The Indian cement industry is second largest in the world after China and has grown at a CAGR of 8% in the last decade. The 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 (latter half of the previous decade), the industry is currently in a consolidation phase, with capacity additions coming up to cater to the increasing demand. Demand has been driven by a booming housing sector and increased activity in infrastructure development such as state and national highways. While the demand is growing at a robust pace of 8% to 10% annually, the paucity of major capacity additions is putting upward pressure on the cement prices.
Fragmented: The Indian cement industry has been characterised by a high degree of fragmentation. Currently, the number of players in the domestic industry is over 50. As on March 31, 2006 there were 130 large plants, accounting for approximately 80% of the total capacity and 365 white and mini plants in the country, accounting for the rest. The top 4 companies account for almost 40% of the total domestic capacity, while the remaining is distributed among the large and mini plants in the industry.
Cyclical: Cement industry is highly cyclical in nature and depends largely on the economic growth of the country. There is a high degree of correlation between the GDP growth and the growth in cement consumption. This can be gauged from the fact that after experiencing robust growth from 1994 to 1996, the sector was one of the worst affected due to economic slowdown during 1997 to 1999. The industry registered an impressive growth during the 1999 to 2000 which was mainly due to demand from housing sector which accounts for 60% of cement consumption, the rest accounted equally between infrastructure and industry/others. This resulted in huge capacity built up leading to excess capacity. However, cement prices have firmed up during the past few years (post FY02) due to improvement in the demand-supply position, increasing consolidation in the industry and the government's thrust on infrastructure development. 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 profitability.
Standardised technology: Cement manufacturing is a standardised and simple process, which does not offer any technological advantage to specific players. The industry is characterised by matured and stable technology with only minor improvements taking place over the years. The financial viability / profitability of a unit depends on operational efficiency (both manufacturing and marketing) apart from general demand supply situation in the region. Any innovations in the manufacturing process can be easily diffused across the industry. Thus access to the latest technology is not an entry barrier for anyone entering the sector.
Localised operations: Given the bulky nature of the product and the resultant high freight costs, transporting cement beyond 250 km is economically unviable. Regional supply imbalances affect the realisation and margins of the manufacturers within that region. Uneven capacity expansions have intensified these imbalances in the industry. While the southern region is excess in capacity owing to abundant availability of limestone, the western and northern regions are the most lucrative markets on account of higher income levels. However, manufacturers have capacity expansion plans depending upon the infrastructural development. The eastern and northern regions will see major capacity additions taking place in coming years.
Conglomerations: The domestic cement industry is characterised by the presence of various diversified companies, which have significant presence in the cement sector. These were the players, which ventured into the sector after the government loosened its control in 1982-1991. Some of the prominent diversified players operating in this sector are - Grasim Industries, Jaiprakash Industries and Century Textiles, Birla Group and the like. These diversified conglomerates have significant interests in the cement business.
Imports: The international trade in cement is very limited and only between the neighbouring countries due to the bulky nature of the commodity. The domestic industry is relatively insulated from import threat, mainly on account of the freight rates involved in transporting cement. The countries that export their produce to India are amongst the cement surplus countries having an access to the water transport. These include mainly the East Asian countries. The countries where Indian companies like Ambuja Cements and Ultratech export their product are located near Indian shores and these include Bangladesh, Nepal, Sri Lanka, UAE and Mauritius. With a view to make imports of cement competitive and moderate prices by increasing availability of cement, the Government of India abolished customs duty of 12.5%, countervailing duty (16%) and special additional customs duty (4%) and have imposed differential excise duty. Moreover, so far, they have been proved to be futile and in the future too, we believe that it is the market dynamics that will determine these variables.
The industry is likely to maintain its growth momentum and continue growing at around 8% to 10% in the medium to long term. With no major capacities coming onstream in the near term, the demand supply equilibrium is expected to continue and this will help prices to remain firm. However, capacity additions announced till date will add approximately 75 MT to the existing capacity, the bulk of which will come onstream by 2008 and onwards. We believe this will start imposing downward pressure on cement prices in the country.
While we are positive on the sector growth, we are uncomfortable with valuations at the current levels, with stocks from the sector already factoring in strong growth in the future. This suggests a word of caution.