Oversupply, volatility and worse

Ever since it became more expensive to find good quality stone, cement has been used more and more commonly, although its use actually goes back to the Roman Times. Cement is produced throughout the world, but the largest producers are Brazil, China, Russia, USA and India. The Indian cement industry is the second-largest market after China.

In India, the cement industry is experiencing a boom on the account of overall growth of the Indian economy. The demand for cement, being a derived demand, depends primarily on the industrial activity, real estate business, construction activity, and investment in the infrastructure sector. India is presently passing through a positive trend of growth on all these fronts and hence the cement market is flourishing like never before. Fitch Ratings has commented that cement demand in India is expected to grow at 10% annually on account of rapid growth in housing projects, infrastructure activities and corporate capital expenditures. Housing and Infrastructure sectors consume around 55% and 35% of India’s cement output respectively, and now act as a major driver of growth for the cement industry.

Interestingly, despite a growing demand for cement, capacity additions have created surpluses in some parts of the country and put pressure on prices. Cement companies have added a capacity of 89 million tonnes in the last three years with close to 45 million tonnes of fresh capacity being added during 2010-11 alone. The companies are expected to add 35 million tonnes of capacity by FY-13. Consumption was 179 million tonnes last fiscal.

As a global commodity, cement prices are affected completely by demand and supply worldwide. In 2010, for example, India experienced a 50% rise in the prices of cement as the housing market boomed. In the March quarter of the current year, cement prices shot up by 30%, making a 50 kg bag of cement available for Rs 290. However, despite price hike, the net realisation by cement companies remains lower than what it was in 2007, with transportation and input costs emerging as major reasons behind this dismal state. Cement, being a bulk commodity, is a freight intensive industry and transporting it over long distances is uneconomical.

The Cement Manufacturers’ Association (CMA) has now demanded 50% freight subsidy for transportation of cement and clinker from the factory to port, as most plants are located in the hinterland. The overall supply position of railway wagons to the cement industry is also much lower than the requirement even as the direct and indirect cost of railway transportation continues to rise. In December, the Railways changed the classification of cement resulting in 4-5% rise in the transportation cost. Though steel and cement are equally important materials needed for construction activity, the VAT rates on steel and cement differ vastly. While VAT on steel is only 4%, VAT on cement and clinker is 12.5%. Further, steel enjoys ‘declared goods’ status while cement and clinker are excluded.

With about $1 trillion of infrastructure projects slated over the next five years, demand for cement looks set to remain high. However, though capacity expansion appears to be in sync with the expected demand, achieving the targets will require the Rs 77.8 billion cement industry to get rid of the bottlenecks first.

For the past one year, the shortage of raw materials like coking coal and gypsum has posed a big problem, and the recent floods in Queensland, Australia have triggered a steep rise in input cost. Speaking to TSI, H.M Bangur, MD, Shree Cement, said that coal continues to be the industry's predominant source for fuel requirements. "Coal prices have increased tremendously, both in the domestic and international markets, badly hitting the profitability of cement players," he said, adding that the alternatives also have their own issues and limitations.

Another hurdle is the irregular supply of power to the cement factories, leading to huge losses in capacity and output. Cement plants have been forced to put up a captive power plant to meet their power needs. Environmental obligations, such as reduction of green house gases and the growing need to reduce emissions, have put extra burden on the cement manufacturers leading to higher production cost. Facing such challenges is not easy and many producers of cement with a capacity of less than 1 million tonnes a year have been acquired by bigger players in the Indian market. Until now, consolidation in the cement industry has only taken place with the top five players which control over 60% of the total industry capacity. However, with a number of foreign players planning to enter India to capitalise on the growth opportunities considering the long term growth story, fair valuations, fragmented structure of the industry and low gearing, another wave of consolidation would not be a surprise.

The cement industry as a whole is not yet on a sustainable path in any of the dimensions of the ‘triple bottom line’ – society, economy and ecology. Rising energy and materials costs, and adverse business impacts of poor environmental performance only mean that companies who compete on the basis of sustainable development might ultimately come to have the competitive edge.