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Cement: Benign mismatch!

Nov 14, 2006

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 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 (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. The effect of this is clearly witnessed in the robust topline and bottomline growth achieved during the quarter July to September 2006 by major cement companies.It's all in realisations: Cement companies managed to increase capacity utilisation to cater to the growing demand. But the major boost in the topline is on account of better realisations. During the quarter, sales were higher by 9% YoY and the prices scaled up by 35% YoY. This helped companies report outstanding performance during the quarter. It must be noted that cement consumption in the southern region has registered an impressive growth of 13% YoY and Madras Cements being a key player in the southern states of India, has benefited from the same. Gujarat Ambuja's production and despatches grew by 9% YoY and 10% YoY respectively, largely in line with the industry growth. The company has achieved this growth despite heavy monsoons and floods in the regions where company has its production facilities. Gujarat Ambuja, the larger exporter of cement, has also benefited from the 30% YoY growth in export prices. Also, the diversified major, Grasim, posted good results during the quarter. Thanks to the excellent performance of the cement business segment, in which the topline grew by 47% YoY and bottomline by 26% YoY, the company posted 80% YoY growth in profit. Ultratech, a 51% subsidiary of Grasim, benefited by the strong volume sales which grew by 17% YoY and significant improvement in realisations, both in the domestic and export markets.

July to September quarter
% YoY growthACCGujarat AmbujaGrasimUltratechMadras Cements
Net Sales30.450.322.758.3 65.50
EBITDA126.5108.965.4291.9208.1
Net Profit0.3225801274378.8

Surprising Margins: Besides the higher realisations, few companies have also managed to lower costs, by improving operational efficiencies. The improved bottomline growth has been backed by lower costs and growth in other income.

As in the case of Ultratech, a substantial improvement in operating margins, coupled with a 47% YoY rise in other income and lower interest charges have helped the company report a profit against a loss in the corresponding quarter last year. Similar is the case with Gujarat Ambuja wherein higher other income and lower interest charges helped achieve 225% YoY growth in net profits, despite rising input costs, such as coal and petroleum products.

ACC, one of the oldest cement companies, managed to cut raw material and staff cost but higher coal and petroleum products prices did have a negative impact on overall cost, which have grown by 15% during the quarter compared to same period last year. The net profit of the company grew by 338% YoY, if we exclude the income of divested refractory business.

Amongst the companies discussed so far, the biggest beneficiary has been Madras Cements, which operates in the region of demand supply imbalance (south). It is the first company in south India to convert all its capacity to the energy efficient dry process, thus reducing its power costs by almost 10% YoY. Reduction in interest expenditure on account of increased cash flows from operation and extraordinary growth in operating profits helped company achieve 379% YoY growth in bottomline.

Also, Grasim, the flagship company of Aditya Birla Group, has benefited from higher other income and lower interest cost. But it being a diversified conglomerate, the growth was also aided by the good performance of the VSF business (contributes 24% to topline). Had the company's chemicals and sponge iron businesses done better, the results would have been more enthusing.

What to expect?
Being a core infrastructure sector, the growth of the cement industry tracks the GDP growth of the country. Currently, the demand is growing at a rate of 8% to 10% annually and the upcoming capacities will start their operation by the end of 2008. Riding on strong demand, no major capacity additions has led prices to scale up by almost 35% YoY during the quarter. However, once the new capacities become operational (by FY08), we expect the prices to cool off.

While we continue to remain positive on the growth prospects of the cement sector in India, we are uncomfortable with the fact that the current valuation levels already seem to have factored in the medium term growth prospects in the sector. At the current juncture, we believe that the valuations of most of the stocks are stretched on an EV per tonne valuation basis. Hence caution needs to be exercised.

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