Bridging The Gap Between Demand And Capacity Utilisation

Cement is a cyclical commodity with a strong correlation with the GDP. It is sold in two segments – trade and non-trade. While trade cement is sold directly to dealers and is priced higher, non-trade cement is sold directly to consumers, most of which are institutional buyers. As cement is a bulk commodity, the industry is freight-intensive, rendering transportation over large distances uneconomical. Consequently, the cement industry has been fragmented into five regions, namely – North, South, East, West and the Central region. The southern region has the highest installed capacity and accounts for about a third of India’s total installed cement capacity. The sales volumes largely depend on the distribution reach and retail presence of the company. 

Market Size
India ranks the world’s second largest cement market in production as well as consumption. India’s total cement production capacity is around 455 MT as of 2017-2018. India is presently producing 285 MT of cement, of which 280 MT goes to meet domestic demand while 5 MT is exported. The cement consumption is expected to rise by 4.5 per cent in FY19. The Indian cement industry is dominated by a handful of major players. The top 20 cement companies contribute about 70 per cent of the total cement production in India. Out of the 210 large cement plants having a total installed capacity of over 350 MT, 77 are located in Andhra Pradesh, Rajasthan and Tamil Nadu. Additionally, India also has 350 small plants.

Growth Drivers and Government Policies
Cement demand is closely tied to economic development. The housing and real estate sectors are chief growth drivers for cement, accounting for about 65 per cent of the total consumption in India. Furthermore, industrial (15 per cent) and infrastructure (20 per cent) sectors have proven to be demand drivers in recent years. The government spending on infrastructure and housing has been on the rise. This, along with rising per capita income, is a major growth driver for the industry. Recent policy developments along the lines of ease of doing business, endorsing start-ups, streamlining the tax structure and administration, and establishing foreign investment avenues have further augmented the prospects in the cement industry. From a long-term perspective, increased infrastructure spending and diminishing interest rate trends are likely to revive demand. Additionally, government's initiatives such as the Seventh Pay Commission, “Housing For All” by 2020 and 'Smart Cities' programme will propel the demand for cement. In Budget 2018-19, the government announced setting up of an “Affordabe Housing Fund” of Rs.25,000 crore under the National Housing Bank (NHB) to ease credit to home buyers.

The existing capacities are sufficient to meet the demand if the consumption growth rate remains stable at 5-6 per cent. With this projection, the rate of new capacity additions has declined to accomplish judicious utilisation of resources. Based on a CRISIL report, the demand for cement was expected to soar 5-5.5 per cent in FY2018 owing to increased expenditure on roads and railways, the government impetus on affordable housing and the revival of demand in rural housing.

Challenges
However, not everything is hunky-dory for the sector. High capital costs and long gestation periods serve as barriers to entry. Limited access to limestone reserves is an obstacle. The Government of India strictly controls the licensing of coal and limestone reserves and supply of power from the state grid – all of which are key inputs for manufacturing cement. Nevertheless, many producers are turning to captive power as an alternative. The competition in the industry has intensified with companies expanding reach across the nation. The industry has transitioned into a more amalgamated one with a few major players controlling sizeable market share. Subdued pricing environment and input cost pressures are major irritants.

Opportunities
The eastern region of India is relatively under-penetrated and could contribute to the bottomline in the future. India stands a very good chance of becoming an exporter of clinker and gray cement to the Middle East, Africa and some developing countries in the next 10 years. Plants situated in the vicinity of ports, such as the ones in Gujarat and Vishakhapatnam, have an edge over exports and are better positioned to withstand tough competition from plants located in the hinterlands across the country. The impending elections augur well for the demand prospects in the country. In FY19, the demand for cement is expected to surge 7-8 per cent and reach 550-600 million tonnes per annum (MTPA) by 2025. In order to meet this increased demand, cement companies are estimated to contribute 56 MT capacities by 2019. The demand has gained momentum predominantly from the individual house builder (IHB) segment and the government-led infrastructure segment. However, the demand in the organised real estate segment remains feeble. Over a five-year period, the demand is forecasted to spurt at a CAGR of 6-6.5 per cent. Moreover, foreign players are expected to enter the cement industry in India due to attractive profit margins and steady demand. The domestic cement companies could very well find themselves on global listings via the FCCB route or the GDR route in future. 

Demand vs Supply Trend 

A study of the demand-supply dynamics yielded highly skewed results as supply significantly surpassed demand. This resulted in lower capacity utilisation by cement companies. In 2017, production stood at 280 MT versus a capacity of 375 MT, resulting in about 75 per cent capacity utilisation. The Department of Industrial Policy and Promotion (DIPP) reported a growth of 5 per cent in the industry during the first half of 2017. However, the overall year witnessed a negative growth of 1.2 per cent, partially owing to the impact of demonetisation. 

The sluggish progress in infrastructure projects and truncated demand from housing and industrial user segments are responsible for muted growth. While feeble market conditions dampened urban demand in the real estate the less-than-normal monsoon compressed rural demand. Contrarily, a fall in commodity prices such as coal assisted the cement companies in optimising the cost of production. The DIPP also reported that cement and gypsum products attracted FDIs worth US$ 5.26 billion between April 2000 and June 2018. The demand for cement in June 2018 revealed growth of 13.2 per cent YoY. The demand growth in Q1FY19 was stronger at 14.2 per cent YoY. It marked the second consecutive quarter of strong growth after witnessing 18.5 per cent growth in Q4FY18.

Pricing Trend
Despite cement supply surpassing demand, the cement prices across India rose around 3 per cent towards June-end. Based on the latest dealer check conducted by IIFL Institutional Equities , this was done to pass on the rising costs to the consumers. However, the prices witnessed a partial reversal in July. The brokerage house further stated that an additional price hike of 2-3 per cent is necessary in FY19 to sustain the EBITDA per tonne from FY18. This is a dampener on the sector’s profitability prospects in 2019. Price hikes have been announced in certain pockets like the western region w.e.f September, 2018.

However, the excess of supply over demand raises questions on the sustainability of such price hikes. The price gap observed between the trade and non-trade segments remains higher, thereby indicating that the demand prevails in the project segment and falls short in the retail segment.

Although the cement sector reported a 16 per cent YoY volume growth, realisations were up by merely 2 per cent, just slightly exceeding cost inflation. In the past, such a scenario always resulted in the industry regaining pricing power easily. However, FY18 was an exception. Major consolidation moves resulted in powerful players like UltraTech driving volumes and gaining instant market share. 

Geographical demand-supply scenario
As of end of August 2018, the prices in Gujarat fell in response to weakness in monsoon and the start of the festive season. While the prices in Ahmedabad remained unchanged, prices in Surat fell in July 2018. This was attributed to excess supply over demand in the home state, as well as in Maharashtra and the northern region. The demand in Punjab, Rajasthan and Delhi remained subdued, backed only by infrastructure activity. Although the infrastructure segment drove the demand ahead of the state elections, prices continued to remain under pressure. Prices in Nagpur remained unaltered as there was no shift in demand from government projects, such as the metro rail project. 

However, prices in Nashik dropped because of sluggish construction during the monsoon and weak real estate market. Pune, too, witnessed a fall in prices, more so in the non-trade segment because of passive demand. The eastern region, particularly Kolkata and Raipur, witnessed weakening prices due to abundant supply and limited demand. The central region, especially Bhopal and Indore, was affected by the seasonality factor, which drove the sales down. The southern region produced mixed results. Prices in Bengaluru firmed up in response to revival in demand. The tragic floods in Kochi, which hit storage centres across Kerala, lowered demand significantly.

However, with rebuilding processes underway, the demand has recovered enough to compensate for the losses. The demand in Hyderabad remained stunted. Although the overall demand was impacted by the monsoon, supply pressure and weakness in the real estate sector, the situation is expected to rebound in Q3FY19. Progress in the infrastructure sector and recovery in the IHB segment will serve as catalysts for the recovery. While the urban real estate prices remain modest, the supply push from large-sized manufacturers indicates restricted price gains. Furthermore, the reduction in GST rates on several products has enhanced hopes of a tax cut for the cement sector. 

Conclusion
Based on the above inference, we can deduce that weak demand and excess supply have exerted pressure on cement prices. Most of the new demand-pull has been led by infrastructure and housing, i.e., the non-trade segment.

Industry pricing power is likely to return as the expected demand CAGR (7-8 per cent) is nearly twice the capex CAGR (< 4 per cent) over the next 4-5 years. Price upticks will be in small increments of Rs.2-5/bag, thereby reducing price volatility. Thus, cement prices will be structurally better and more sustainable in the near future. Increase in non-trade demand will remain a near-term concern as it has contributed to dilution in pricing power.

However, this increase will eventually induce an increase in trade demand as well. Major cement players have expressed confidence in demand uptick and enhanced capacity utilisation. In Q1FY19, these companies placed tremendous emphasis on the importance of brand value and are recalibrating their strategies to reap brand premiums. These factors certainly render investment in cement stocks a lucrative investment option.