Surplus capacity, cost rises eroding cement margins

India Cements Managing Director N Srinivasan says cement industry profit caving in is due to transport and freight costs rising 21 per cent and power bill going up 30 per cent in the 2012-13 second half while "competition and sluggish market conditions" pulled down the prices of the building material. In Andhra Pradesh, a market of big consequence for the company, cement prices in the last two quarters slid Rs 75 to Rs 195 a bag of 50 kg. Cement prices fell in different degrees in different markets. With the bells already ringing for 2014 assembly elections in Andhra Pradesh, cement prices there have started edging forward. Incidentally, power and fuel constitute approximately 30 per cent of operating cost of a cement mill, while another 20 per cent of cost is on account of transport and freight.

For cement, the January-March quarter is traditionally most rewarding with a spurt in demand. But the final quarter of 2012-13 proved an exception with profits skidding whammed by all-round rising costs and squeezes in retail prices. India Cements, a market leader in the south with plants in Tamil Nadu and Andhra, saw its final quarter net profit plunging as much as 60 per cent to Rs 26.28 crore year-on-year.

What, however, happened to India Cements is symptomatic of the industry downturn, as working during March quarter of bigger constituents like UltraTech Cement, part of Aditya Birla group and Holcim subsidiaries ACC and Ambuja Cements, bears it out.

Deceleration in economic growth, bites of inflation and policy paralysis left the Indian cement industry, the world's second largest after China, with considerable idle capacity. According to India Ratings & Research, a unit of global rating agency Fitch, cement capacity use in India fell to 71 per cent in 2012-13 from a high of 89 per cent in 2009-10. In the calendar year 2012, as much as 34 million tonnes (mt) of new cement capacity was commissioned to take the total to 360 mt. Cement demand here is primarily driven by the housing sector with a share of 67 per cent of the total, followed by infrastructure (13 per cent), commercial construction (11 per cent) and industrial construction (nine per cent). It was in response to strong demand growth for housing and also commercial construction in pre-economic downturn that the local cement industry went for major capacity expansion, both by way of greenfield ventures and expansion of existing mills. This will explain the creation of more than 100 mt capacity in the last five years.

In the past too, since the withdrawal of debilitating controls in phases, the country witnessed large capacities coming in a bunch at regular intervals of five years, causing low capacity use, price falls and regional price disparities. History is then continuing to repeat itself in cement. Industry woes will not be over too soon. Capacity overhang notwithstanding, the industry will be commissioning new capacity of up to 25 mt by the final quarter of 2013-14. This new capacity is resulting from projects launched some three years ago.

  What also impacted cement demand negatively were persistently high inflation and interest rates and local currency value eroding vis-a-vis US dollar in which energy prices are denominated. Rural and semi-urban house building and other construction are influenced to a large extent by the behaviour of Indian south-west monsoon. Last year, the monsoon deficit was eight per cent. A natural fallout of this was rural cement and steel demand contraction in the second half of last year. Rural India accounts for less than 25 per cent of total Indian cement demand. What has kept rural demand low is the use of cheaper building materials for making non-permanent structures. Growing idle capacity should motivate major cement manufacturers to work unitedly in framing a strategy to educate rural folk why they should be using cement for building permanent structures and save money in the long run. Success in rural marketing is much about taking products virtually to the doorstep of people living there and convincing them about the benefits of using them.

Cement company margins have been under pressure for a while. According to Thomson Reuters, UltraTech, as a result, will slash capital expenditure by 50 per cent in the next 12 months compared with an estimated spending of Rs 4,430 crore during 2012-13. Surplus capacity weighing heavily on cement prices and house building and construction far from gaining the desired pace are leading other cement industry constituents too, to settle for a modest capital expenditure programme for this and next year. This certainly is not the ideal time to push the pedal for expansion. Cement exports are also becoming increasingly difficult with not many orders materialising from neighbouring countries. A common refrain of cement producers, irrespective of their size, is that their costs are staying ahead of benchmark levels, largely because of irregular coal supply from mines with which they have official linkages. This is forcing them to buy coal which is auctioned by government-owned Coal India Limited and/or import the fuel. Local coal supply is becoming particularly difficult for the units commissioning new capacity. The industry is waiting for the Indian economy to get back some bounce for capacity use to improve.