Hampered on input front

S. Vaidya Nathan

PERHAPS no other economically-sensitive industry has such a limited flexibility on the cost front as the cement industry. Close to 70 per cent of the inputs come under some form of administered pricing or the other.

Be it power, coal, freight and fiscal imposts -- the pricing of all these are decided by the Government or its various arms. This aspect goes on to cover other items of cost such as royalty and cess on limestone.

On the wage cost front too, the industry has limited flexibility as it has a three-year agreement with the unions at the All India level. The most recent agreement was concluded in late 2000-01 and the increase on this score will be reflected in the 2001-02 bottom-line.

With very little flexibility -- except by way of coal imports and the use of bulk transportation (done with good effect by Gujarat Ambuja Cements) -- on the pricing of inputs, cement companies have focussed on cutting down usage of power/coal for every tonne of cement produced.

The industry as a whole has managed good progress on this front. As far as power goes most companies have moved to a 86-105 kwh range from 95-115 kwh. Considering that close to 50 per cent of the installed capacity is old, companies such as ACC, India Cements and Century Textiles have had to invest in modernisation.

It is here that companies such as Gujarat Ambuja, Madras Cements, Grasim and Larsen & Toubro have an edge. Almost all their capacities -- except those acquired in the last three years -- are of recent vintage.

The units of Gujarat Ambuja and Madras Cements have consistently managed operating profit margins in excess of 25 per cent in difficult times and over 30 per cent in good times. These companies have had to invest only modest sums on modernisation. This also explains to a large extent why they have been able to improve capacities without much trouble.

DLF Cement (now known as Ambuja Cement Rajasthan) which was acquired by Gujarat Ambuja was a contemporary capacity which was just three years old at the time of the deal and is capable of delivering OPMs of around 25-30 per cent.

In sharp contrast, Modi Cements (the erstwhile Ambuja Cement Eastern) which was picked by Gujarat Ambuja off the BIFR has a long way to go before it can consistently match the profitability parameters of its parent company.

The contrast between the two also explains why most of the takeovers by other players have yet to pay off. Acquirers such as L&T, Grasim, India Cements and Lafarge have to invest in the upgradation of the units.

Given the financial outlay involved in these acquisitions, unless the units deliver operating profit margins of 20-25 per cent, the payback period is bound to be protracted. In any case, there is a limit beyond which consumption parameters cannot be cut.

Going forward, this could leave the industry with limited room for further improvement. For some companies such as ACC, India Cements and smaller units, there may be some additional scope for improvement.

The underlying nature of the cost structure -- a high degree of administered pricing inputs -- is unlikely to change. There are no signs that competition could provide cheaper alternatives for key inputs such as power, railway freight, road freight and coal.

In this backdrop, the following may well be factors that could merit a close watch: Low levels of debt, flexibility to raise equity without much expansion of the equity base, operating margins that are at the 25-30 per cent level with a high degree of consistency and ability to ramp up volumes as a vehicle for revenue and earnings growth.

In these aspects, companies such as Gujarat Ambuja, Grasim and Madras Cements are relatively better placed. ACC and India Cements need to look for efficiency gains, though, in the case of the latter, interest costs could eat away gains made elsewhere by the company.