Ultratech Cement: Sheer size doesn't matter - Outside View by Luke Verghese

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Ultratech Cement: Sheer size doesn't matter
Sep 22, 2011

It is high time that the cement industry got to the bottom of finding a solution to the flip flop demand/supply scenario, and the ever recurring problem of either being confronted with excess capacity, or gravitating to the other extreme of staring at excess demand.

A topsy turvy scenario

The chairman, Kumar Mangalam Birla, in his pontification to the shareholders states boldly upfront 'that overall in the short term one feels bearish about the sector. In the last few years new capacity additions of around of 100 million tonnes per annum (MTPA), coupled with the prevailing sluggish demand has resulted in a surplus scenario. And the substantial hike in coal and petro product prices has led to a drastic increase in input costs'. (Has the capacity addition really gone up by 100 MTPA please, or is there a typo here?) UltraTech's current capacity stands at 52 m tonnes. Fearful that the competition will get the better of the company, the management has decided to take the fight to the industry. It intends to splash a capital outlay of US$ 2.4 bn (Rs 110 bn) over the next 3 years which will augment its capacity by 9.2 million tones (MT), etc. In other words, every company is complaining of surplus capacity and uncontrollable cost increases on the one hand and expanding capacity in the same breath on the other. The mantra is to first create total confusion and then complain about it. It is a mad hatter's party out there.

Ultra Tech has of late been acquiring size through acquisitions. The company currently has 12 cement plants including the white cement plant in Rajasthan. In 2010-11 it almost doubled cement production to 32.9 MT from 17.8 MT previously, when it acquired the cement division of its parent, Grasim Industries. The expansion in production was a lot more sedate prior to this. The production in 2006-07 for example was 15.2 MT.

What the operative results tell

As stated earlier the company's 'net sales' expanded by 87% to Rs 132 bn during 2010-11. But significantly, raw material consumption costs rose 88% to Rs 18 bn, and manufacturing expenses rose 112% to Rs 45 bn. If this was not enough, employee costs rocketed by 164% to Rs 6.7 bn while selling, distribution and admin costs did similarly, rising 118% to Rs 36 bn. With interest and depreciation charges adding their mite to the expenditure side of the equation it is not difficult to see why UltraTech had a torrid year trying to match the expenditure side of the profit and loss account to the income side.

It is not as if the company did not generate cash from operations. On the contrary, according to the cash flow statement it generated net cash of Rs 21 bn from operations against Rs 16 bn previously. With this surplus, it invested Rs 12.2 bn in fixed assets and splurged another Rs 5.4 bn in investments and so on and so forth. But sad to say the cash flow statement does not appear to give the true picture of the funds flow scenario during the year. For example, and in reality, the accretion to gross block, including capital work in progress, was to the tune of Rs 107 bn (including assets requisitioned during the year), and the debt rose by Rs 25 bn against a rise of Rs 20 m as shown in the cash flow statement. The depreciation in turn amounted to Rs 34 bn against the company's calculation of Rs 7.6 bn, etc.

The many hiccups that confront the industry

So what's with this industry that it has to endure so many hiccups on the expenditure front? Apparently, even the cost of raising limestone from captive mines is proving to be a bother. The cost of limestone rose 85% to Rs 18 bn. Why should this be so? The principal culprit in the expense schedule titled 'manufacturing expenses' appears to be 'power and fuel' consumed. This item of expenditure rose 118% to Rs 31 bn. (Separately the schedule giving the breakup of cost of power and fuel shows that the total cost of lighting coal, furnace oil, light diesel oil and high speed diesel rose to Rs 26 bn from Rs 11.5 bn previously or by 126%).

This is despite the fact that more than 80% of the power consumed was internally generated - either through diesel generator, steam turbine or waste heat recovery. What makes it even more interesting is that 78% of all the power consumed was generated through steam turbines. The cost of generating this steam power came to Rs 3.7 per Kwh against Rs 3.2 previously. In percentage terms that worked out to an increase of only 17%.The cost of purchased power - which accounted for another 19% of all power consumed toted up to Rs 5.4 per Kwh, or an increase of 6.5%. For the matter of record, the total power consumed increased to 2.9 m Kwh or an increase of 78%. Further, the consumption of electricity per unit of production was actually lower at 82 Kwh against 83.1 Kwh. It all adds up to bizarre maths, and makes no sense at all to the uninitiated.

If the percentage increase in raw materials and power and fuel was not difficult enough to digest, freight, handling and other expenses rose 108% to Rs 25.6 bn, while advertising costs rose a phenomenal 146% to Rs 3.3 bn. Such is the intense competition, brought about primarily by industry rivalry that a commodity business like cement (which has no USP to boast of) has to take recourse to advertising to sell its products, while simultaneously expanding capacity at full throttle. This is about as nuts as it can get. The flummoxing part of it all is that UltraTech was still able to sell cash down in spite of depressed market conditions as reflected by the marginal trade debtor balances at year end. The increase in employee costs is also a bother, but its effect on the P&L account is minimal.

The double whammy

But what really got its goat were the lower 'gross' price realisations that the company was able to garner in the market place. Atleast this is the evidence from a perusal of the statistics. Sales of grey cement accounted for 83% of all product sales. Sales of ready mix cement tossed in another 9%. Sales of white cement and white cement based putty together brought in a mere 5.7 % to the cash kitty against NIL previously. The problem is that the average price realisation of grey cement fell to Rs 3,290 per tonne, from Rs 3,419 previously. But the volume sales of grey cement rose 87% to 33.2 m. The company had the delicate task of trying to balance the production and sales of grey cement to try and get the better of standing costs, as the cost of variables jumped the gun. But at the end of the day it was still a touch-and-go situation. The average price realisation of the minor contributors such as ready mix concrete was Rs 3,158 per cubic meter, which was 5% higher than previously. The white cement price realisations were much higher than that of grey cement, netting the company Rs 7,770 per tonne.

With the interest and depreciation charges (which are controllable) also accelerating relentlessly, it was a mugs game, with the profit before tax inching up only marginally by 12% to Rs 17.8 bn. However the post tax profit grew more sharply but this was due to a book adjustment. The Aditya Birla group is a very conservative institution even in normal times. They take parsimony to new heights when it comes to parting with post tax profits or even in the matter of issue of bonus shares. So it is surprising that the dividend payout was actually hiked in a year when the company was in a spot. The dividend payout as a percentage of post tax profits rose to 13.6% from 8%. But this is a mirage, as in reality the dividend payment was actually maintained at the same level, as the equity capital ranking for dividend also rose to 2.7 bn from Rs 1.3 bn previously, due to merger issues. Some attitudes never change.

Massive expansion planned

In the midst of this chaos, and as stated earlier, the company is all set for a massive expansion in cement capacity. Whether this expansion will happen in the time span that the company has set for itself does make for a likely proposition. The more vexing point is that the capacity utilization of the standalone company in 2010-11 was only 68% of the installed capacity of 48.8 m tonnes. In other words there was idle capacity to the tune of 15.8 m tons. That is not small beer by any yardstick and another reason why the company had difficulty in making ends meet, as the capital costs already incurred, the depreciation provision that it entails, and the borrowings that financed it, had no revenues accruing. Why the company would desire to expand capacity by 9 MT when it has large unutilised capacity on hand, is an anomaly that only the management can surmise. Even in the case of Ready Mix Concrete the idle capacity is excessive. Against an installed capacity of 10.4 m cubic meters the actual production was only 3.8 m cubic meters. The management should also be having their hands full resuscitating the several cement units acquired from ETA Star. The holding company of these six cement units, UltraTech Cements Middle East Investments, has total liabilities of Rs 5.4 bn comprising of debts, current liabilities and provisions, against total assets of Rs 20 m!

The future is uber cool

But at the same time the strength of the Aditya Birla group is in their financial management skills. At year end the company had surplus dough of Rs 35 bn parked in liquid debt instruments. And, cement is a commodity which is more precious than even gold perhaps, given the shortage of some 100 m housing units or more in India. The basic building block for shelter, work, and recreation is cement, and there is no alternative. This statistic alone makes for cement as an excellent continuing bet in the longer term. The way forward then is for cement manufacturers to find a lasting solution if any, to the pernicious problem of controlling material input costs, the increasing cost of power and fuel, and transport and logistics issues as a way of keeping a tab on runaway cost increases. This is despite of cement units having captive limestone deposits, are increasingly acquiring captive coal mines and are generating more in-house power as a way out of a sticky situation.

P.S. This company too like its parent Grasim Industries believes in featuring the photographs of only three direct male descendants of the immediate family. The ones featured are the great grandfather GD Birla, his grandson Aditya Birla, and his offspring K M Birla. No mention at all of GD's son B K Birla.

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 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.


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