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Where is the cement sector headed?

Aug 26, 2011

The financial year 2010-11 was a very bad year for the cement industry. Sluggish demand, capacity overhand, high input costs and pressure on cement realisations culminated into a classical downcycle.

During the quarter ended June 2011, of the top three cement players- ACC, Ambuja Cements & UltraTech Cement- only ACC registered a rise in cement sales volume. On the other hand, Ambuja Cements and UltraTech Cement registered a 2% decline in volume sales.

The figures for the month of July 2011 seem to indicate a significant improvement, with all the top three companies witnessing a healthy rise in cement despatches.

  Cement despatches (in m tonnes)
  Jul-11 Jul-10 Change
ACC 2.0 1.6 28.2%
Ambuja Cements 1.7 1.5 13.9%
UltraTech Cement 3.1 2.9 7.4%

But does that mean the cycle has turned? We believe that the improvement in July despatches should not be taken at face value. It is important to note that the rise has taken place from a relatively lower base last year.

According to a recent Crisil Report, the cement industry may go through even more turbulent times in the next couple of years. Owing to subdued cement prices and high input costs, the industry’s margins may halve to 10% in 2012-13 which would be the lowest level in a decade.

There is already a wide demand-supply mismatch in the cement industry, with supply being in far excess of demand. Cement overcapacity is expected to rise even further as 60 m tonnes of new cement capacities are expected to be added during in the next two years. On the other hand, cement demand is expected to grow by just 30 m tonnes. As a consequence of this, capacity utilisation rates will plunge even lower from78% in 2010-11 to 72% in 2012-13.

On the cost front, power and fuel costs which form a sizeable portion of the operating costs are expected to rise by 18% in the current financial year 2011-12. To add to the woes, higher effective excise duty rates will subdue cement realisations by 2-4%.

The smaller cement players, those with capacities less than 2 m tonnes, will continue to be the worst hit. The larger players are relatively in a better position to deal with the downcycle on account of economies of scale and captive power plants that meet a significant proportion of their power requirements.

We believe that an industry downcycle such as the current one can throw up good buying opportunities for long term investors as stock prices get beaten up beyond reasonable levels. For one, the long term demand prospects of cement are undeniably robust given that it is one of the most basic building blocks of an economy without any substitutes. The cement industry as a whole has become far more efficient than a decade ago. Additionally, the balance sheets of the major cement players are in a pretty healthy state. Of the three giant cement companies, ACC and Ambuja Cements have positive net cash.

(Rs m) Balance sheet position as on year ended CY10/FY11
  Total Debt Cash & Bank Net cash
ACC* 5,238 10,800 5,562
Ambuja Cements* 650 17484 16,834
UltraTech Cement^ 41,446 1448 (39,998)
*Calendar year ended December 2010; ^Financial year ended March 2011

In conclusion, we believe that the best time to scoop up commodity stocks is during an industry downcycle. Companies that have efficient managements and low leverage are the ones to look out for.

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