Narrowing, but capacity overhang persists

S. Vaidya Nathan

PERHAPS the most significant factor dampening the profitability of the cement industry is the impact of the capacity creation binge in the past decade and the attendant pressure on prices. The demand-supply equation is tilted in a big way in favour of supply.

Much of the capacity creation happened in the mid-1990s as existing cement industry players and a plethora of new ones wanted to ride the industry boom. The easy access to equity also spurred this trend. So much so that by 1996-97, the gap had risen to around 30 million tonnes.

It has since narrowed to 24 million tonnes. The capacity overhang that has hit the industry has another interesting twist. The gap has remained big despite cement consumption growing by a percentage point more at 7.3 against supply at 6.4 between 1989-90 and 2000-01.

In this context, the views expressed by the largest player, Larsen & Toubro, in its annual report for 2000-01, is worth noting: "The overall performance of the industry continued to be unsatisfactory. The excess supply of cement persisted during the year. This was compounded by negative growth of 2 per cent as against positive growth of 8-9 per cent annually in the past decade. This was on account of drought in several States, lack of government spending on infrastructure..."

Going forward, the likely levels of capacity creation will still be the critical factor for the industry. If the industry maintains the current growth rate of 5.6 per cent in 2001-02, supplies would still exceed demand by close to 20 million tonnes.

Some of this capacity may be inoperable. However, if prices are ramped up high, then capacities may well get cranked up for a while. The consolidation that has taken place in the last three years has placed close to 58 per cent of capacity in the hands of the Gujarat Ambuja-ACC combine, Grasim, Larsen & Toubro, India Cements, Lafarge and Madras Cements.

With the profitability of most of the 1-2-million-tonne players poor and with most companies highly leveraged, there may not be much capacity creation from this set of players. Financial institutions may also not be willing to bankroll any of the players except the Big Six and Zuari Industries. The B. K. Birla group may also look at only improving the profitability of existing capacities than creating new ones.

Even so, the projects lined up by Gujarat Ambuja Cement, L&T, Madras Cements and Zuari Industries among others add up to a whopping 15 million tonnes. What may happen is that this may be phased out over a longer period than envisaged.

But Gujarat Ambuja and Madras Cements are slated to add around 5 million tonnes over the next two years, while small players such as Chettinad Cements and Dalmia Cements have also cranked up capacities by around 1.5 million.

Overall, there is bound to be more discipline in capacity creation in the years ahead. This has been the case in the last two years as well. For instance, in the last two years just 6 million tonnes have been added compared to 18 million tonnes and 15 million tonnes in the immediately preceding blocks of two years. This year (2001-02) may well see an addition of 4 million tonnes.

Still, despite the better discipline in the last two years on the capacity creation front, there is bound to be a gap that could persist for at least a couple of years. What the industry needs to bridge the gap quickly is the kind of 15 per cent growth in demand witnessed in 1998-99.

But that rate of growth has proved unsustainable and the following year saw a decline -- which to some extent was due to production cuts than actual demand. This year the industry is growing at 5.6 per cent. The long-term growth rate has been 7-8 per cent. Even at this rate, it could take up to three years to dry up the demand-supply gap.

Another important aspect would be the profile of the companies adding capacities. These big companies would be able to add capacities and simultaneously operate at lower levels to ensure better price levels. This may, however, be a short-term trend at best.

But over 2-3 years, they would want to operate at full throttle and enhance market share. For all the efforts to ramp up prices (for which an industry-sponsored CRISIL study has come in handy), the major players would not be unaware that it is finally a volume-efficiency game.

One aspect that can be ruled out is the kind of binge witnessed between 1993 and 1997 -- when close to 40 million tonnes (a rise 61 per cent of the capacity as of 1993) were added. The rough times of the last five years have effectively ensured that no such pace of capacity creation takes place.

In this likelihood of moderate capacity increases, the ability of big producers to wait out before operating new capacities at full throttle and the hope of growth rates of around 10 per cent per annum hinges on the industry's ability to have better and sustainable pricing levels. More consolidation over the next 2-3 years could improve the picture from the producers' side and lead to a better balance between demand and supply.