Cement Sector Outlook – 2019
The prospects of the cement industry in India seem to be mixed with their fair share of positives and negatives in 2019. This outlook is shared by two major cement players, namely – ACC Ltd. and Ambuja Cements Ltd.
The aforementioned companies are subsidiaries of LafargeHolcim – which is Europe’s largest maker of construction material. In their annual reports, both companies have downplayed their estimates of growth in the industry to 7 to 8 per cent in 2019. Contrarily, the Indian cement industry clocked a growth of 9 per cent in 2018.
Cement companies have been grappling with the repercussions of rising crude oil prices and the hike in raw material costs. Their balance sheets have been under duress with the potential of generating negative cash flows owing to ongoing expansion and cement being taxed at 28 per cent GST.
On a positive note, the ramifications of these headwinds are likely to be offset to an extent as the costs are declining and prices are picking up. In February 2019, cement prices increased by Rs. 24-25 per bag of 50 kg as compared to the previous month. This will undoubtedly help the cement industry by boosting operating profitability of manufacturers.
The southern regions of India witnessed the steepest price hikes. The prices rose by Rs. 77 per bag in Hyderabad while Chennai and Bengaluru witnessed price hikes of Rs. 62 per bag and Rs. 52 per bag, respectively. The prices in the west rose by Rs. 26 per bag while they rose by Rs. 12 per bag in the east, Rs. 4 per bag in the north and Rs. 7 per bag in the central regions of India. Thus, the downtrend in cement prices since the rollout of the GST in July 2017 seems to be reversing.
In the present financial year, the prices of cement experienced a decline of 2.5 per cent between April 2018 and January 2019 despite positive demand growth of 12.5 to 13 per cent during the period. However, the hike in cement prices in conjunction with falling costs and rising demand growth will trigger an year-on-year improvement of 200-250 bps in margins in the ongoing quarter. The cost of power, fuel and freight has also been trending downwards. While there is still no clarity as to whether these prices can be sustained in upcoming quarters, the demand momentum seems to be positive, particularly in the light of the approaching elections.
Furthermore, ACC and Ambuja Cements also expect the benefits of a master supply agreement to register in 2019. Under the agreement, the companies will supply cement to each other at discounted prices amongst a horde of other conditions. The master supply agreement (MSA) was fashioned by the boards of both companies after they abandoned the possibility of a merger between them in May 2017. The MSA serves to maximize synergy, achieve economies of scale, reduce operational costs and unlock value without an actual merger. By optimizing costs, the companies aspire to service markets by making use of each other’s plant capacities and enhancing the utilization of assets to generate additional sales for each company while also utilizing spare inventory. The benefits of this agreement are likely to be realized this year.
Regrettably, the companies’ operating cash flows declined to five-year lows in 2018. ACC’s cash flows posted a drop of 28 per cent while that of Ambuja Cements’ plummeted by a staggering 68 per cent. Their operating cash flows stand at Rs. 1,118 crore and Rs. 596 crore, respectively. The pressure on operational cash flows is attributable to increase in working capital requirements as well as tax payments. Rising prices of pet coke and imported coal resulted in an increase in trade receivables and inventory. This in turn caused an increase in working capital requirements. The companies ascribed the increase in trade receivables to increase in sales.
In October 2017, the Supreme Court had imposed a temporary ban on pet coke in Rajasthan, Haryana and Uttar Pradesh with the intention of controlling pollution. This caused the inventory costs to increase. In the absence of pet coke, companies had to rely on imported coal, which led to an increase in fuel costs as imported coal is 20 to 30 per cent more expensive. In conclusion, the substantial increase in trade receivables and inventory resulted in a higher turnover ratio and sales days outstanding for the companies. Although the companies’ expansion plans can be funded through internal accruals, their free cash flows face the risk of turning negative. That is why they did not declare interim dividend in the year ended March 2018 so as to conserve resources for upcoming expansion and other capital expenditure projects.
The major growth drivers for the cement industry include the government’s focus on the infrastructure and housing sectors. The government emphasis on railways and ports will also scale up the demand for cement. ACC anticipated demand to flow in from central and east India where it is presently adding capacities of ~ 5.9 million tonnes. This will result in capital outflows of Rs. 3,000 crore.
Similarly, Ambuja Cements is setting up a greenfield integrated plant with a capacity of 3.1 MT for clinker and 1.8 MT for cement grinding at Rajasthan. This will require the company to fork over capital to the tune of Rs. 2,350 crore. A major risk faced by the cement industry includes the discrepancy in total installed capacity and capacity utilization.
On Thursday, the shares of ACC Limited opened at Rs. 1,577.00 per share and closed at Rs. 1,539.25, down 2.04 per cent. While Ambuja Cements opened at Rs. 231.40 per share and closed at Rs. 224.65, down 2.22 per cent.