The paradox of cement in the south

If weak demand equals higher bottomline, strong demand equals what? 

India’s cement story has not looked pretty for a while now. If manufacturing capacities have been installed in anticipation of high economic growth sustaining, it has only been turned out to be an ill-timed bet with demand not matching up. This has obviously caused severe heartburn to many cement manufacturers who are now saddled with high levels of debt and a serious difficulty in servicing it.

If every sector has an anomaly, cement is no exception to that rule. While there is a situation of excess capacity across India, the southern part of the country has managed that precarious situation exceedingly well so far. Cement producers here have been able to grow impressively during a phase that can at best be described as lukewarm.

What is the secret sauce to improving profitability in a commodity industry when there is a huge demand-supply mismatch? The answer lies in that one trick that the Indian cement industry survived on for the longest time when demand for building materials in India was weak with infrastructure moving at snail’s pace; and later thrived on when infrastructure boom took-off. And that is, by killing competitive mindset, instead embracing concerted action by competing players to keep prices high.

While the Competition Commission put a brake on that, the southern region continues to find a way to perpetuate price discipline. While the southern region has the lowest level of utilisation in India, prices are actually the highest – and by a wide margin. A bag of cement (50 kg) sells in Kerala at ₹420, while the corresponding price in northern India is barely ₹270. But how have the players managed this?

South India today accounts for 139 million tonne per annum (mtpa), which is 37% of the national capacity of 373 mtpa. Here, utilisation levels were 48% for FY15, which was down from 61% in FY11. By contrast, national utilisation levels stand at 68%, with the other four regions — north, east, west and central — well in excess of 80%. High prices orchestrated through low production have ensured that there is enough money to be made.

What turns the battleground for cement in the south into a cozy club of convenience is that there is no clear market leader. For instance, unlike in the north, where Shree Cement accounts for 25% of the market or in central India where UltraTech accounts for 20%, or in the west where UltraTech’s share again is a handy 40% dwarfing the next players, in the south, the market is more evenly distributed among key players. So if UltraTech has 15 mtpa, India Cements is just behind with 14 mtpa and a host of players follow with capacities in the 10-13 mtpa range.

There is bit of a background to this scenario in the south. Till the late 1990s, this region had many small players with capacities of just 1-2 mtpa. Most of them have either been acquired or just shut down. Understandably, there was no pricing power then and much of that changed when larger players bought some of these minnows.

Now, this even distribution of the market among the top players has ensured that every player’s self interest is in perfect sync with each other’s and their collective interest. So players have seen merit in cutting production and keeping prices high.

For the first quarter of FY16, Ramco Cement clocked net profit of ₹94.67 crore compared with a net profit of ₹35.51 crore, even as topline remained more or less the same.  For FY15, it clocked total revenue of ₹3,739 crore, again ₹3,747 crore for the previous fiscal, but net profit soared to ₹244 crore against ₹114 crore for the previous year. Chettinad Cement again nearly doubled its net profit to ₹210 crore, while revenues grew only 10 per cent to ₹2,456 crore. India Cements cut its losses from ₹242 crore to a mere ₹1.19 crore, even as revenue fell from ₹5,104.76 crore to ₹5,082.66 crore during the fiscal.

Can this dream-run continue? “The current capacity utilisation levels are too low for this situation to sustain. If one player decides to slash prices, the story can change dramatically,” says Sandipan Pal, vice-president, Motilal Oswal Financial Services. 

Paradoxically, this situation in the south is expected to last only as long as demand remains tepid. Pal thinks a region like the north will see prices going up when demand takes off. “South will not have that flexibility since the selling price is already very high,” he says. Besides, companies in the south with high debt on their balance sheets may find the going difficult when prices plateau. As it is, on an average, they have a debt-equity ratio of 0.9x, which compares to 0.3x for its counterparts in the north. A recent report put out by Spark Capital maintains that even a strong demand recovery of sustained 25% growth each year from FY16 to FY18 will see utilisation levels at only 67%. “We do not see cement producers regaining pricing power in this region and pricing discipline will hold the key going ahead,” it states.

It is commonly known that apart from being financially stretched, cement manufacturers in the south have high fixed costs. In that situation, a greater realisation, as is the case, becomes even more essential at lower levels of utilisation. For now, that has been good enough to take care of the debt. Tomorrow appears to be quite another story.