold as capacities across regions would start coming on stream soon or later and with the changing regional demand for the construction material. Realisations i.e. cement prices do have a material impact on the operating margin of the cement manufacturer. However, that alone does not dictate the operating leverage for a cement producer. It also depends upon the ability to control costs. To understand the same let us take a look at two cement majors that belong to the same group- Holcim. Here we would take a look at the performance of ACC and Ambuja Cement. ACC is the oldest cement manufacturer and generally considered as operating at high cost. Ambuja Cements, an exporter of cement is generally considered as the least cost producer owing to its high margins.

These notions have been changing and today we would show it to you. The following discussion would help to understand the fact that margin expansion comes on account of higher realisations and control on cost of operation. In general, it is advisable to enjoy higher margins by controlling costs. As in times of cyclical downturn, control on costs would cushion margins.

Till CY08 Ambuja Cement enjoyed higher margins as compared to ACC. Apart from brand benefits that Ambuja Cements enjoys domestically, higher export realisations supported profitability. Although exports account for minuscule share of much less than 10% of sales and volumes, realisations in export markets were higher by almost 50% as compared to domestic markets. However, export volumes started declining and the same impacted the performance of Ambuja Cements. Decline in exports was the result of ban on exports (beginning of CY08). It was also owing to weakening demand on account of global economic slowdown and cement capacity built up taking place in Gulf countries (export markets of Ambuja Cements).

In such times of cyclical downturn, operating efficiencies take the driver's seat. Cement companies have been focusing on building their brands that can help them push their product in a competitive environment. However, cement ultimately is a commodity and we do not foresee it enjoying brand value the way FMCG products do. Even in case of building solution and materials, we believe paints may enjoy brand benefits as compared to this construction material. Well we do not say branding is a futile measure but in times of cyclical downturn these initiatives are less likely to benefit a commodity manufacturer.

What is of prime importance is check on costs. The restructuring exercise in ACC initiated in FY02 has helped it lower cost of production and hence improve profitability. Moreover, upturn in cement cycle and Holcim interest in this oldest cement manufacturer has helped it keep a check on rising cost of operation. Its pan India presence has further enabled it offset volume growth in a particular region. All of this has led ACC outperform Ambuja Cements in terms of profitability.

Ambuja Cements enjoyed higher EBITDA per tonne largely on account of cushion provided by exports. With rising cost of operation and vanishing export premium, the real picture came forward. It started losing sheen. The company has been taking initiatives to keep costs under control. <>Ambuja Cements has outlined investments to set up captive power plants and logistics project to improve connectivity. These initiates are likely to restrict rise in cost of operation. After all Ambuja Cements is also a Holcim group company and would also benefits from Holcim's expertise in manufacturing cement going forward.

Thus, it is clear that higher realisations alone do not fetch sustainable margins. One also needs to keep check on costs on a continuous basis and diversify revenues. In case of cement one needs to diversify geographical revenues to the extent possible to offset demand lull in a particular region.

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