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Cement sector: A review

Mar 24, 2008

The cement story was in the limelight over the past few fiscals owing to the fact that the demand grew at a faster pace compared to supply and therefore, cement prices remained firm. The need to build up infrastructure to sustain a 9% GDP growth, also kept investors keen on the sector.Prior to FY04, the sector was looming in the darkness. However, the turnaround post FY04 prices marched northwards leading to significant improvement in the companies' profitability owing to strong increase in demand with no major capacity additions taking place. With the increased cash flows companies started cleaning their balance sheets and lined up huge expansion plans to cater to increasing demand for the commodity and witness higher realisations.

However, ultimately cement is a commodity and has to pass through the cyclicality. The cement industry is highly cyclical in nature and depends largely on the economic growth of the country. There is a high degree of correlation between the GDP growth and the growth in cement consumption. Hence, if the GDP growth slows down, so should the demand for cement.

So will the sector continue to be in limelight?

If the Indian policy makers have to put the country on a high GDP growth trajectory, sizeable investments in infrastructure will have to be made, thus boosting the demand for cement. With the government going in for 25% concretization of roads, six-laning 6,500 km Golden quadrilateral and selected National highways, four-laning and widening of roads, constructing new rural roads, capacity addition of major ports, additional 70,000 MW generation of power capacity, upgrading and modernising of railways and ports, improving irrigation facilities etc is likely to translate into higher demand for cement. However, how will the investments be funded remains a question?

The growth of the economy is reflection of the growth of various sectors. Having said that, the slowdown of IT/ITES industry, slower housing loan off take with hardening of interest rates and an overall slowdown in employment is likely to have an impact on the cement sector. The cooling off of the growth in the housing sector, one of the major growth drivers of the cement industry - accounting for over 50% of the demand for cement, is expected to turn the tide in terms of the demand for cement.

Nonetheless, rather than the demand for cement, what worries us is the reverse trend of the all time high realisations once the announced capacities come on stream. It is not the demand that where the problem is, it is the supply side concerns.

How have things moved?

Source: Cement Manufacturers' Association
To understand the same let's take a look at the sector fundamentals. The industry capacity has grown by merely 6.4% in past 12 years from 78 MT in FY95 to almost 165 MT in FY07. While the consumption during the same period reported growth of almost 9% and production grew at a tad lower rate of 8.5%. Thus, demand growing at a faster pace compared to supply led to firm prices.

Cement being a cyclical industry goes through phases of ups and downs, and accordingly, companies' realisations are affected. The surplus position had resulted in significant pressure on price realisations in the past. The cyclical trough in the late-1990s had a severe impact on the industry financials and many companies were referred to the BIFR.

However, the favorable pricing scenario witnessed by the sector post FY04 has resulted into increased profitability for the cement companies irrespective of their scale and efficiency in operations. The things were never so good for the Indian cement industry in the past. With cement prices having ruled firm on the back of a favourable demand-supply scenario (up by almost 20%+ during CY06 / FY07 owing to waning demand supply gap), cement manufacturers benefited significantly. Floods that hit the western parts of the country in mid- 2005, 2006 and 2007 hardly had any impact on the sector's growth on account of robust demand that grew at the rate of around 10% YoY. Besides the higher realisations, few companies have also managed to lower costs, by improving operational efficiencies.

The hike in prices is not only the result of demand supply mismatch but also owing to consolidation in the industry. Consolidation of capacities over the years has seen UltraTech, Grasim, and Ambuja Cements emerge as the leading players apart from ACC. In FY08, the top 4 companies account for 40% of the total industry capacity. The booming sector has also witnessed top 4 MNC's foraying into the Indian stock market through acquisition of stake, companies and setting up greenfield project.

In the last budget (2007-08), the government in order to rationalise prices and contain inflation had hiked excise duty on a deferential basis, rationalised import duty and reduced countervailing duty to nil. The moves were not expected to have significant impact on the sector as being a bulk commodity transporting across regions is a problem and hike in excise duty is generally passed on.

However, if we look at the chart, it highlights, the moves even though not resulting in reduction in prices, have resulted in price stabilization during July to November 2007. Now one may argue that monsoon period is a slack season. However, the year before even in monsoon season prices continued to march northwards. The prices again started inching upwards post November 2007 till December 2007 with consumption exceeding supply and no major capacity addition. Thus, movement of price reflects demand supply situation.

The hike in price on year-on year basis in January 2008 works out to 10%. This highlights that the hike in prices has moderated, which earlier reported growth of 15% to 30%, with the capacity built up and imports on a miniscule basis.

What to expect?

Though it is debated time and again whether the domestic economy is strong and is unlikely to face the impact of slowing down of major economies across the globe, the fact remains that India is no more insulated to global trends. The slowdown may not have severe impact on the growth of the economy immediately but the investments required to fund the huge capex plans, necessary to give a further fillip to the growth of the economy, might get impacted. This may result in the economy growing at a slower rate than expected, in turn impacting the current robust growth of the cement sector.

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