Industry Analysis: Cement – Part 2

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7. Competition and Consolidation

• Although the Indian cement industry has some multinational cement giants, like Holcim and Lafarge, which have interests such as ACC and Ambuja Cement, the Indian cement industry is broadly home-grown.
• Ultratech Cement, the country’s largest firm in terms of cement capacity, holds over 18% of the domestic market, with ACC (50%-owned by Holcim) and Ambuja (50%-owned by Holcim) having 10% and 9% shares respectively (as per FY13 capacity numbers). Many of the remaining dozen top players are India Cements, Shree Cements, Ramco Cements, Lafarge, Birla Cement and Binani Cement.
• Between them, the top 6 and top 12 cement firms have around 50% and 70% respectively of the domestic market. Around 100 other smaller companies produce and grind cement on a wide range of scales but are often confined to small areas.
• The industry has seen some consolidation in the past, and the same is going to be the mantra for most large payers in the years to come. With larger capacities, companies enjoy a better cost structure driven by significant vertical integration and location advantage with respect to sourcing of raw materials and market access. Most small companies, because of lack of one or more of these factors, have a weaker competitive position.
• The industry economics and the regulatory actions exhibited by the Competition Commission of India (see here and here) may push marginal players to consolidate. However, not all marginal companies would be attracting acquirers. Companies with either access to resources (raw material and power/fuel) or proximity to relatively underserved markets or both are most likely to be targeted for consolidation.
• A few compelling reasons why Indian and foreign cement majors appear to be gung-ho about acquiring cement capacities in India include a). Excess capacity of the existing players which can be used to fulfil the global demand at lower cost of production; b) Rising cost of greenfield/new projects which also tend to have longer gestation period.

8. Capital Cost & Return
It takes around US$ 120-140 per tonne to set up a cement plant. This has risen from around US$ 100 per tonne 3-4 years back. Given the rising cost of land and its unavailability, rising costs of equipment and engineering services, this capital cost to set up cement capacity is only going to rise. This will most likely fuel a greater drive to acquire existing units by bigger players.

Table 1: Capital Cost to Set Up 1 MTPA Cement Capacity

Source: Avendus Research
What is more, given the rising cost of setting up a greenfield cement capacity, the operating profitability or EBITDA (earnings before interest, tax, depreciation and amortization) is likely to remain under pressure, thereby again deterring new capacities to come on stream.

Break-even EBIDTA, for instance, for a 1 MTPA (million tonne per annum) capacity, operating at 80% utilization, and assuming a 70:30 debt to equity ratio, works out to around US$ 21 per tonne. In other words, this is the minimum a new cement capacity must earn in order to provide for depreciation and interest costs.

Table 2: Break-Even EBITDA for 1 MTPA Capacity

Pan India players – the most profitable ones, given their brand strength and economies of scale – currently earn around US$ 13-16 EBITDA per tonne. And given that ROCE for new plants is less than 10% – or US$ 14 per tonne – setting up new capacities are not profitable anymore, until cement demand and prices were to head northwards.

Thus, higher cement demand plus greater consolidation is the only way for existing cement companies to earn higher profitability going forward, which seems likely at this point of time. Of, lower cost of raw materials can also boost margins, but there is a lesser likelihood of this happening, plus this is something that is not under control of cement companies.

9. India’s Leading Cement Companies
India’s top six cement companies control almost 50% of the domestic capacity, production, and market. Leading the pack are Ultratech Cement (55+ MTPA capacity), ACC (30+) and Ambuja Cement (28+). ACC and Ambuja are now owned by Swiss-based Holcim, which owns over 50% stake in each of these companies.

Other key players in the market are Shree Cement (13+) and Ramco Cement (12+).

• Ultratech Cement: Ultratech is India’s largest cement manufacturer and exporter (30% of India’s cement exports), with an annual capacity of around 55 MTPA (FY14). The company is the largest player in the Southern and Eastern regions in terms of installed capacity. It is also one of the most efficient and profitable cement companies. (Ultratech’s Annual Reports)
• ACC: ACC Limited (Formerly The Associated Cement Companies Limited) is one of the largest producers of cement in India. The management control of company was taken over by Swiss cement major Holcim in 2004. ACC has a pan-India presence expect the Western market. (ACC’s Annual Reports)
• Ambuja Cement: Ambuja, the third largest cement company in India by capacity, has significant footprints across western, eastern and northern markets. Like ACC, the company is also majority-owned by Holcim. (Ambuja Cement’s Annual Reports)
• Shree Cement: Shree Cement is a leading cement company in north India, with a current total capacity of 15.5 MTPA spread across Rajasthan (13.7 MTPA) and Uttarakhand (1.8 MTPA). It is one of the lowest-cost cement producers in north India, primarily because of its captive power plant and lesser power consumption per tonne of cement, and lower freight cost as its grinding units are close to demand centres. (Shree Cement’s Annual Reports)
• India Cements: India Cements is south India’s largest cement manufacturer. Approx. 50% of its plants are located in Andhra Pradesh, rendering it well poised to benefit from any pick-up in cement demand in the state. The company currently transports a substantial quantity to farther markets in the east, west and other parts of south India due to political unrest and thus low demand in Andhra Pradesh. (India Cements’ Annual Reports)
• Ramco Cements: Ramco (earlier known as Madras Cements) is one of the top three cement producers in South India with total capacity of around 12.5 MTPA. (Ramco Cements’ Annual Reports)

Here are the key performance and valuation figures of these companies –

Table 3: Indian Cement Companies – Key Metrics

10. Investing in Cement Stocks
Cement is a cyclical industry, closely tied to the level of economic activity in the country. So this is not a business for people who get worried seeing violent ups and downs in a company’s performance (like profit and return on capital) and thus stock prices.

Given such volatility in business and earnings, valuing cement stocks on a P/E (price-to-earnings) basis is not feasible. While growth in the past has been good overall, margins for the industry as a whole have been coming down owing to rising cost of raw materials, transportation, and other operating costs.

Cement stocks should generally be valued on Enterprise Value per Tonne (or EV/tonne) basis, as this suggests roughly how much it would take for someone to set up a given cement capacity.

The formula for EV is “Market capitalization + Debt – Cash”.

Think of EV as the theoretical takeover price. It is more comprehensive than market capitalization, which only includes equity shares. It also includes the net debt (Debt minus Cash) that a company has to assume to set up a new cement plant.

As discussed above, it takes around US$ 120-140 per tonne to set up a new cement capacity, so that’s the level you must have in mind while assessing a cement stock’s valuations.

The best companies in the sector will mostly trade above this level of US$ 120-140 per tonne, given their brand name, size (economies of scale) and integrated nature of business (captive raw material sources, wide distribution etc.) Most mid and small size companies will usually trade at less than US$ 100 EV/tonne.

But, in general, the best cement companies get attractive when prices crash in a cyclical downturn to near or less than the benchmark EV/tonne of US$ 120-140. This is when you need to get into them and then be willing to ride the volatile tides over the long run.