Cement: Consolidation benefits all?

The year 2002-03 was rather forgettable as far as the cement sector is concerned. While the industry saw strong demand for cement, an oversupply scenario adversely impacted the operating efficiencies of cement companies and consequently their profitability. The current year on the other hand has started off with a bang. Here we are referring to the consolidation witnessed in the sector early this year. In this article we look at the year that went by, i.e. FY03 and the current year, and the changes that have occurred in the cement sector, both in terms of fundamentals as well as stock market performance.

The year FY03 started on a poor note with significant oversupply in the cement market, which led to poor cement prices. However, demand (up 9% in FY03) continued to remain buoyant in the same period. The housing sector that accounts for a majority of cement demand in the country has been the main catalyst for robust cement demand growth in FY03. Low interest rates as well as a significant demand-supply mismatch (in the housing sector) have ensured strong demand for dwelling units and consequently cement.

That apart, the government’s stress on infrastructure development has led to strong incremental demand for cement, especially from the highway projects. With these highway projects expected to continue well into 2007, cement demand from this area is likely to be strong. While FY03 was largely uneventful, FY04 has been equally eventful till now. In the last one-month, investor perception towards the sector as a whole has changed dramatically. Consolidation has been the major reason for the same. However, well before the Grasim-L&T deal, investors recognizing the easing pricing pressure (on cement) started taking interest in pivotals like ACC and Gujarat Ambuja.

The Grasim-L&T deal (read more) has acted as an icing on the cake. This deal has possibly triggered another round of consolidation in the cement industry. Post this historic deal, three players now control nearly 45% of the total domestic cement capacity. This augurs well for the whole sector as increased consolidation will bring about its own benefits in the form of better pricing power in the hands of the producers. For years, the Indian cement industry has been plagued by fragmentation and this new development has already fueled a re-rating of the entire cement sector from the long-term perspective.

Having enumerated the nature of the cement sector in the recent past, we would like to point out that, while cement demand is likely to be strong going forward, benefits of consolidation will only be realised by large players. Due to bullishness towards the sector, one may witness gains across all the stocks in the sector. What investors need to realise is that since the benefits of increased consolidation may only be available to large players, smaller players may face difficulties going forward. Thus investors need to carefully look at fundamentals in order to make their investment decisions.