The cement industry forms one of the bedrocks of any economy but even efficiently run companies such as Ambuja have to navigate through roadblocks which appear insurmountable
Under the Holcim fold
Ambuja Cements started life in 1983 as a corporate entity under the name plate of Gujarat Ambuja Cements. It had dual promoters, the Sekhsaria family and the Neotia family. Along the way between the years 1999 and 2000 the management in a midnight coup of sorts swallowed up ACC, one of India's oldest and largest cement manufacturing companies from the Tatas after the latter put up a 'For sale' signboard of their minority interest in the company, on the company's notice board. Then in one flanking move both the companies were sold to the Swiss cement giant Holcim almost at one go for a king's ransom and some more in 2005 and 2006. Both ACC and Ambuja are today subsidiaries of Holcim. Holcim holds a slice over 50% of the paid up equity of Rs 3.06 bn in Ambuja comprising of equity shares of the face value of Rs 2 each. In terms of overall revenues, Ambuja ranks third highest among the listed cement companies after Ultra Tech Cement Ltd and ACC Ltd according to Capital Market magazine.
Holcim has ten other companies operating out of India - 9 fellow subsidiaries, and one step down subsidiary. The fellow subsidiaries include ACC Ltd, ACC Concrete Ltd and Ambuja Cements India Pvt. Ltd. This list excludes two joint venture companies - one of which appears to be mining coal. Ambuja has assorted inter-se dealings with some of these group companies, but the individual group transactions are minimal given the overall operational size of Ambuja.
Attaining its silver jubilee in manufacturing operations
The company completed 25 years of manufacturing operations in 2011 and to its good fortune it has stuck to the knittings in the interregnum. And boy oh boy how it has grown over time! Between end 2007 and 2011 its cement manufacturing capacity has grown from 18.5 m tonnes to 27.4 m tonnes, a jump of 48%. (The gross block on the other hand grew from Rs 52.3 bn to Rs 97 bn over this period-or an increase of 86%. This infers that the capital cost per tonne did rise irrationally at some point, relative to the increase in productive capacity. Interestingly enough, inspite of the massive addition to gross block, the accumulated depreciation on its plant and machinery in end 2011 amounted to over 43% of the historical cost). The cement production relative to the capacity increase grew from 16.9 m tonnes to 21 m tonnes over this period, or a mere 24%. That is to say in the financial year 2011 there was a mismatch of 6.4 m tonnes between what the company could theoretically produce and what it produced at the end of the day. That is a huge margin of error and it would have had a negative bearing on the efficiency of the use of capital.
Superb financial management skills
However, the capacity additions that it has incurred means that the company currently has a market share of around 9.5% on a pan India basis. But the noteworthy story behind the capacity addition is that the borrowings at each year end fell steadily from Rs 3.3 bn in 2007 to Rs 490 m in 2011. (This appears to be the business trait of the new owners, and Indian owned companies would do well to put such delectable practices into effect). This would suggest that the company was generating sufficient cash from operations over the years and was spending this cash in the most judicious manner to more than take care of the capex requirements which were growing exponentially. This fact is clearly brought out by the cash flow statement of the last two years appended to the annual report. This is top of the pops stuff every which way one may choose to look at it. Organisations that adopt such adept financial management are precisely the type of companies that investors should lay their bets on-putting your money where your mouth is.
There are other material aspects too of the company's functioning which puts it in the spotlight. The company has been able to obtain a steady increase in the net price per tonne for what it sells in the market place. In 2007 it realised an average price of Rs 3,340 per tonne. It grew to Rs 3,502 the next year, to Rs 3,758 the year after, to Rs 3,671 in 2010, and finally to Rs 4,060 per tonne in 2011. That is to say an average price increment of 21.5% over 4 years from the base year. The net sales increased to Rs 85.2 bn in 2011 from Rs 56.3 bn over the 4 year period - or a cumulative increase of 51%. The difference between the two percentage figures being accounted for by the higher volume sales. As stated earlier the capital cost per tonne of cement was going out of kilter - in 2010. The cost per tonne of installed capacity suddenly rocketed to Rs 3,512 in 2010 from Rs 2,594 in 2008.
Unable to keep a tab on input costs
The single biggest revenue expenditure by far for cement companies is the outlay on power and fuel. And cement units make do with a variety of power inputs to generate their revenues. Ambuja for example makes do with electricity, diesel generator, steam generator, windmill power, coal, light diesel oil and high speed diesel and, through 'internal generation' by whichever means. Ambuja has little leeway in trying to control the input cost of any of the expenditure items on display here. The single biggest outlay in this agglomeration is coal power. Going by the information that it has furnished, the company was able to reduce the unit cost of consumption of coal and other fuels during the year vis-a-vis the preceding year on the one hand, and on the other, the unit consumption costs are way below the industry norms for consumption. (The company could have also gained significant traction on the funds flow front if only it had made better use of its net current asset management skills).
Inspite of such fine-tuning (based on the latest year-end figures of almost zero debt, effecting cost savings on the consumption of power, selling cash down as reflected by negligible trade debtors at year end helped also by a high level of trade creditors, a growing cash hoard in the form of bank balances and sizeable liquid investments which bring in ample interest income, disproportionately high reserves relative to the paid up equity, and low year-end inventory levels relative to the financial year sales pitch, etc) the company could not quite capitalise on its good fortunes in the crucial bottom-line department. The profit before tax has been on a down-hill journey over the last five years. From a recorded pre-tax profit of Rs 27.1 bn in 2007 the company showed a steady and alarming decline each succeeding year to record a low of Rs 16.6 bn in 2010, before posting a pre-tax of Rs 17 bn for 2011. The fall in margins is also partly due to the heavier depreciation charge each year due to the ongoing expansion of its gross block - the plant and machinery classification accounts for over 65% of the gross block. But on the face of it this conundrum is still a bit difficult to 'comprende'.
The twin realities of cement units
The problem really lies on two fronts. On the one hand there is a mad scramble to hike capacity incessantly to protect market share, simply because the competition is up to mischief, and thereby putting a heavy strain on resources. On the other it is the inability of cement units to market cement as a brand. There is no specific USP in the selling of cement. It is merely a commodity and the open market price of cement is basically a factor of the demand/ supply equation, and cement cartels in the Indian context are not a very effective proposition of late. Besides, the way the system operates, the demand and supply imbalance never seem to cancel out each other favourably to get the benefit of an optimum price increase. (Then there is the issue of big brother looking over the industry's shoulder, as government organisations are the most ravenous consumers of cement). Hence the price increases that companies are able to muster does not quite cover the cost increases of the two major consumption items - power, and transport. For example, of the total revenue expenditure of Rs 66 bn during the year (excluding interest and depreciation), power and fuel alone accounted for Rs 20 bn, followed by freight and packing charges of Rs 19.3 bn. These two items together toted up to close to 60% of all such expenditure.
The company has provided some interesting statistics on the demand for cement. The demand for cement it says emanates from four key segments - housing which accounts for 67% of all demand, infrastructure with 13%, commercial construction with 11% and industrial demand at 9%. Increasing demand for residential cement will be driven by 5 key factors - increase in per capita income, nucleus family, urbanisation rate, change in population growth, and government stimulus to affordable housing schemes. Industrial demand will be driven by increase in the industrial, retail and office segments.
On the whole, the cement industry scenario would appear to resemble the proverbial curate's egg - good in parts.
Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme.
This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.