Bloomberg

CUT TO SIZE: Major cement stocks have seen a sharp correction in 2008, making valuations reasonable. While the broader benchmark BSE Sensex declined 27 per cent so far this year, several cement scrips have fallen 40-60 per cent.

First quarter results from cement makers were largely in line, but the sharp decline in operating margins took the market by surprise. Rising input costs and many government interventions impacted the profitability of most cement makers. With gross domestic product growth on slippery grounds, high raw material costs and fear of a surplus scenario, the sector’s outlook seems wobbly.
Cement prices, which were on the rise for over a year, have failed to cover the high input costs after the government capped further price hikes. The industry expects that once the cap is eased and the limp monsoon season is over, cement prices may go up, with
the onset of construction season from October.
Major cement stocks have seen a sharp correction in 2008, making valuations reasonable. While the broader benchmark Sensex declined 27 per cent so far this year, several cement scrips have fallen 40-60 per cent. However, despite correction, unrelenting cost
pressure and seemingly inevitable oversupply leave little room
for upside.
Last month, UltraTech chairman Kumar Mangalam Birla said, “Fresh capacity may coincide with slower economic growth and result in a surplus scenario from next year itself, hurting the margins.” The government recently cut its GDP growth projection to 7.7 per cent during FY09, against 9.1 per cent growth recorded last fiscal year.

Margins on decline
June-end results of most cement makers were mainly in line with expectations. On an average, net revenue rose by about 10 per cent year-on-year. Cement firms based in south India far out-performed the overall industry with a net revenue growth of about 25 per cent. However, operating margins of most companies showed signs of strain.
Rising fuel, power, raw material, freight and employee costs hurt the results. Raw material and employee costs in the sector went up by more than one-fourth, and fuel prices shot up by one-third over the last year. These increased the total cost of production, bringing down the operating profits even more than what the analysts had estimated.
Government intervention, like the brief ban on export of the building material, rise in excise duty and cap on cement price hikes, also dented the profitability of the players. The Cement Manufacturers’ Association (CMA) is now in dialogue with the government to find ways to lessen the impact of excise duty, rising coal costs and
freight problems.

Controlling input costs
Apart from the CMA initiative, the cement makers have taken steps at individual levels to face the crisis. To reduce exposure to rising energy costs, some players are establishing/expanding captive power plants to cut down their power costs. Jaiprakash Associates plans to set up a 500 mw power plant in Madhya Pradesh.
Fuel and power account for more than 40 per cent of the cost of cement production. Imported coal prices have more than doubled since last year. Some of the cement companies have gone a step further in order to hedge themselves from rising coal prices. For instance, UltraTech Cement has plans to invest in coal mines.
With the end of moratorium, firms may raise cement prices to offset high input costs, particularly in south India, where there is strong demand. A 50-kg cement bag may become costlier by about Rs 10 in south India. The average price of a 50-kg cement bag is Rs 230, as of now. However, the government may not favour price hikes of such quantum.

Inflation pressure
The Rs 85,000-crore domestic cement industry, which saw consumption grow by about 10 per cent in FY08, faces a slowing down economy, hurt by high inflation and credit crunch. The construction industry, too, is slowing down, resulting in a fall in cement demand. Fuel prices and interest rates, therefore, need to be contained to add momentum.
India, the world’s second largest cement producer after China, is facing its worst inflation in the last 16 years. Wholesale prices rose 12.44 per cent in the week to August 2, after rising to 12.01 per cent in the previous week. Inflation may further worsen, as the government has approved wage increases for civil servants.
Higher inflation, apart from squeezing the consumers’ purchasing power and factory output, has led the Reserve Bank of India (RBI) to raise interest rates to a seven-year high. In the quarter ended June 30, India’s industrial production grew by 5.2 per cent, almost half the 10.3 per cent growth recorded in the same period a year earlier.

Surplus scenario
Annual cement production is expected to touch 250 million tonnes from the current 200 mt by 2009 end. The domestic cement industry, with about 75 mt of capacity addition planned in the next two years, may be in for a shock as the slowing economy might create a situation where supply far exceeds demand.
The Aditya Birla Group, which produces 31 mt of cement a year, plans to hike its production capacity to 48 mtpa. The plants will go operational by 2010. Jaiprakash Associates plans to set up two cement plants with a total
production capacity of 5 mt at an investment of Rs 4,000 crore in Madhya Pradesh. Even if consumption grows again by 10 per cent, analysts believe there will be a surplus and the prices of cement will
fall in the long run. The industry has been witnessing 95 per cent capacity utilisation in the last few years, compared with 80-90 per cent earlier. Analysts expect the utilisation to fall to 85 per cent next year.
With the industry growing at about 10 per cent every year, many large foreign cement firms have set up base in India. If the recessionary trends persist, the growth rate will decelerate. However, in terms of surplus scenario, analysts say the cement industry is used to such cycles and it won’t be a surprise for the cement makers.