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Cement: The freight fuss! - Views on News from Equitymaster
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Cement: The freight fuss!
Dec 1, 2006

Cement industry is highly freight intensive in nature. Outward freight on cement is an important element in the operating cost of a cement plant. It accounts for around 1/3rd of the total variable costs. Every tonne of cement manufactured involves the transportation of 1.6 tonnes of limestone, 0.25 tonnes of coal, 0.05 tonnes of gypsum and 1 tonne of the finished product. Freight accounts for about 18% of the total cost. Cement companies use both road and rail transport to transport cement and to receive coal. Rail dispatches amount for about 33% while roads carry the balance 66% of the total cement produced in the country. The balance 1% is accounted for by sea transportation. Around the world, almost 80% of the cement transportation is carried out in the bulk form. But in India, only 1% of total cement is transported in this form. This is on account of problems like inadequate infrastructure in the form of port facilities and lack of timely availability of wagons from railways. Unreliable rail transport has resulted in the increasing proportion of cement being transported by road.

Optimisation of rail-road mix helps minimise the impact of the increase in freight costs. To overcome increasing freight costs, some of the coast-based companies like Gujarat Ambuja Cements and India Cements have started using water transport. Though this involves initial capital expenditure on acquiring ships and installing jetties, the operating costs are almost half of road transport. Gujarat Ambuja has taken the advantage of the coastal location of its plants and has constructed its own jetties at Kodinar, Surat and New Bombay. It uses these facilities and its own ships to move cement to markets in Gujarat and Mumbai. It enjoys a significant cost advantage by using this route. In this way, Gujarat Ambuja has also overcome the problem of poor port facilities.

From the table its clear that although on the higher side, the freight cost per tonne for Gujarat Ambuja has not increased considerably as compared to its peers ACC and Madras Cements. This is on account of its coastal locational advantage. Gujarat Ambuja currently sells 15% of its production in the export market.

Freight Cost per tonne basis
Company FY04 FY05 FY06 CAGR of past 3 years (%)
ACC 318 338 404* 12.7%
Gujarat Ambuja** 441 462 456 1.7%
Madras Cements 209 238 361 31.4%
* 9mths ended CY05
**Gujarat Ambuja has changed its accounting year from financial
to calendar year. The data mentioned in the above table
pertains to FY03, FY04 and FY05

In fact in case of Gujarat Ambuja, freight cost per tonne basis in FY06 was lower by approximately 1%. Freight cost per tonne basis for ACC and Madras cements have increased by 12.7% and 31.4% respectively in a span of 2 years. Road transport for ACC almost accounts for 50% of its total despatches. Madras Cements also is dependent on road and rail transport. To minimize the transportation cost, the company is trying to make optimum use of rail and road.

To lessen the impact of the Supreme Court ruling in December 2005 against overloading of trucks, cement companies have started shifting to rail transport since 1QFY07 to lower their dependence on road. To minimize freight costs, companies are relying on 'Own your Wagon' (OYW) and 'build operate lease transfer' (BOLT) schemes. It is clear that the companies that have procured own wagons and leased the same to the railways will be given priority in allotment of wagons. Companies like Grasim and ACC have already invested in the OYW scheme.

Given the role government has in fixing the key input costs like freight, coal etc., it is very difficult for any company to minimize the cost beyond a point. Hence, companies have to reduce freight cost by resorting to alternatives, like railways or increasing the scale of operation so that economies of scale sets in.

Close study of freight strategy adopted by cement companies can give an interesting insight on how serious cement companies are about tackling their costs and improving margins. While it may not make a difference in times such as these where every cement company, irrespective of its cost structure is recording bumper profits, in the long run, it does help in zeroing in on the most competent company, if one wants to be a part of the industry growth story.

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