The Indian Cement Industry

In FY16, sharp decline in real estate demand, floods in Tamil Nadu and a lower government spending led to a decline in cement sector in this region. North region witnessed lower demand due to lack of rural demand and already piled up real estate inventories. But, there was a huge government spending witnessed in north eastern states backed by allocation of funds in Union Budget. This led to an increase in demand for cement in this region. The demand for cement has been affected after demonetization. This has also been corroborated by reports which talk of lower freight revenue by railways. Indian railways have witnessed significant impact on revenue due to reduction in coal and cement traffic after demonetization.

It is possible hence to say that had demonetization not been invoked, growth would have been pushed by the housing segment on the back of announcements made regarding PMAY- rural and Housing for all by 2022, smart cities and various irrigation projects.

Import and Export Scenario

Cement imports in the country are almost close to negligible with domestic supply being adequate. Nevertheless, 64% of our import demand in terms of quantity was from Pakistan in FY16. Imports have increased from 1.095 mn tons in FY11 to 1.35Mn tons in FY16. Exports on the other hand have increased from 3.49 mn tons from FY11 to 6.22 mn tons in FY16.

Rising input costs to put pressure on the margins:

Power & fuel and freight are the major components of costs of the cement industry given the fact that it is an energy and freight intensive industry. Power & Fuel costs as well as transport/freight costs contribute about 22-23% each to the overall cost of production for the sector. Therefore, the margins of the players are susceptible to adverse changes in these input costs. It gives the cost structure of the industry based on the cost structure of a select sample of 42 companies as of FY16.

Industry cost breakup in FY16

Source: Ace Equity

Increase in freight rates was partially mitigated by softening of the diesel prices in FY15 and FY16, though the same have increased in FY17. Also, the cement industry during Q4-FY16-FY17 benefitted from subdued coal and pet coke prices. However, coal prices have started to firm up since July 2016. Further, pet coke which is an alternative to coal has also witnessed price increase since February 2016 (price increased by 78% since February 2016) primarily due to supply constraints as well as high demand. Therefore, the ability of the companies to pass on the rise in input costs would be crucial in order to sustain the margins.

Coal is primarily used as a fuel in the process of cement manufacturing. Approximately, 0.12-0.14 tons of coal (excluding coal consumption in captive power plant) is required for the production of one tone of OPC. Due to limited availability and inferior quality of coal, Indian cement Industry is dependent on high calorific coal from foreign countries like Indonesia, Australia and African countries. Thus, making it vulnerable to international supply shocks, currency fluctuation and price volatility.

Y-o-Y Growth in International coal prices

Source: CMIE

Power: The standard power requirement to produce one tone of cement varies in the range of 80-110 units for different cement companies. In order to save themselves from regular supply cuts, cement companies has shifter to captive power generation which requires coal. Even though this makes them vulnerable to price volatility and supply shock, the consistent supply of power is ensured. Freight cost: Companies use railways, roads and sea route to transport cement, cement clinker and ready mix concrete. But roads and railways are the preferred modes. Chart 8 gives an idea of how freight and forwarding charges have moved in 6 years for the Industry.

Source: Ace equity

The freight and forwarding charges has increased by a CAGR of 17.3% from FY10 to FY16 and is expected to further increase in FY17 as the diesel costs have increased by 6% y-o-y in April-August 2016. (A part of this increase in cost would also be linked to the volumes that are transported). The reason of an increase in costs could be attributed to increase in the lead distance, increase in the rail freight and increase in the volumes transported. But, the increase was marginally offset due to a decline in diesel prices in FY15 and FY16.Shortage of wagons, increase in the rail freight rates and a decrease in the diesel prices had made companies to shift to road transportation. However, increase in diesel prices is likely to affect the industry in FY17.

Y-o-y growth in Wholesale prices of cement

Source: Government of India, Ministry of commerce and industry

During 2012-13, cement prices had risen as a result of increase in the cost of production. There was a rise in logistic cost due to an increase in rail freight and diesel price which was transmitted into cement prices. - Growth in cement prices declined in 2013-14 on account of fall in construction activity, prolonged monsoon, drop in government spending and an increase in the interest rates. - In 2014-15, the reasons were different compared with other years. The prices rose on account of a supply crunch due to the closing of major plants in Himachal Pradesh and Rajasthan. - In 2015-16, Cement demand could not pick on account of delay in government spending and a muted demand from private housing.