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On Firm Ground: Given The Potential For Demand Growth, Cement Companies Have Embarked On An Acquisition And Merger Spree

Early this year, Ultratech Cement, India's largest cement company by capacity acquired two plants of JP Associates; and Dalmia Cement acquired Bokaro Cement of JP Associates. And only recently, two units of French cement manufacturing giant Lafarge were acquired by Kolkata-based Birla Corp.

More importantly, the merger of Swiss cement giant Holcim and French cement giant Lafarge is a prime example of how 'acquisitions' have become a frequent development in the past one year. These acquisitions point to an overarching theme that is building up in India's cement industry.

Here is a low-down on India's cement industry, why consolidation is the most profitable way of expanding at present and the reason for foreign institutional investors' bullish view on cement counters.


At present, India's cement industry is dominated by two well-diversified players: Ultratech Cement and Holcim India through its holdings in ACC and Ambuja Cements. Ultratech Cement with a cement capacity of 65 MT dominates the industry. However, if one considers the merger of Indian operations of Swiss construction materials major Holcim with that of French cement Lafarge, then Holcim India would be the largest player by capacity with cement capacity of 70.7 MT. This is followed by JP Associates, which is the third largest player by capacity with its cement capacity of 22 MT.

Apart from these three players, Shree Cement and The Ramco Cements come at fourth and fifth spots, respectively, with cement capacity of 18.5 MT and 15.5 MT, respectively.

Rest of India's cement industry has small and medium-sized players such as Dalmia Cement, Heidelberg Cement, Andhra Cement, and Orient Cement, which have cement capacity in the range of 5 MT to 10 MT. Among various regions, the southern region has highest limestone reserves.

Limestone is one of the main ingredients used in the production of cement. According to various government estimates, the southern India has 46,018.3 MT of limestone followed by 3,9051.2 MT in the northern region, 19,422 MT in the eastern region and 19,336 MT in the western region.

Due to this, the southern region accounts for 49% of India's limestone resources. This is one of the chief reasons for southern region experiencing oversupply of cement and relatively lower demand.

Consequently, cement utilisation in southern region is lower than the rest of India. It is estimated that cement capacity utilization grew below 54% in FY14 in southern region when compared to 75% in the rest of India. It is estimated that there is an incremental demand of 23 MT in southern region between FY14-17.

This incremental demand will emanate from two new states (Andhra Pradesh and Telangana). This incremental demand is higher than 20 MT cement capacity that unified Andhra Pradesh consumed at peak cement demand cycle, indicating higher demand in the coming years. In comparison with this, cement demand in north will be 21 MT, in west 18 MT. And in east and central regions, cement demand will be 15 MT in the same period between FY14-17.

Cement prices in the eastern and southern regions have been growing while prices in rest of India region have been flat or have dropped. Also, demand in eastern region has been growing at 8% while cement demand in rest of India has been growing in the range of 2 % to 3%.

In the eastern region, per capita cement consumption is lower in comparison with other regions. More so, there is a shortage of housing projects in the eastern region. With East Freight Corridor work, cement demand in the eastern region is expected to be robust. It is estimated that in the next two years, eastern region would add 11 MT in capacity.

In the past two quarters, south-based cement companies have shown a sharp turnaround in their financial performance. While small-sized companies such as NCL Industries, Deccan Cements, KCP and Sagar Cements have turned profitable, mid-sized ones such as The Ramco Cements (erstwhile Madras Cements) and India Cements have shown massive improvement in their corporate earnings.

The June '15 quarter was the second consecutive quarter when these cement companies showed a stark improvement in their earnings. According to industry experts, the momentum is likely to continue for the next two years thanks to production discipline, fairly stable cement demand and limited capacity addition in the southern region.

For the next two years, there are two factors, which would boost demand in southern region. Firstly, companies from the south have been following high production discipline. This means that they are producing cement in accordance with demand.

Consequently, there is limited capacity addition for the next two years, which would ensure that there is no stiff pricing war. Secondly, with the division of Andhra Pradesh into two new states - Andhra Pradesh and Telangana, cement demand is expected to pick up at least by March '16 quarter.

This should boost capacity utilization of southern cement companies. As a result, with higher capacity utilization, south-based cement companies will improve their pricing power, going ahead.


It is estimated that the demand from across India has been growing in the range of 2% to 3% and in the next two to three years, cement demand is expected to improve to 8%. Given this potential for demand growth, cement companies are following an inorganic way of expansion. One of the chief reasons for the aforementioned acquisition is the cost involved in setting up a cement plant.

It is estimated that the time required for setting up a greenfield cement plant has jumped two times to six years from three years earlier. This delay can be attributed primarily to the time taken in acquiring a land for the said project.

Besides, the cost of setting up a new cement plant has also gone up in the past three years. As per analysis, the cost of setting up a new cement plant has grown at a compound annual growth rate of 7% in the past four years to Rs. 7,500 per tonne. Given relatively low cement demand, according to various estimates, even if one considers capacity utilization of 80% at Rs. 300 per 50 kg, the return on capital employed (RoCE) on a new cement plant comes at a single digit 4.2%, which is not lucrative for a cement player.

Hence, setting up a new cement plant does not seem to be a viable option for cement players at present. This is why cement players go for the inorganic way of expansion since it will save more than six years of gestation period for them and also help them cater to cement demand, which is expected to improve by the end of the second half of FY16.

This inorganic way of expansion is going down well with foreign institutional investors (FIIs) also. FIIs have remained invested in cement stocks as key factors that would enhance cement business are playing out. There are three important factors that would ensure that the interest of FIIs' in cement stocks would sustain in the coming quarters. First, fall in operational expenses of cement firms is likely to boost their earnings. Falling coal and crude oil prices due to weak demand should keep freight costs for cement companies moderate.

Power, fuel and transportation costs of cement and other raw materials form 55% to 60% of the operational expenses of cement companies. This saving in costs would translate into earnings for cement companies in the coming quarters.

With coal and pet coke prices both coming down, we expect operating cost growth of cement companies to come down to 2% to 3% at the end of FY15 from 5% at present. At least in calendar year 2015 coal and pet coke prices are expected to be subdued, which should help cement companies to save on their expenses.

Second, it is the composition of sectors in MSCI India Index that works in favour of cement companies. In MSCI India Index, materials segment (which include cement, metals) has 6.8% weightage. Unlike metals, since cement is domestically produced and consumed and has no direct link to international markets, foreign institutional investors have been overweight on the sector and buying cement stocks.

FIIs have been buying and holding on to cement stocks with at least two to three year investment period. In the last one-and-a-half years, FII holdings in mid-sized cement companies such as The Ramco Cements, JK Lakshmi Cement, Shree Cement, and Mangalam Cement have gone up to 18.8%, 10.8%, 10.6% and 1.58%, respectively from 13.7%, 8.65%, 7.77% and 0.09% .

Third, in order to benefit from the India growth story, besides banking stocks, cement stocks are better investments than infrastructure companies. Even after considering expansion, the average debt to equity ratio of most cement companies is 0.5 and they have funded their expansion through cash flows.

On the other hand, infrastructure companies fund their projects through external debt. So, for FIIs it makes more sense to be invested with cement companies since their balance sheets are lighter and they would be the first beneficiaries once demand growth picks up.

Typically, cement demand grows at 1.5 times the Gross Domestic Product (NYSEMKT:GDP) growth. For FY16, according to Bloomberg's estimate, India's GDP is expected to grow at 6.3%. This translates into cement demand growth of at least 8%. This should improve cement utilization levels to over 77% in FY16-17 period from 72% at present, which could boost operating profit of cement companies.

About the Author:

Nirmal Bang Securities Pvt. Ltd. is an online share & stock trading company in India. This one of the best trading company where you will see online share trading tips, NSE live news, Indian currency trading market, depository services, equity share market, IPO and live commodity market prices in India for stock and share trading.