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Cement: Tale of two efficient players
Sep 10, 2008

In this article, we will take a closer look at the two of the most cost efficient cement manufacturers, Madras Cements and Shree Cement to find out apart from better realisations what are the other factors or strategies that have helped them to sustain profitability. The cost per tonne of Shree Cement has increased at CAGR of 16.9% in past two years (from Rs 1,390 in FY06 to Rs 1,899) and that of Madras Cements has increased at a CAGR of 13.3% during the same period (from Rs 1,691 to Rs 2,170). While on cost per tonne basis Shree Cements fares well, the growth in cost has been at a faster pace compared to Madras Cements.

The major costs involved in cement manufacturing process are raw material costs and energy and transportation costs. The key raw material required to manufacture cement is limestone, fly ash and coal. Cement being a bulk commodity and transporting over long distances becomes difficult, proximity to markets and proximity to raw materials is equally important. Though, both the companies have sufficient limestone reserves, the cost of raising limestone and hence the raw material cost has increased in recent years. While the raw material cost per tonne of Madras Cements has increased at CAGR of 16.6% in the past two years, in case of Shree Cement the same has increased at a CAGR of 9.4% during the same period. The reason for the comparatively slow growth in raw material cost per tonne for Shree Cement is utilisation of low cost pet coke as fuel instead of coal for its cement production. Madras Cements has been dependant on diesel, prices of which have scaled up in the recent past thus leading to increase in cost of operation.

As seen in the table below, even on power cost per tonne basis, Shree Cement fares well compared to Madras Cement. However, growth in power cost per tonne has been steep in case of Shree Cement at a CAGR of 16.6% in past two years as against 13.8% for Madras Cement. The steep increase in fuel costs such as diesel and coal have been impacting Madras Cementís overall cost of production. In order to control costs, recently the company has increased focus on usage of alternative sources such as wind energy. The companyís dry manufacturing process and efficient plants have helped the company restrict growth in cost of operation. After witnessing the benefits of captive power plats and wind mills, the company has planned to install wind electric generators of an aggregate capacity of 74 MW. In order to control costs, Shree Cement has been scouting alternative options and has also improved its logistics operations. With the increase in diesel costs the company has increased rail despatches. Further, it has planned to foray in the southern region, the only region that is witnessing near equilibrium situation, while other regions have started and are expected to face excess supply situation. Diversifying revenues geographically helps offset effect of low prices in one region. Moreover, Shree Cement has been operating at optimum capacity utilisation levels and the same has helped the company achieve economies of scale.

Madras Cements Shree Cement
Particulars FY06 FY07 FY08 FY06 FY07 FY08
Raw material cost/ tonne (Rs) 323 355 439 278 342 333
Power cost/tonne (Rs) 539 547 698 426 489 579
EBITDA/tonne (Rs) 430 400 448 693 1,266 1,362
EBITDA margin (%) 21.0% 35.4% 37.2% 33.1% 44.7% 41.7%
Capacity Utilisation (%) 78.5% 94.5% 73.2% 117.5% 101.6% 92.9%

While both the companies are amongst the lowest cost producers of cement in the country, Shree Cement enjoys better EBITDA margins due to being more cost efficient. Here one must note that Shree Cement is an efficient cement manufacturer but the improved realisations have driven the companyís performance. As the planned capacities started coming on stream the growth in realisations has slowed down exerting downward pressure on EBITDA margins, apart from rising cost of operation. On the other hand, Madras Cements has been able to improve margins on account of strong demand in the southern region. Moreover, Madras Cements has been able to sustain EBITDA margins at an average rate of 25% even in the cyclical downturns. The southern player has longer proven history; however, it needs to diversify revenues geographically to mitigate adverse conditions in one region by the other.

While profitability is an important parameter that determines returns on capital, we value cement companies based on enterprise value per tonne basis as we believe that commodity stocks should be valued at their replacement cost. On the basis of asset valuation method, the stock of Madras Cements is fairly valued at an EV/ton of around Rs 4,000 as per our FY11 estimates. On the other hand, Shree Cement is trading at an EV/ton of around Rs 2,000 as per our FY11 estimates, which makes it attractive considering the replacement cost method.

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