Cement is one of the key infrastructure industries. The Indian cement sector has evolved significantly in the last two decades, going through all the phases of a typical cyclical industry. After having gone through a period of over-supply and the phase of massive capacity additions, the industry is currently in a consolidation phase, with capacity additions coming up to cater to increasing demand for cement.
No more a regulated industry…
The Indian Cement Industry was fully regulated till March 1, 1980, subject to price and distribution controls, and licensing was dispensed with since July 25, 1991. With this move, the industry underwent a complete metamorphosis after the two phases of decontrol. Post deregulation, the industry became a more profitable proposition and a number of players entered into the segment to tap the latent demand and the benefits of price decontrol. The demand rose at an average of 8% to 10% over the last two decades. However, the performance of the industry and prices of cement are monitored on a regular basis. The industry is subject to the quality control order issued on February 17, 2003 to ensure quality standards.
Post-deregulation, larger capacity plants came up, which were based on the more efficient dry process, as against the older plants, which were undersized as well as technologically obsolete using the inefficient wet process. The dry process is more modern and energy-efficient, followed by the semi-dry and wet process.
Cement is a power-intensive industry requiring on an average 110 to 120 units of power per tonne of cement produced. Significantly, power accounts for 15-20% of the variable cost of cement manufacturing. Cement manufacturing consumes power mainly for 3 purposes - raw material grinding, kiln rotation and clinker grinding. Each stage accounts for roughly one-third of the total power consumption. However, with the increase in the frequency of power cuts and rising power tariffs, many cement companies are meeting 60-100% of their power requirement through captive facilities. During FY05, roughly 43% of the total domestic cement production was undertaken using captive power as against only 21% in FY95. Thus, the share of cement production using captive power has only increased over the years.
Scale of Operation
The cement industry has witnessed a significant change in the scale of operations. In 1990, the largest kiln had a capacity of just 1.5 m tonnes per annum (MTPA) or 4,500 to 5,000 tonnes per day (tpd). By the end of FY06, there were 7 plants with a capacity exceeding 3 MTPA at a single location, and 71 plants with a capacity exceeding 1 MTPA at a single location. Thus, it is abundantly clear that the scale of operations has increased significantly over the years, which, in our view, is crucial to gain size and scale, improve operating efficiencies and compete against the best in the business.
Changes in cement products
In India, about 44% of the cement produced is Ordinary Portland Cement (OPC), 47% is Pozzolana Cement (PC), 8% is Portland Blast Furnace Slag Cement (PBFSC), and the remaining 1% are special cements. Blended cement (PC and PBFSS) has a significant share of India's cement production and this is expected to rise in future as well.
In India, the share of blended cement in the total production had increased from 47% in 1978-79 to 76% in 1982-83. After this, the Indian cement industry witnessed a higher production of the higher grade OPC, and the production of blended cement gradually declined to 27% in 1992-93. However, this was followed by an upward trend, and the share of blended cement reached approximately 56% in 2004-05.
A focus on more value-added products like Ready Mix Concrete (RMC) is emerging. RMC is a compound in which sand, gravel, additives and water are added to cement and sold as ready made concrete. Cement producers benefit from RMC production as it involves low capital expenditure. The cost of setting up a 100 metric cube per hour plant is in the range of Rs 70 to 90 m. Cement manufacturers prefer this method of cement transportation, as it results in lower packaging costs. Also, the damages during transit are lower.
Volume growth and capacity utilisation
The demand for cement mainly depends on the level of development and the rate of growth of the economy. There are no real substitutes for cement and it forms a very low proportion of the total cost. The demand for cement is, therefore, price inelastic. Post deregulation, the production in 1989 rose to 44.1 MTPA as compared to only 23.5 MTPA in 1983. As on March 2006, capacity stood at 160 MTPA. Capacity utilisation was 77% during FY01, which went up to 83% in FY05. Over a 5-year period, capacity has grown at CAGR of 6% as against that production and consumption has grown at 8%. Also, the capacity utilisation has improved from 74% to 80%. Major players in the industry, in fact, are operating within a range of 90% to 100% capacity. Many have announced expansion plans to meet the growing demand. Major capacity additions will be completed by FY08, and post that period, there could be a situation of excess supply.
Cement being a cyclical industry goes through phases of ups and downs, and accordingly, companies' realisations are affected. Even in a downturn, companies those are cost effective, will sustain. Players with well-disciplined cost structures, high capacity and a wider geographical spread will outperform their industry peers. The surplus position had resulted in significant pressure on price realisations in recent years. The cyclical trough in the late-1990s had a severe impact on the industry financials and many companies were referred to the BIFR. However, cement prices have firmed up during the last few years due to improvement in the demand-supply position, increasing consolidation in the industry and the government's thrust on infrastructure development in the country.
Going forward, we are positive on the growth prospects of the cement sector in India, given the above-mentioned factors. However, as regards valuations, we believe that most of the stocks are stretched, given their historical valuations, on an EV/tonne basis. Even though there is clear visibility in growth in the medium-term, we believe that this has already been factored in.