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Cement sector: Under the government's lens - Views on News from Equitymaster
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  • Apr 8, 2009

    Cement sector: Under the government's lens

    The cement sector is back in headlines as cement manufacturers are raising prices per bag of cement when inflation levels are all time low. Further, it being the basic construction material the cost of housing and development gets impacted. The real estate sector has lost its sheen and rising cement prices are putting pressure on its margins, especially in case of affordable housing development. Noticing all this government has warned cement manufacturers that it will not extend any stimulus packages to the industry until and unless they roll back the price hikes.

    The policy makers argue that despite reducing excise duty on cement, cement manufacturers have raised prices thrice in past two months. While government has its own justification, manufacturers argue that excise duty cut is applicable to bulk cement, which contributes hardly 10% of total cement consumption in India.As such the move is not beneficial. Further, they say that change in railway freight classification has raised the cost of transportation thus exerting pressure on cement margins to the extent of 3% to 4%.

    The demand-supply scenario
    While the tussle between government and cement manufacturers continue, we thought of taking a look at the change in demand-supply and pricing scenario over a year.Before that, we would like to highlight a fact that cement price is a function of demand and supply level. If cost of production and transportation increases and demand to remain high, hike in costs are passed on to consumers to sustain profitability.

    The table below highlights the fact that consumption as such has not taken a back seat and industry has been operating at near equilibrium levels. Supply had fallen short only during the last monsoon season, usually a slack period for construction industry. Also, the industry has been operating at near 100% capacity utilisation levels.The capacity utilisation has been lower in recent couple of months but one should also take into account that players have added over 20 MT of capacity in CY08 taking the total industry capacity to over 200 MTPA.

    Cement industry demand supply scenario
    Date Production(% change) Consumption (% change) Capacity utilisation (%) Excess supply
    Jan-08 5.2 10.8 102.4 1.0
    Feb-08 (0.9) 5.4 101.2 0.1
    Mar-08 11.2 (0.3) 104.1 1.8
    Apr-08 (8.3) 10.7 91.9 (1.1)
    May-08 (0.9) (9.8) 89.1 0.4
    Jun-08 (1.5) 2.0 86.5 (0.2)
    Jul-08 (0.1) (1.3) 86.4 0.0
    Aug-08 (10.2) (2.5) 77.3 (1.1)
    Sep-08 5.6 (9.5) 81.6 1.0
    Oct-08 6.2 4.9 86.3 1.2
    Nov-08 (2.9) 3.1 83.3 0.4
    Dec-08 10.3 0.9 91.7 1.7
    Jan-09 2.0 11.0 93.4 0.5
    Source: Prowess

    Cost issues
    Approximately 60% of industry dispatches take place through railways. The availability of railway wagons is another problem that results into inability to satisfy demand within the given time frame leaving a room for bargain prices. Further, increasing cost of production has also resulted in price hike. The cement industry on an average maintains two months inventory of fuel and such costs. The crude prices have only started cooling off November 2008 onwards, the benefit of which should start flowing in starting quarter ended March 2009 onwards. One must also note that coal linkages for the industry are poor. Further, on account of erratic supply of state grid power and high costs, industry has opted to set up captive power plants based on coal. This has further raised increased demand for coal. At a time when the industry's demand has for coal has increased, the linkage ratio has dropped below 50%. So the players either have to purchase it from open market or import, which results in increased cost of operation. All this has resulted in cost of operation increasing at a faster pace compared to sales growth, which has dented profitability of the industry.

    A look at industry performance
    Quarter ended Sales (% change) Expenses (% change) Operating profits (% change) EBITDA margin (%)
    Dec-07 18.5 23.1 26.1 32.4
    Mar-08 15.5 19.3 5.2 29.8
    Jun-09 10 17.4 -6.2 30.1
    Sep-09 13.7 21.7 -16.3 24.4
    Dec-09 9.9 14 -19.1 24.1
    Source: Prowess

    Cash flow Issues
    Lower cash flows would obstruct the industry investments plans going forward.As a whole industry gearing ratio has come down in the last decade but not all players do have clean balance sheet. Industry majors such as ACC (which had a net cash balance of Rs 5 bn in its books at the end of CY08) are of the view that current prices do not support investments plans beyond 2010.While players may be right on their part in rising prices in the light of rising demand and unabating cost of operation, the government does not seem to agree.

    The government's role...
    As such an unregulated industry cannot be directly forced by the government to roll back prices. Given the problems faced by industry and considering the benefit of the society at large, the government should rationalise its tax structure, improve linkages such as coal and availability of railway wagons. Further, the government should bring in policy changes that successfully address issues such as cartelization and at the same time make the business for cement manufacturers more viable.



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