Cement king in making

21 May 2014
Corporate India

The cement industry, like many others, is pinning its hopes on the new government to revive its fortunes. Among the worst hit by the economic slowdown, the cement industry is tormented by excess capacity, tepid demand and rising costs. Consolidation is the new buzz word in the industry with Mr. Kumar Mangalam Birla, chief of the Aditya Birla group, all set to strengthen his leadership position in the industry by ramping up the aggregate capacity past 100 million tonnes through acquisitions. He is eyeing the acquisition of plants belonging to Holcim and Lafarge (headed for a merger and slated to become the world's largest cement group), if the companies decide to leave India.

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Kumar Mangalam Birla, head of the $40 billion Aditya Birla Group that includes India's largest cement maker Ultratech Cement, looks all set to cement his leadership position in the sector.

UltraTech Cement is reportedly looking to buy Indian assets of Holcim and Lafarge SA. If the move succeeds, it can give a whole new dimension to the consolidation that is underway in India's troubled cement industry.

In a move that will have far-reaching impact on the Indian cement industry. Holcim and Lafarge, the world's two largest cement companies, agreed to merge last month to form the world's largest cement maker with combined annual sales of $44 billion. The two companies are looking to wrap up the merger by the first half of 2015.

Holcim, which entered India in the middle of the past decade, controls the country's two large cement companies — Ambuja Cements and ACC. Put together, the Swiss giant has a manufacturing capacity of 58.05 million tonnes a year (ACC 30.1; Ambuja 27.95 mtpa), which is 17 per cent of India's capacity.

Lafarge, present in India since 1999, though has managed only 8 mtpa. Besides, unlike Holcim, the French manufacturer is still a regional player, focused in central and eastern parts of the country.

Following the Jaypee deal, UltraTech's capacity had risen to 59 mtpa against Holcim's 57 mtpa. However, together Lafarge and Holcim will again rule the roost with an overall capacity of 65 mtpa. Moreover, Holcim plans to increase capacity in India to 65 mtpa by next year, which would take the duo's total to 73 mtpa. By contrast, UltraTech plans to increase capacity to 70 mtpa only by 2016.

The latest twist in the tale, however, is that Holcim and Lafarge are preparing to sell assets worth euro 5 billion ($6.9 billion) in several countries including India to win regulatory approval, and Ultratech has every reason to take keen interest in looking at what is on the offer.

As the two biggest listed companies in the sector already, with operations in 90 countries, they expect to face antitrust scrutiny in 15 countries and plan to sell some assets to persuade competition regulators to allow the creation of Lafarge Holcim.

In fact, there cannot be better news for Mr. Birla. The merger of Holcim and Lafarge would c;reate a formidable rival for him. But if they have to leave India, the Birla group is the only industry house which has enough funds and keen desire to acquire these assets.

"There's a huge market interest and we are currently working on the filing and divestment packages," said Eike Christian Meuter, Holcim's Zurich-based spokesman last fortnight. Earlier, Lafarge CEO Bruno Lafont had told investors on April 7 that Holcim and Lafarge may divest in Brazil, India, China, Canada, and the US.

On his part, Mr. Birla had already signaled his intent of expanding through acquisitions when he said last year. "We have the balance sheet, the wherewithal, the cash flows and knowhow of running a cement unit. Therefore, it is extremely attractive for us to expand in this market."

Ultratech plans to add 20 million tonnes to its current capacity in the next three years, for which a few buyouts will be necessary, according to industry sources.

Given this backd;rop, Holcim - Lafarge's asset shedding would be a big opportunity for Ultratech to bolster its market share. Being the largest player in the sector with a healthy balance sheet, it is a natural buyer of good assets on the block. The ready availability of assets may help the Indian firm gain market share without having to build green field factories.

Assuming that Holcim and Lafarge decide to pull out completely from India and all their Indian assets are lapped up by Ultratech (each is a big assumption), Ultratech would be more than doubling its capacity to a whopping 127 million tonnes a year, accounting for 34 per cent of the total installed capacity in the country at present.

This does not seem to be a likely scenario not just in view of the costs involved but also because such an entity is bound to attract attention of the Competition Commission of India. It seems quite likely though that Ultratrech will be especially interested in Lafarge's assets with a view to strengthening its presence in the eastern India.

It is no secret that Mr. Birla is keen to consolidate his leadership position in the cement industry. Capacity addition is crucial to secure UltraTech's top position. In September 2013, UltraTech bought the 4.8-million tonne Gujarat unit of Jaiprakash Associates for an enterprise value of Rs.3800 crore ($631 million) in Birla's biggest acquisition in more than two years. The company was in talks to buy a second cement unit in Himachal Pradesh from India's only Formula One track builder, but the negotiations are on hold as Jaiprakash's plant is awaiting some approvals.

What's more, the Aditya Birla group is set to receive the cement businesses of all Birla group companies such as Mangalam Cement and Vasavadatta Cement, part of Kesoram Industries - the flagship of BK Birla group of companies.

Mangalam Cement has a capacity of 2 million tonnes and Vasavdatta Cement 7.25 million tonnes. Century Textiles, another B K Birla group company, is ramping up its cement capacity. The Manikgarh Unit-II with a capacity of 2.8 mtpa is expected to be operational by September 2014. After expansion, the company's total cement manufacturing capacity will stand increased to 12.8 mtpa.

Ultratech is also scouting for assets and sites to build plants in Indonesia, Thailand, Myanmar, Oman, the Philippines and Malaysia. It is already present in the United Arab Emirates, Sri Lanka, Bangladesh and Bahrain.

It is only a matter of a few years before Mr. Kumar Mangalam Birla, through various companies, comes to control over 100 million tonnes of cement manufacturing capacity in India if all his plans succeed. All of it may not be brought under a single umbrella so as to avoid problems with the competition commission, but there will no doubt in the minds of industry circles as to who the uncrowned king is.

Obviously, Mr. Birla is looking far ahead of the present slump in the industry when the overall capacity utilization has d;ropped below 75 per cent. He is positioning his companies for a revival of demand. The new government at the Centre is expected to revive investment in infrastructure and encourage construction and housing sector. This would, inter alia, give a fillip to the moribund cement industry. Mr. Birla is all set to seize the opportunities that will be thrown up in such a scenario.

Coming back to Holcim and Lafarge, even if the entity formed by merger of Holcim and Lafarge sheds some of its assets in India, it would still be the one of the largest – probably the second largest – cement maker in the country.

In India, the merger will c;reate the largest market share in the eastern states of West Bengal, Jharkhand and northern Odisha, making these the probable hotspots for asset sales. Unlike southern India, which suffers from oversupply, the eastern region has sufficient demand making these assets among the most lucrative.

The merger is likely to accelerate consolidation in Indian cement industry, where the current top two players may become aggressive to maintain their market share. After the consolidation of Lafarge India and Holcim India, the top five players are likely to hold around 50 per cent of the market share of the cement industry. But this will be a big challenge to Mr. Birla. But the reported move of Holcim -Lafarge to reduce their assets has proved to be heart-warming for him.

Of course, the Indian cement industry is passing through a dull and depressed phase of late, it being among the worst hit by the economic slowdown. Tormented by excess capacity, tepid demand and rising costs, cement majors either witnessed flat growth or negative growth in cement sales during the December 2013 quarter and the estimates for the March 2014 quarter also are none too bright. In fact, cement production was flat in March on year-on-year basis and inched up by a modest 3 per cent to 255.63 million tonnes in the year ended March 2014, according to the Office of the Economic Advisor, Ministry of Commerce and Industry.

The performance is in line with modest expectations of the industry and observers. "In 2013-14, we may not even see five per cent growth. It could be somewhere at around three per cent," according to Mr. V Srinivasan, research analyst at Angel Broking. ACC said in a statement, "Based on current demand indications, we do not foresee any significant improvement in the cement market in the near term."

Laments Mr. H M Bangur, chairman and managing director of Shree Cement. "We are selling cement at a five-year low price. The outlook is not bright. Ups and downs are part of the business cycle. But I would say these are more than simple ups and downs, (may be) like a roller coaster." Explains Mr. Shailendra Chouksey, whole-time director of JK Lakshmi Cement, "If economic growth remains poor, the cement industry cannot grow."

India's cement sector, the world's second largest after China's, is already sitting on overall capacity of 363 million tonnes. Besides, additional capacity of about 52 million tonnes in expected to come on stream by March 2017. The 12th Five Year Plan envisages a target of 479 million by March 2017, which can be easily achieved, taking into account an addition of 10 per cent every year from now.

But the demand is much lower at 280 million tonnes. The housing sector is the biggest consumer of cement, accounting for about 67 per cent of the total consumption, followed by infrastructure (13 per cent), commercial construction (11 per cent) and industrial construction (9 per cent). All the consuming sectors are facing a slowdown.

Amid lower cement offtake, capacity utilisation is below 75 per cent (while in some regions it is not more than 60 per cent). As the Cement Manufacturers Association points out, the massive surplus cement capacity of about 100 million tonnes means a dead investment of about Rs. 60,000 crore, if calculated in today's cost of setting up a million tonne cement plant. In fact, cement industry saw investments of around Rs. 50.000 crore during 2007-12, doubling its capacity to the present level. In retrospect, that impressive growth looks like a self-made trap. "When those targets were made, people had not anticipated the current slowdown," says Mr. Chouksey. According to him, the industry's current capacity is enough.

In addition to sluggish cement demand, this industry has been acutely suffering on account of spiraling cost of inputs and their transportation, including cement and clinker. All the three key inputs — coal, power and railways — are in the public sector and the industry has no control over their functioning.

Coal receipts against linkages have been showing a d;rop for the last 10 years, from 75 per cent in 2002-03 to 35 per cent in 2012-13, while the cement production capacity has been on the rise, resulting in increased dependence on costly open market purchase and coal imports. Similarly, inadequate availability of railway wagons and lack of infrastructure at terminals have forced the industry to rely increasingly on the costlier road transportation. As regards power, cement being a continuous process industry, many producers have thought it fit to set up captive power generation facilities.

"There is all the potential to enhance the rail share again to at least 50 % provided the end transportation cost to the consumer is brought at par with road transport. To tide over the power shortages, cogeneration of power through Waste Heat Recovery needs to be encouraged, and further, this technology should be granted 'Renewable Energy' status for issuance of RE certificates" says Mr. MAMR Muthiah, president, Cement Manufacturers Association.

Freight costs have significantly increased over the past two years, as a result of a rise in freight rates by railways, diesel prices and dependence on expensive road transport (due to a shortage of railway wagons), as a report from the rating agency ICRA pointed out. The rise in domestic coal prices has resulted in an increase in the cost of power and fuel. Prices of raw materials such as limestone and gypsum have also increased.

At the same time, sluggish demand and excess capacity prevent producers from passing on the increased cost to consumers. Though cement manufacturers made a few attempts to raise prices in recent months, most of the price hikes undertaken by the industry were partially or fully reversed.

Meanwhile, the cement industry seems to be moving towards consolidation. The conditions seem ripe: the industry has too many players with small capacities, business is down, greenfield plants are becoming difficult to set up and big ones would find it easier to expand through acquisitions.

The Indian cement industry is the second largest producer in the world comprising 185 large cement plants and 365 mini cement plants. However, just half a dozen players at the top — UltraTech, ACC, Ambuja, Jaypee Cement, India Cements and Shree Cement — control half of India's cement market.

The emphasis on acquisition is not without reason. Analysts point out that for a new plant to achieve a rate of return on capital employed of 10-12 per cent, the industry would need a price of over Rs.320 per bag, as against the prevailing price of Rs. 275-280. Asset acquisition would provide a better rate of return than asset building. According to a Credit Suisse report, greenfield capacities commissioned in 2009-12 are still not breaking even on cost of capital, since they are operating at around 70-75 per cent utilization.

The new land acquisition law has made getting land for new plants a time consuming, costly and tedious affair. Setting up green field projects has become a challenge. "Expansion is taking time. It takes at least 5 years for land acquisition and then two more years to erect the plant. In all, seven years for an efficient player compared to three years earlier," says Mr. Bangur of Shree Cement.

Yet, stocks of many cement majors have had a good run on the bourses in the last few months. Investors hope that the election will lead to a politically stable and reform-friendly new government at the Centre which will accelerate growth by resuming the investment cycle, especially in infrastructure.

JP Morgan's Asia Pacific equity research team says: "Hope that a reformist and stable government will take charge post general elections is fuelling a broad-based rally in industrials and asset owners. The promise of swift policy action to remedy bottlenecks is a potent one, though in s;elect stocks,expectations appear disconnected with fundamentals."

The long term prospects of the industry remain bright. India's per capita cement consumption (@ 225 kg) is much too low, compared to the world average of over 350 kg per capita, which shows great potential for growth. The corresponding figure is 660 kg per capita in China, 631 kg per capita in Japan and 447 kg per capita in France.

But India's economy is growing fast. Over the past 15 years, the per capita consumption of cement has almost doubled in the country. Though the growth in demand for cement in the last financial year was just 3.5 per cent, it will definitely improve in the coming years. In fact, India's low per capita consumption of cement is one of the main reasons for strong interest shown by the foreign players in India.

The major consuming sectors — housing and infrastructure — have tremendous growth potential and continue to receive policy support from the government. The housing segment accounts for a major portion of the total domestic demand for cement in India. Demand from the housing sector will be driven in the coming years by the increasing per capita income, nuclear families, rapid urbanization and government stimulus to various rural and affordable housing schemes. These trends do not show any deceleration.

The focus of the government on strengthening infrastructure, besides promotion of low-cost affordable housing etc. is expected to drive cement demand. The Government of India (GOl) is strongly focused on infrastructure development to boost economic growth and plans to increase investment in infrastructure to $1 trillion in the 12th Five Year Plan (2012-17). Infrastructure projects such as dedicated freight corridors as well as new and upgraded airports and ports are expected to further drive the industry.

The government also plans to expand the capacity of the railways to ease the transportation of cement. With the ever-increasing industrial activities, real estate, construction and infrastructure, there is a continuous demand for cement.

So, the worst may be over for the cement industry on the demand front. According to a Citibank report: "India's cement demand grew at (estimated) 3.5 per cent in 2013- 14 and we expect the growth rate to improve to 6.5 per cent in 2014-15, 7.5 per cent in 2015-16, nearly 1.2 times the GDP growth rate. A case for better growth in 2014-15 and 2015-16 can be made as we come off a low base, announcement of projects and capex are expected to increase and we expect a stronger GDP growth."