Cementing A Profitable Bond
Currently, India is the second-largest producer of cement after China. It has an installed capacity of approximately 500 million tonnes. Globally, the industry contributes around 8 per cent of the global cement installed capacity. In India, the southern region contributes maximum by 35 per cent of the total cement capacity followed by the northern region with a capacity of 20 per cent, eastern region with a capacity of 18 per cent, western region with a capacity of 14 per cent and the central region contributing least by 13 per cent of the total cement capacity. In recent times, volume growth and capacity in some regions was affected due to electionrelated uncertainties
Sneak Peak at Statistics
The Indian cement industry, which is one of the largest employment providers in the manufacturing sector with around 20,000 people for every million tonne of cement produced, has attracted various foreign and domestic investors. According to the Ministry of Commerce and Industry, the cement industry has shown a CAGR of more than 5 per cent in the year 2018-19 from 2014-15. Imports of cement, clinker and asbestos cement were at a CAGR of 7.99 per cent to USD 158.49 million for FY19. Cement production capacity stood at 502 million tonnes per year (MTPY) in 2018. From FY19 to FY21, capacity addition of 20 million tonnes is expected depending on the economic conditions. Up to 70 per cent of the total cement production of India is provided by the top 20 companies. There are about 210 large cement plants in the country with a combined installed capacity of over 410 million tonnes and the rest is contributed by more than 300 small plants. The graph shows the movement of production and cement capacity over the years. From it we can understand that cement production was unable to keep up with the surge in cement capacity owing to various economic factors. But with tightening economic conditions both are expected to grow at a similar pace in the future.
Cement Pricing In spite of subdued volumes on sluggish demand, the cement sector turned out to be one of the few sectors to report good performance and that too better-than expected performance. Market reports suggest that price hikes were the main booster. This is a surprise as despite a slow demand in regions, the cement manufacturers hiked prices. The all-India average cement prices increased significantly by 13 per cent to Rs326 per bag in the first quarter of FY20 compared to the prices for the same quarter of the previous fiscal year. Subsequently, prices were hiked most in the northern region, up by 17 per cent followed by increase of 14 per cent in the central region, 13 per cent in the eastern region, 11 per cent in the western region, and least in the southern region by 5 per cent.
Cement companies benefitted from the hike in cement prices as operating margins and profits improved but investors were left worried due to the rough patches the industry has been through. Commenting on the situation, Ajit Mishra, Vice President-Research, Religare Broking Limited, says, “The cement companies have taken a reasonable price hike in Q1 FY20 despite weak demand scenario which instils confidence that the companies are not willing to compromise on profitability. With a weak demand outlook, pricing would be crucial to maintain or enhance profitability. The commodity cost pressures have also eased and are likely to remain subdued and this could provide some cushion to margins. But after the price hike, dealers started offering discounted prices as demand failed to keep up.”
To boost sales, companies offered discounts and special lower price incentives for bulk orders to dealers. Compared to the hiked prices, towards end of Q1FY20, several regions witnessed slight reduction in prices due to supply issues. With the start of the monsoon season, the prices reduced as construction activities declined and ongoing projects halted for the season. Cement pricing is heavily dependent on coal and pet coke prices which are its main raw materials. With the reduction in coal prices by 17.5 per cent since last year and reduction in pet coke prices from Rs9,200 to Rs7,000 per meteric ton, the cost pressures on the companies will remain eased, thus resulting in lower power and fuel expenses in the near future. Going forward, this will act in favour of the financial performance of the companies and will also help in keeping a check on cement prices.
Initiatives and Incentives
The Government of India directly and indirectly encourages the cement industry. A boost to infrastructure is a demand driver for cement. Hence, initiatives such as development of 98 smart cities are expected to provide a major boost in the demand for cement. For enhancing the source of capital for infrastructure financing, Credit Guarantee Enhancement Corporation will be set up in 2019-20 for which the RBI has notified regulations. As per the Union Budget 2019-20, the government has announced of upgradation of 1,25,000 km of road length over the next five years. For the cement industry, the current government’s emphasis on affordable housing and infrastructure will maintain the demand even with economic fluctuations.
Further, the government announced the Bharatmala Project which is construction of cement concrete roads, highways and also the Pradhan Mantri Gram Sadak Yojana which is construction of rural roads. Apart from these, the proposed metro rail network plans for many cities, housing for all by 2022, bullet train networks, etc. is set to contribute on a large scale to the growth of the cement industry in the medium to long-term view. The 7th Pay Commission is expected to aid in housing demand. Mainly any increase in government spending on infrastructure benefits the cement industry.
Cement and Railways
Logistics is an important factor to be considered while discussing the cement industry as freight and forwarding costs make up to 20 per cent of production cost of cement. Indian Railways directly benefits from the volume and demand growth of the cement industry. The most preferred logistics partner of the cement industry is the railways as it is most convenient for transporting cement to the far corners of India, all along keeping a control on expenses. For Indian Railways, cement deliveries is the second-largest source of revenue with contribution of around USD 1.3 billion per annum in freight revenue for FY17-18. With an increment of 9.6 per cent, for FY17-18, total cement and clinker loading stood at 114 MTA, the highest ever for Indian Railways. For FY18-19 cement and clinker loading grew at a slow pace because of the shortage in rake availability.
The Government of India has taken various steps to promote the use of railways for cement transportation. The Long-Term Tariff Contract Scheme, Freight Incentive Scheme for loading bagged consignments in open and flat wagons, Incentive Scheme For Auto Traditional Empty Flow Directions, General Purpose Wagon Investment Scheme, are a few of such schemes. For ease of transportation of cement and also to lower the costs involved, the government intends to expand the capacity of the railways and its handling and storage facilities. To reduce operating costs and for receiving allotment of rakes, various cement manufacturers have signed long-term contracts with Indian Railways.
In Table 1 we have considered the top five cement manufacturers based on market capitalisation. For FY19, Ultratech Cement reported the highest net sales of Rs35,703.5 crore with net profit of Rs2,455.72 crore. In the same fiscal year, the company successfully acquired Binani Cement Limited and renamed it as UltraTech Nathdwara Cement Limited which provided easy access for the company to large reserves of high-quality limestone. Ambuja Cements posted a PATM growth of 13.09 per cent for FY19. Despite low demand and decrease in volume, for FY19 cement companies performed well enough. With the increase in cement prices, manufacturers were able to post a high EBITDA per tonne.
For some time now, markets have been very dodgy with US-China trade issues, Brexit, rise in oil prices, etc. and companies with smaller market capitalisation are unable to sustain prolonged and drastic economic changes.
Table 2 highlights that smaller companies have negative stock returns due to their high volatility to market exposure whereas large-cap entities are much more diversified and have appropriate implementation of risk management strategies.
The companies included in Table 2 are the top 10 companies based on market capitalisation and their stock returns. Comments Ajit Mishra, “We would remain cautiously optimistic on the cement space as on one side weak demand would impact growth but higher realisations and better margins would enhance profitability. A prudent approach would be to stick to larger cement names like Ultratech, ACC and Ambuja and accumulate these stocks in a staggered manner as further correction cannot be ruled out at this point in time
The demand for cement industry is expected to reach around 660 million tonnes per annum by 2025 due to the expansion in various sectors such as housing, commercial construction and industrial construction. Thus, road, urban infrastructure and commercial realty will primarily drive the demand for cement. In FY20, cement production is assumed to grow at 5-7 per cent provided the industry conditions remain favourable. Previously, the cement industry witnessed setbacks on the cost front because of increase in input cost from price increase of fuel, imported coal and pet coke.
With effective risk management policies, the industry can mitigate these risks arising in the future. Increase in domestic production of high-quality limestone will ease cost pressure on cement manufacturers as currently many prefer to import limestone because of quality issue in domestic produce.
In the pollution category, the Indian cement industry is under the red category which represents highly polluting industries. So the industries must continue to focus on more investments in carbon reduction technologies.
The volume growth has remained weak in FY20 and it is believed to continue to remain subdued due to peaking pace of construction of houses under PMAY and lower economic growth. Further, spending by the government is likely to reduce as it would focus on maintaining fiscal discipline. Cement companies will benefit from the recent corporate tax rate cuts and volumes would start to revive post-monsoon season.
Thus, for the long-run, cement stocks will benefit from government initiatives and rising demand with further softening of pet coke, coal and diesel prices.
"Outlook: Retain long-term positive view on the sector. Despite expected volume contraction for the cement industry in Q2FY20, we anticipate a gradual improvement in demand from November post end of the festival season. Simultaneously, we believe improved utilization levels with demand revival will provide better pricing power to cement firms. Fuel prices have been on a declining trend in the past few months. This should reduce cost pressure in the upcoming quarters. Therefore, we retain our positive stance on the sector and recommend stocks with a higher presence in North & Central India and Northeast, such as JK Lakshmi Cement, Heidelberg Cement and Star Cement."