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Blame it on fragmentation - Views on News from Equitymaster
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  • Sep 2, 2000

    Blame it on fragmentation

    The Indian cement sector surely gave rise to false hopes early last year when interest in cement stocks surged on the back of estimates that cement prices would rise in coming months. However the situation has turned out to be a disappointment with cement prices retreating sharply from the highs attained in 1999. Stock prices too have corrected subsequently. Demand is however not where the problem lies.

    What fed the enthusiasm was the fact that finally the government had initiated measures to boost the domestic housing construction industry. The Indian economy was shaking off the slowdown even talk of fresh economic reforms gained momentum. Numbers too reflected buoyancy in the sector. Financial year 2000 saw demand for cement grow a fantastic 15 percent even as supply grew 14 percent. Finally, and most importantly, after adding 35 million tonnes to domestic cement capacity between FY95 and FY00, fresh commissioning of plants was expected to slow down to a trickle (12 million tonnes over the next three years and this includes the benefit of debottlenecking). In short, a scenario of rising demand and controlled supply.

    (Rs bn), FY00 Gujarat Ambuja ACC Madras Cements
    Gross Sales 12,620 31,385 4,977
    % growth 0.8% 6.3% -1.7%
    EBITDA 3,580 1,688 1,316
    % growth 1.2% -20.5% -6.3%
    Net Profit# 1,750 (589) 402
    % growth 24.3% NA 0.8%

    #Excluding extraordinary income

    Despite this the anticipated rise in prices failed to materialize. The primary cause for this was the fragmentation in the sector. There are over fifty players which account for the total capacity of 110 million tonnes. Of this, five major Indian groups own 50 percent of capacity. This has created, what many term as an ‘undisciplined’ market with a multitude of players, each vying for market share. As a result, players readily up their capacities as soon as cement prices show signs of hardening. The anticipated price rise, therefore either fails to occur or is suppressed considerably. Efforts to control supply have come to naught as smaller players readily breach agreements to capitalize on firm prices.

    The cement sector it must be pointed out also had its share of bad luck earlier this year, when drought in parts of Indian affected demand. As a result for a three-month period, corresponding with the first quarter of the current fiscal year, cement prices retreated sharply as a supply glut was created in the market. Leading cement companies posted a dismal performance for this period. However the resilience in demand can be gauged from the fact that despite a bad first quarter, it is widely anticipated to grow by 10 percent this year. Prices nevertheless continue to remain lackluster.

    The Indian markets are unique not only for the high degree of fragmentation but also for the fact that domestic markets are totally insulated from imports. This is largely due to inadequate infrastructure. It is however felt that even in future imports will continue to remain uneconomical. This is due to the fact that domestic markets would remain intensely competitive even as importers will find it hard to generate volumes in order to exploit scale efficiencies. International companies are however finding other ways to participate in domestic markets – acquisitions. Among the successful companies is Lafarge, which has acquired the cement plants of both Tata Steel and Raymond. Talks that Holderbank, Cemex and Blue Circle are also on the prowl have been doing the rounds.

    With the monsoon having been largely normal, growth in demand for cement is once again expected to gain momentum as the year progresses. However, once again there are grey clouds on the horizon. This time it is the rising crude prices. India has been slow to adjust domestic fuel prices, but as and when it does so, cement companies will be hit hard as transportation costs account for a large chunk of operational and selling costs. Operating margins could be hit if companies are unable to pass on the rise in costs to consumers.

    The Indian cement sector shows all the signs of increasing buoyancy in coming years. However, the going will be good only once the fragmentation is taken care of. And given the fact that 26 percent of cement capacity has changed ownership over the last couple of years, such a scenario now seems more likely than ever.



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