Usually in horror flicks, when a group is chased, they lock themselves in some random house. After that they latch the main door and shutter the windows. Just as everyone sighs in relief, they hear the backdoor break open and the floorboards creak. Often, when preoccupied with the task at hand, we overlook the obvious. It can happen when running an MNC too, like it seems to have happened at LafargeHolcim’s India business. They were busy securing their house while competition has been aggressively running amok. The latest being Ultratech Cement’s Rs.55 billion investment to add 12.8 million tonnes to its existing capacity, in addition to the nearly 7 million tonnes in the works.
The story begins with Holcim’s entry into India in 2005, through a big-ticket transaction. The Swiss company joined hands with Gujarat Ambuja Cements to make a bid for ACC, as part of its $800 million investment in the subcontinent. It remains one of the largest foreign investments in the domestic cement sector. But, the aggression in expansion has whittled away.
In the past ten years, when Indian peers were buying out each other’s assets and smaller companies, LafargeHolcim’s ACC and Ambuja Cements chose to remain conservative. They stuck to their organic growth strategy, even when it cost them market share and valuation (See: Finding local favour). The two companies’ total capacity stands at a little over 63 million tonnes, which is way behind market leader UltraTech’s over 113 million tonnes. Though the ACC-Ambuja combine remains the second-largest player in the segment, Shree Cement and Dalmia Bharat are growing fast and are snapping at its heels (See: Chasing scale).
What slowed things down for the combo?
Over the past decade, the parent company was too caught up with the restructuring of the subsidiaries and the merger that brought Lafarge and Holcim together. The restructuring involved Ambuja acquiring 24% stake in its holding company Holcim India in 2013, and then a stock merger between Ambuja and Holcim India. Complex much? This had Ambuja’s investors fuming. They were worried that this was simply a convoluted way to move about Rs.65 billion from Ambuja’s strong balance sheet to Holcim, and the former being sold the not-very desirable business of ACC by Holcim.
The Swiss company denied the allegation and said the deal would optimise the supply chain and fixed costs for the two Indian companies and unlock synergies worth Rs.9 billion. At an investor presentation, a representative of the company spoke about adding another 10 million tonne capacity and bagging more projects. The transaction got the go-ahead from the government in 2016 and ACC became a subsidiary of Ambuja, but none of the plans discussed at that investor presentation came to fruition. Both companies had been preoccupied with the restructuring.
Stuck in the middle
Even as these events were unfolding, in 2014, Holcim and France’s Lafarge announced their global merger. Then, the companies had to deal with the implications of that merger in India. The Competition Commission of India conveyed that Lafarge’s domestic assets would need to be divested for the merger to go through. With the Indian businesses now under the umbrella of LafargeHolcim, Ambuja and ACC said they were “evaluating a potential merger.” By May 2018, that plan was dropped on the grounds that “there were certain constraints in implementing the merger.” The management at both Ambuja Cements and ACC declined to respond to a detailed questionnaire from Outlook Business.
In 2019, three years after the aligning of Ambuja and ACC businesses through that convoluted deal, the two finally got down to unlocking that synergy. They signed a master supply agreement (MSA). It broadly was to reduce operational costs, such as using each other’s plants, and achieve economies of scale. Finally, they seemed to have turned a corner, but not without paying a cost for the delay.
Between FY14 and FY19, Ambuja’s market share had dropped from 8.4% to 7.1% and ACC’s from 9.6% to 8.5%. Rashesh Shah, senior research analyst, ICICI Securities, thinks both Ambuja and ACC suffer from the twin problems of demonstrating no inorganic growth and being slow organically.
Capacity expansion is key in the cement industry. During the period leading up to the MSA, the companies stayed away from potential buyouts. The Ambuja-ACC alignment was expected to be completed by 2014 and then they had planned to go looking for the right acquisitions. But, we know, that took longer to materialise and it stalled the expansion as well. Besides, Holcim had cash-flow pressure globally and that took a toll on its India business as well.
During this lull, its peers were shopping vigorously: UltraTech bought Jaypee Cement’s assets in Gujarat and Binani Cement, Dalmia Bharat bagged Nagpur-based Murli Industries and Shree Cement bought Jaypee’s grinding unit in Panipat. Meanwhile Nirma Group’s cement arm acquired Lafarge’s India assets (total capacity of 11 million tonne) and, early this year, it picked up Emami’s cement assets (See: Judicious buyer).
Each of these deals has been struck around $125-135 per tonne, and now Ambuja and ACC are setting up plants from scratch at a cost of around $100-110 per tonne. “There is no doubt a new project will take time, but it is their way of doing it. They think buyouts in India are still expensive,” says Shah. He points to the cost this strategy is extracting, saying that capacity concern is driving down their valuation. “That coupled with losing market share in a commodity business is an issue,” he says. The new plants, which will add 1.8 million tonnes capacity for Ambuja and 4.8 million tonnes for ACC, are expected to be fully operational between 2021 and 2022.
Jigar Shah, CEO, Maybank Kim Eng Securities, believes this is a smart move on their part. He says, “It’s not as if cement prices have improved dramatically over the past few years. Besides, their focus has historically been more on return on capital employed (ROCE). Adding capacity or going for a buyout would have affected that equation significantly.” In terms of utilisation levels, both operate at well over 80%, when the national average is around 70%. In terms of geographical spread, the two companies complement each other and there is little overlap, according to Jigar. Of Ambuja’s 30 million tonnes capacity, 70% is housed in north and west India, while ACC’s is spread evenly across India.
However, Ambuja and ACC present a peculiar situation of being the second-largest player at a pan-India level but not being the leader in any of the regions (there are five in India – north, south, west, east and central). ICICI Securities’ Shah says, “It is important to be the No 1 player in a region for the purpose of controlling costs and possess pricing power as well.” Leadership in a region gives the player muscle to control distribution and build a strong brand. And the combine is well placed given its strong balance sheet with cash well over Rs.60 billion.
“One knew they had the cash but that was not accompanied by enough action. That is now changing,” says Prateek Kumar, analyst, Antique Stock Broking. “Earlier, there was a lot of focus on return on capital employed. While that still remains, both the companies are moving ahead on capacity expansion,” he adds. The past 12-18 months, according to him, have seen increased focus on volume and capacity enhancement.
Jumping into action
For Ambuja and ACC, implanting the MSA seems to be paying off. Ebidta/tonne has increased from Rs.900 to Rs.1,400 for Ambuja and from Rs.800 to Rs 1,200 for ACC. One of the key challenges for ACC was its cost of production. With older plants and inadequate investment having gone into modernising them, ACC was spending 15% more than Ambuja. “That has been reducing over the past couple of years and with the ushering in of MSA apart from cost optimisation measures, it is expected that the cost gap will reduce going forward,” says Kumar.
Even for freight, ACC, till earlier this year, spent Rs.1,450-1,500/tonne with the industry average at Rs.1,100. It has managed to bring it down to Rs.1,400. Ambuja, known for its tight cost structure, was at Rs.1,250-1,300 and that has come down to Rs.1,200. Kumar says with the MSA project, both ACC and Ambuja are targeting cost savings for freight to the extent of 3-5% by 2022.
Despite these improvements, Kumar says the two companies must consistently deliver on operating performance, like large domestic peers, to get better valuation. “While there is cash, they are still viewed as being slow and extremely risk-averse,” he says. However, with the recent management shuffle between the two companies, that concern should get addressed soon, making them potential candidates for re-rating.
India is still a cement surplus nation and that is reflected in how prices have moved over the past decade (See: Lacklustre growth). The money invested into capacity creation has been in anticipation of demand from housing, roads and infrastructure at large. Ambuja and ACC have taken a contrarian route, though not entirely by design. As the two entities attempt to get their India story right, they might have to chase volume more aggressively to stay ahead. After all, they have money to fuel their ambition.