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Indian cement: turning corner but pitfalls ahead

With the world's second-biggest market for cement after China and a developing economy, India offers a huge potential for companies in that sector to grow and prosper.

Yet, till last year, the local industry had fallen on hard times More than 30 companies were in the red of which 10 were bankrupt.

Much of that was because Indian cement prices were half of those in Thailand, and 70 per cent lower than Mexico, both also emerging economies.

While Mexican companies get around $4,100 per tonne and Thai around $2,100 -- Indian firms fetched $1,050-1,250 a tonne of cement, according to a January report by the domestic Cement Manufacturers Association.

Excess capacity

Frenzied capacity building - a legacy of the past decade when companies banked on infrastructure growth and spent heavily - was the root cause of the problem.

Total capacity jumped from around 70 million tonnes in 1995 to 115 million tonnes in 2001, a rise of 64 percent.

Most of the capacity increase came through new plants.

Companies like Grasim Industries Ltd and Larsen & Tubro Ltd who were not traditional cement producers entered the sector in the mid-1990s, lured by prospects of high growth. Over the years, they built new plants, acquired old ones and overtook the established players like Associated Cement Cos and Gujarat Ambuja Cements Ltd.

Coupled with low demand and fall in government spending on big projects, the effect of the capacity rise on the industry was disastrous.

But the tide could now be turning. Cement companies posted strong profit growth in January-March helped by price increases in key markets.

ACC, India's second-largest cement producer, posted a profit of Rs 474.8 million in the year to March versus a year-ago loss of 588.1 million.

Third-largest cement maker Grasim saw full year net profit climbed 62 per cent to Rs 3.78 billion.

Margins too improved and cement stocks, which were languishing at 52-week lows last October began surging.

"We are overweight on the sector. We think prices will stay high and demand will improve," said Namita Manel, cement analyst with ICICI-Securities, an Indian investment firm.

The number one Indian cement maker, Larsen & Toubro, is due to release results later this month. For the October-December quarter, its net profit jumped 72.13 per cent to Rs 332.9 million, while sales rose 12.2 per cent to Rs 19.41 billion.

Gains not convincing everyone

The industry's recent progress hasn't convinced everyone that that tide has turned.

They note the price increases were not the product of higher demand, but from artificial scarcity created by producers who curbed cement shipments.

Between November 2000 and early January, cement prices rose 10-25 per cent and shipments fell.

Major cement stocks rose on the news and look likely to extend gains as prices are staying high.

So far this year, three out of four leading cement stocks have outperformed the Sensex.

L&T has risen 17.27 per cent to Thursday's close of 229.45 rupees, Grasim has risen 4.6 per cent to 302.20 rupees, and Gujarat Ambuja, the fourth-largest producer, has jumped 20.96 per cent Rs 191.25. The exception to the group is ACC, which has fallen 13.76 per cent to Rs 138.05.

The main stock index has fallen 10.16 percent during the same period.

Indian cement stocks are fairly priced compared with their Asian peers on parameters like enterprise value per tonne, analysts said.

Associated Cement Companies earns an enterprise value per tonne of $90 compared to $55 for Thailand's Siam City Cement, $119 for Malaysia's Malayan Cement and $25 for Indonesia's PT Semen Gresik Tbk. India Cements Ltd has an EV per tonne of $61 and Madras Cements $70 per tonne. Analysts said the average figure in emerging markets ranges between $50-$120 per tonne.

Enterprise value refers to market capitalisation plus debt.

Analysts estimate prices for a 50 kg bag in April-June to be at least Rs 15-20 higher than the year-ago quarter, signalling improved profits.

"I don't see foresee much of a pick-up in demand this year. It may be in low single digits," said an analyst with a European brokerage who did not wish to be named.

Rain the key factor

The main reason is the uncertainty of monsoons. Patchy rains - five large states are considered affected by drought - last year hurt agricultural production in key markets which in turn affected cement demand.

Rains boost crop output and consequently the disposable incomes of farmers. This usually leads to higher spending on rural housing and consumer goods.

Rural housing consumes a large chunk of the cement produced and analysts estimate that last year this segment did not generate much demand.

Cement consumption thus fell 0.72 per cent to 93.32 million tonnes in the year ended March 2001, after growing by 15 per cent in the previous year.

Analysts say prospects would be bleak if the rain gods play truant again, especially since demand from big industrial and infrastructure projects is still dormant.

"We remain medium term underweight on the sector as we expect the managed cement prices to decline due to new capacities," said analyst Shatayu Mehta, of Anagram Stockbroking in a report.

At least 16 million tonnes of additional capacity is expected to be commissioned this year, which could put pressure on prices.

Producers can cut shipments once again to keep prices firm but that could be difficult. When they did so the last time, they were stung by a big backlash from builders who struck work alleging that the companies are behaving like a cartel.

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