Cement: On weak foundations, set for consolidation

The fortunes of the cement industry do not look as bright as they did, say, a year ago.

A combination of factors, such as slow demand growth and sluggish price trends, points to at least one more year of flat/low earnings growth. This could mean continued lower stock valuations. But vis-a-vis acquisition-led consolidation process, it could turn out to be one more active year, says S. Vaidya Nathan.

THIS TIME last year, stocks of the cement industry were on a roll. The numbers for April 1999 showed volume year-on-year growth of over 20 per cent. Such growth, it was expected, would improve the demand-supply balance as also the producer pricing power over a period. With a sudden renewal of market fancy for stocks from the economically-sensitive sectors, the cement scrips came to the fore. But just 12 months later, the story appears to have changed considerably. As the accompanying graph shows, cement stocks have declined precipitously.

A far cry from the highs of late 1999. In the last week of December 1999, the Business Line Cement Index (Gujarat Ambuja, ACC, India Cements, Madras Cements and Birla Corp) touched a high of 2,380 points. This was a 220 per cent rise since the last week of April 1999 when the bull phase started. But since then, as cement earnings did not match expectations, there has been a sharp decline in the scrip prices. The cement index lost 66 per cent from the highs, and since February 2000 also underperformed the market after being an `outperformer' for close to six months.

The bull phase was tripped by the absence of profit growth to match the sales growth especially in volume terms (See accompanying story: Price trends, the culprit).

So, is the cement story over for the moment? On fundamentals, that would seem so, though some stocks would keep ticking on the prospect of acquisition. The consolidation process may gather apace even as cement stocks look largely set for a rather poor 2000-2001.

Big players in consolidation mode

The process of acquisition-led consolidation, that started with small units two years ago, has now entered a stage where even control over some big names seems in serious doubt. One trend the last three months is of more MNCs, that had shied away a few years ago, showing interest in the Indian market. The acquisition activity would be the key determinant of the emerging structure as also of the likely survivors and long-term winners in the profitability game.

Lafarge, the first MNC entrant, is on the prowl for capacities. Notable is the kind of prices it has been willing to pay for these capacities. After forking out Rs. 550 crores for the Tata Steel capacities in 1998-99, it has now signed up to pick up Raymond's capacities for Rs. 760 crores. The per tonne price paid by Lafarge has been amongst the highest.

As a global player with deep pockets, higher entry costs seem to no problem for Lafarge. There is the possibility of its buying up a few more plants to match the capacities of the extant majors -- India Cements, Larsen and Toubro, Gujarat Ambuja Cements and Grasim Industries. Whether this would fetch attractive enough returns over the long term is another matter altogether. Especially, as it has had to pay `above-average' prices for the acquisitions. Equally, the leading players, especially Gujarat Ambuja Cements, are keen on preserving their turf.

Since it has consistently had better cash flows and operating efficiencies, in a battle among Indian players, there is little doubt that Gujarat Ambuja would have emerged No. 1 on all key areas, including capacities over a three-five-year period.

But with the coming in of Lafarge and the possible entry of Cemex, Ciments Francais, the Italcementi Group and Blue Circle Victor, which have better access to resources and the staying power, the industry scene has changed. The moves of Zuari Industries and Jaiprakash Industries should give some of the newer entrants a sizeable capacity and established market presence.

To ensure that it retains its dominant position, and also as a strategic move to stall the MNCs walking away with ACC, Gujarat Ambuja paid a hefty price of Rs. 370 per share to acquire the promoters stake (that of the Tatas) of around 14.2 per cent. Though the issue of ownership control of ACC is by no means settled, if Gujarat Ambuja can hold on to its most recent buy, it may as a group (with operations in the industry shared with Ambuja Cement India) control around 25 per cent of the market in a couple of years' time. This would ensure that it can take on the likes of Lafarge and other big players without being handicapped on the capacity front.

More consolidation ahead

The consolidation phase is by no means over as yet. If this fiscal turns out to be difficult for the industry, especially on the profitability front, quite a few cement units, with capacities of one-two million tonnes, are sure to go on the chopping block. This happened in 1997-98 when major cement stocks languished on floundering fundamentals and small cement company stocks had a good time on the prospect of takeovers.

Click here for Chart

A similar price pattern for the rest of 2000-2001 can be expected with select small cement company stocks moving out of line with fundamentals in anticipation of a takeover. In the earlier phase, quite a few, such as Narmada Cement, Shree Digvijay Cements, Dharani Cements, Modi Cements, Sri Vishnu Cements and Raasi Cements, were acquired by bigger players. More recently, Zuari Industries and Raymond have also divested the whole or part of their businesses.

Changes at top

Clearly, the capacities that are changing hands are gradually increasing. Barring a few select players, it is difficult to see units with less than three million tonnes surviving and making good profits over a period. With the slowdown in demand across the board and low prices in the drought-hit Andhra Pradesh, Gujarat, Madhya Pradesh and Rajasthan, smaller units may find the going tough.

These States account for bulk of the cement capacities and in all these markets, at least one, if not more, of the bigger players has a presence. If the latter go for market share and as they have no need to be in informal arrangements with the smaller players, quite a few units from the key cement-producing States may go the takeover way.

This process would also be driven by the fact that just four companies -- India Cements, Gujarat Ambuja Cements, Grasim Industries and L&T -- control over 52 per cent of the industry capacity. This percentage shot up dramatically in the last two-three years because of acquisitions and the commissioning of greenfield units by these companies. Just three years ago, the top five units accounted for around 20 per cent of the capacities. Such a dramatic change in the industry structure cannot be without implications for other players.

If these four with Lafarge and Madras Cements gain a bigger share, the pressure could build on the smaller units even without any industry-level negatives. In this backdrop, it is clear that over a two-three-year period, the industry may well be dominated by ten players -- one or two MNCs and some domestic players.

There may be no room for the smaller players, by way of catering to niches, given the industry's characteristics. Some niche segments tried out by companies such as Nihon Nirman and Indian Rayon (white cement) have ended in the red, and businesses of this kind are either down and out or part of other cement majors. This high level of consolidation has serious implications for investments, both long and short term (see story on investment outlook), in the industry's stocks.