Cementing its place

Cement is back in demand. Century Textiles and Industries’ plan to merge its cement business with India’s largest cement maker, UltraTech, is almost sealed. This follows the clearance received by the merger of Lafarge and Holcim by the Competition Commission of India. Industry activity apart, the government has announced several infrastructure and road projects that should see immense activity involving consumption of cement.

The impact of these activities is visible the way the stock price of companies like UltraTech, Shree Cement, Ambuja Cements, ACC, JK Laxmi, Prism Cement and J.K. Cement, among others, have gained since January 2014. The gains have ranged from 30 to over 300 per cent. The thrust towards infrastructure and a sharp increase in the government’s capital expenditure will further boost the fortunes of the sector considering the 36 companies that are committed to supply 95 lakh tonnes of construction material during this year at a price of up to Rs.180 per bag to the government.

Rising demand

The demand for cement was hugely impacted between 2010 and 2014, as the sector witnessed problems owing to execution delays in projects and high leverage burden on balance sheets with credit shortfall. Amey Joshi, Associate Director (Corporates), India Ratings and Research says: “If you see historically, GDP multiplier to the cement demand was 1.3x that has been reduced to 0.7x in FY14 because of the slowdown in capex.”

Currently, the housing sector is the biggest demand booster for cement, accounting for about 67 per cent of the total consumption. The other major consumers include infrastructure at 13 per cent, commercial construction at 11 per cent, followed by industrial construction at 9 per cent. Cement production witnessed a growth of 0.5 per cent in January 2015. Its cumulative growth during April to January 2014-15 was 7.1 per cent over the corresponding period of previous year.

The other factor that plays a favourable role in the resurgence of the cement sector is the fall in oil and coal prices, which play a significant role in the margins of cement companies. The average coal prices during April-December 2014 were down 10 per cent compared to average cost during FY14. The slide in the prices of coal and crude oil, as witnessed over the last four-six months, buttressed the cement industry’s Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) margins.

Challenges ahead

Although a cyclical infrastructure recovery and capex revival might catalyse cement demand, structural concerns related to low utilisation levels still prevail. Capacity utilisation for the cement industry at the national level is 71-72 per cent, with the maximum 60 per cent in the south. However, it will take a long time for cement companies to reach a capacity utilisation of 85 per cent, a level of operation that can improve margins and financial performance. Moreover, demand-supply in the plant cluster, efficiency of the plant and extent of limestone reserves gives one a reasonable idea of the long-term prospects of a company.

Says Nitin Bhasin, Head of Research, Institutional Equities- Ambit Capital: “Limestone acquisition cost has increased materially (~3x as compared to 2005 levels) and several companies are aggressively adding limestone mines (our sense is that the premium paid in recent M&A deals was also to secure limestone for the long term).” Recently, the government had proposed to increase freight rates for cement by 2.7 per cent, coal by 6.3 per cent and slag cement by 2.7 per cent from April 1, 2015. Coal costs nearly 50-55 per cent of the total power and fuel cost, while freight costs 15-18 per cent of the total cost, which will impact companies that are dependent on road and rail routes for freight.

Despite the governmental initiatives, the continued slackness in execution of infrastructure projects amid rising fears of rural slowdown could drag volume growth rates for the next couple of quarters. “Our near-term (1-2 quarters) outlook remains grim and our initial expectations of 10 per cent volume growth in FY16, requires a substantial pick-up in infrastructure execution in 2HFY16,” says Bhasin.

Bright prospects

The recent cement demand pick-up and slowdown in pace of capacity additions has led to gradual improvement in utilisation rates across the regions. This will help cement companies as the narrowing supply-demand gap would help in pricing power. Lalit Nambiar, Fund Manager, UTI MF, says: “While there may be a debate on how soon the economy will recover, there is no real debate on the direction. The budget push creates a favourable backdrop but is unlikely to immediately impact volumes. So all in all, sentiment is on a high and hence the valuations.”

Experts and analysts argue that one cannot rule out the consolidation of the cement sector. Globally, the sector is dominated by few major companies who control capacity in particular. In India, there is no such scenario as the industry is regionally fragmented and, today, several cement companies are available below replacement cost, opening opportunities for consolidation for bigger players.

The Secretary, Department of Industrial Policy and Promotion (DIPP), Amitabh Kant, had said in March that the cement industry has to grow 20-25 per cent annually over the next three decades to meet the requirement of a rapidly growing Indian economy. Delivering the inaugural address at the 53rd Annual Session of Cement Manufacturers’ Association (CMA), he said that for sustained high growth a rate, manufacturing has to grow by 13-14 per cent and cement has to be a major driver of India’s growth. Going by the prospects, the cement sector has all the necessary ingredients to cement a place in your portfolio.

himali@outlookindia.com