How to do Business Analysis of Cement Companies

The current article aims to highlight the key characteristics of the business model of cement companies.

After reading the article, an investor would get to know the key parameters that she needs to assess while analysing a cement company. She would be able to determine what make the business model of any cement company fundamentally sound and the challenges that cement companies face.

Key parameters influencing the business of cement companies

1) Cement is undifferentiated, and commodity product; so low customer stickiness leads to price-based competition

The first thing an investor needs to know about cement companies is that their key product, cement, is a commodity where cement of a particular grade made by one manufacturer is hardly different from the cement of the same grade manufactured by some other manufacturer. Therefore, a consumer may easily switch from using cement of one manufacturer to using cement of another manufacturer with any significant impact on her business.

An investor would appreciate that due to undifferentiated products made by cement companies, the stickiness of the customers to using the cement of any particular company is low because there are hardly any problems faced by the customer when she switches from the cement of one manufacturer to another.

The key challenge faced by the cement companies of low customer stickiness due to commodity/undifferentiated product is a global issue. Cement companies in India as well as overseas face the same challenges.

Rating guidelines for the cement industry by the credit rating agency, Rating and Investment Information, Inc., Japan, August 2019 (click here), page 1:

product differentiation is almost impossible and customer continuity is relatively low

Rating guidelines for the cement industry by Japan Credit Rating Agency, July 2011 (click here), page 2:

cement products are difficult to differentiate from those of competitors and are always exposed to the risk of severe price competition.

Therefore, an investor would notice that when the product is similar across all the manufacturers, then the consumer tends to prefer the product that is priced cheaper. As a result, in the cement industry, the competition is primarily based on pricing.

Rating guidelines for cement industry by ICRA, August 2019 (Click here), page 3:

Cement being a commodity item does not allow much premium pricing and thus most manufacturers are price takers in the markets they operate in.

Therefore, an investor would appreciate that in the cement industry, once a customer has decided on purchasing a grade of cement, then the product across different manufacturers is almost the same and the customer decides based on the lowest price offered in the market.

2) Cyclical nature of cement industry: boom and bust phases:

The cement industry frequently goes through boom and bust phases i.e. periods of good performance and poor performance.

Rating guidelines for cement industry by ICRA, January 2013 (click here), page 1:

Cement, like other commodities, exhibits strong cyclicality in volume offtake and price realisations.

When an investor analyses the reasons for the cyclical performance of the cement industry, then she finds many reasons for the same.

2.1) Cyclical performance of the end-user industries:

The major consumers of cement are the housing and construction (infrastructure) industry. An investor would note that both housing, as well as infrastructure industry, are cyclical in nature.

The housing industry is prominent for its alternate phases of strong and poor demand.

Rating guidelines for building material industry by S&P, December 2013 (Click here), page 4:

Real estate markets, particularly in the residential sector, have been subject to boom-and-bust cycles marked by strong demand during an upswing, followed by significant demand declines

On similar lines, the construction/infrastructure sector also witnessed cyclical phases where the capital expenditure by both the govt. as well as private corporates undergo periods of increased spending followed by periods of decreased spending.

FY2009 annual report of Heidelberg Cement India Ltd, page 4:

The industry is cyclical in nature and to a great extent depends on the infrastructure spending by the Government.

Therefore, an investor would notice that the cyclicity of demand from the key end-user industries of housing and construction, contributes to the cyclicity in the performance of the cement industry as well.

2.2) Simultaneous commissioning of new projects by cement companies:

An investor would appreciate that cement companies face alternating periods of high and low demand. As a result, during the high demand phase, many companies announce expansion projects, which take some time to get complete. Thereafter, most of the time, these new projects get commissioned at the same time and create a situation of oversupply, which further increases the cyclicity in the cement industry.

Rating guidelines for cement industry by ICRA, August 2019, page 2:

Given the long gestation period for a greenfield capacity addition, the cyclicality in the sector mainly arises on account of the bunching up of the capacity addition on the supply side

Rating guidelines for cement industry by India Ratings, September 2012 (click here), page 1:

The Indian cement industry is exposed to cyclicality in end-user industries (primarily residential and construction). This is accentuated by bunching of capacity additions, which drives demand supply imbalances.

Apart from cyclicity spreading across many years, the cement industry also faces seasonal variations in demand. The demand for cement goes down during July-September when India faces monsoons. The demand for cement goes up during the festive season and the last quarter of the financial year when different companies and govt. departments rush to utilize their spending budgets.

Rating guidelines for cement industry by India Ratings, September 2012, page 1:

The industry is also affected by seasonality; demand is generally low during the monsoon season and peaks during the festival period and end of financial year (March to April) as government expenditure rises

Further advised reading: How to do Business Analysis of a Company

3) Cost competitiveness is the key in cement manufacturing:

An investor would appreciate that in the industries offering commodity/undifferentiated products, the lowest-cost producer is usually in the most advantageous position. Most of the time, in the long term, the lowest-cost producer decides the market price.

Therefore, in the cement industry, all the players have to continuously work towards reducing their costs as low as possible.

Rating guidelines for cement industry by CARE, May 2020 (Click here), page 3:

As cement is a low-value item, in most cases the pricing is not in the hands of the manufacturers and hence cost control is an important aspect for maximizing profits.

Rating guidelines for cement industry by ICRA, August 2019, page 4:

Given the commoditised nature of cement and market participants being price-takers, profitability of a cement manufacturer is primarily a function of its cost structure and product mix.

A higher operating efficiency leading to a low-cost structure is beneficial to the cement manufacturer across all the phases of the cement industry cycle.

Rating guidelines for cement industry by ICRA, August 2019, pages 3 and 4:

control over operating expenses is essential not only to maintain cost competitiveness and maximise profitability, but also withstand cyclical downturns

since cement is a cyclical industry the profitability of the companies in this industry varies significantly along the cycle. Nevertheless, producers having cost structures better than the industry median level can generally be expected to remain profitable across cycles.

While assessing the cost of cement manufacturers, an investor notices that the major components of the cost are coal/power for heating the kiln, freight/transportation of heavy raw material to the plant and bulky cement to the customers and limestone as a raw material to produce cement.

In order to become cost-effective, cement manufacturers attempt to optimize their expenses on all the three key areas i.e. power & fuel, freight as well as raw material.

3.1) Power & fuel (mainly coal):

Power & fuel is one of the major costs for cement producers. The cement manufacturing process is so much power consuming that the price of cement directly moves with the price of coal.

Rating guidelines for cement industry by India Ratings, September 2012, page 4:

The cost of cement is largely governed by energy costs including that of coal

The high influence of coal prices on the cost of cement production is a global phenomenon. For example, in a developed market like Japan as well, the cost of cement production is dependent on coal prices.

Rating guidelines for the cement industry by Japan Credit Rating Agency, May 2020 (click here), page 2:

Cement manufacturing costs are likely to be affected by coal prices used as fuel.

As per India Ratings, on average, a cement manufacturer spends about 20%-25% of its operating expenses as power & fuel costs.

Rating guidelines for cement industry by CARE, May 2020, page 4:

power and fuel cost is one of the key cost components accounting for about 20%-25% of the operating cost.

Cement companies generally use multiple ways to get coal, like domestic coal, imports or in e-auctions. Directly linkages or long-term supply contracts of coal procurement are much better than e-auction or order based imports. E-auctions and imports expose the cement companies to global coal price fluctuations.

Rating guidelines for cement industry by CARE, May 2020, page 3:

Cement companies with firm domestic coal linkages are in a better position when compared with companies whose reliance on imports and e-auctions are more

Rating guidelines for cement industry by CRISIL, February 2021 (click here), page 9:

Entities with established coal linkages are less exposed to volatility in international coal prices. Procurement of coal mix (domestic, e-auction and imported coal) is also analysed. Entities with greater reliance on imported or e-auction coal are at a disadvantage because of higher prices.

Companies depend a lot on coal for producing heat during the cement manufacturing process because it is much cheaper than using electricity from the grid for thermal power.

Rating guidelines for cement industry by ICRA, May 2017 (click here), page 9:

full cost of producing thermal power based on either domestic or imported coal is substantially lower than grid power

Rating guidelines for cement industry by CARE, May 2020, page 3:

Cost of captive power can be much lower than grid power if such a plant is working on low cost and easily available fuels.

Nevertheless, the dependence of cement manufacturers on coal to heat the kiln in cement manufacturing is so much that a reliable and cheap arrangement to get coal is one of the major barriers to entry for new players in cement manufacturing. Companies with established coal procurement contracts are able to save about 15-20% in their fuel costs, which creates a huge difference in an industry where the companies need to be as cost-efficient as possible.

Rating guidelines for cement industry by India Ratings, September 2012, pages 3 and 4:

The need for uninterrupted access to sources of fuel or resources for generation of captive power, driven mostly by availability of coal from CIL, creates a further barrier to entry of new players.

Strong companies with captive power facility backed by coal links (or long-term coal import contracts) incur 15%-20% less cost on fuel per unit of production than the median players.

In order to reduce their dependence on coal, cement companies attempt to use multiple alternate sources of fuel including renewable power.

Rating guidelines for cement industry by CARE, May 2020, page 4:

Companies using alternative fuels like rice husk, groundnut husk, chemical waste, etc., for kiln firing and captive power generation are at an advantageous position.

Rating guidelines for cement industry by ICRA, May 2017, page 3:

using economic sources of power from mini-hydroelectric plants, windfarms and so on, and using alternative fuels (such as lignite, petcoke or agro-waste) that are available locally.

Nevertheless, while assessing the power & fuel costs of any cement company, an investor should note that the burning of most of these fuels is an environmentally sensitive issue and as a result, getting environmental clearances and continued compliance with them remains one of the key regulatory risks for the cement industry.

Rating guidelines for cement industry by India Ratings, September 2012, page 6:

Regulatory Risks: The cement industry is exposed to risks related to regulations governing land acquisition, mining rights and environmental clearances. The risks predominantly affect greenfield projects but brownfield ones are not immune.

Further advised reading: Credit Rating Reports: A Complete Guide for Stock Investors

3.2) Transportation/freight cost i.e. location of cement plants:

Cement is a heavy commodity. It is difficult to sell cement at a place very far away from the manufacturing plant because the high cost of transport makes such sales loss-making. It is for this reason that there is almost nil competition in the cement sector from imports.

On average, freight cost is about 20-25% of a cement company’s operating cost.

Rating guidelines for cement industry by CARE, May 2020, page 4:

Freight cost accounts for about 20%-25% of the operating cost.

As a result, the transportation of cement is limited to about 200-300 km from the plant because usually, beyond that the costs become too much.

Report of Assessing the State Of Competition in Indian Manufacturing Sector: Pesticides and Cement Industries by Project Director – Prof. Manoj Pant (JNU), commissioned by the Competition Commission of India, March 2007 (CCI-2007-Report, click here), page 9:

Cement is essentially a local product and cement transportation via land is generally limited to 200-300 km of any plant site.

Therefore, an investor would appreciate that cement is mostly a regional market with their independent supply and demand scenarios. In India, there are five such regional cement markets: North, South, East, West and Central India.

Rating guidelines for cement industry by CARE, May 2020, page 1:

Cement, being a low-value, bulky commodity, is unviable to transport across the country due to high logistic costs. Therefore, the domestic cement industry is divided into five geographical regions, viz., North, South, East, West and Central, each region characterized by its own demand – supply dynamics.

However, within these regional markets as well, the cement companies face high logistical challenges because the places where key raw materials (e.g. limestone) are found and the places where most of the cement is consumed (major cities) are usually far away from each other.

Rating guidelines for cement industry by ICRA, August 2019, page 3:

bulk of India’s cement production capacity is concentrated in a few clusters, which are essentially regions where limestone is widely available, however, the major consumption centres are often states that are far away from these production centres.

To counter these challenges, many cement plants break the steps of the cement manufacturing process and complete them at different locations. An investor may note that in cement manufacturing; first, limestone & other raw material are converted into clinkers (called clinkerization). These clinkers are then further processed to make cement (called grinding).

Transporting cement requires special packaging because if it becomes wet during transit, then the cement sets i.e. becomes hard blocks of stone and becomes useless. Whereas clinkers do not need any special packaging and can be moved around in uncovered containers.

Therefore, instead of making cement near the limestone mines, cement companies make clinkers and then transport those clinkers to grinding units near consumption centres. This reduced transportation costs. As a result, many times, making these split-location plants is more cost-efficient than making a single location integrated cement plant.

Rating guidelines for cement industry by CARE, May 2020, pages 2 and 3:

Companies also have split location plants whereby clinkerization plants are near to limestone reserves and grinding units are in proximity of end-user market…By adopting this strategy, companies can minimize freight costs (clinker can be transported in open wagons thereby reducing freight cost).

companies having either split location plants or plants spread across geography especially in cement-deficit states are in a more advantageous position compared with others.

Even in the case of integrated cement plants, the plants located near the consumption centres are better because, they have to transport finished cement, which requires special packing, over a small distance and in turn, save on freight costs. On the contrary, the plants located near limestone clusters have to transport finished cement in water-proof packing over long distances; therefore, incur higher transport costs.

Rating guidelines for cement industry by ICRA, January 2013 (click here), page 2:

ICRA favourably views plants that are located close to the major consumption centres and away from the major production clusters as they are likely to enjoy higher naked realisations and hence profitability over the long term on the strength of lower freight expenses.

Moreover, the plants located near the limestone clusters tend to face more competition because; these locations are a hotspot for new cement plants due to the easy availability of raw material.

Rating guidelines for cement industry by ICRA, January 2013, page 2:

Moreover, plants located within the clusters are also more vulnerable to competition in the longer term as the ready availability of raw materials in these regions offers opportunities for greenfield/brownfield expansion.

As a result, split plants seem to be better placed, followed by integrated plants near the consumption centres over the integrated plants located away from consumption centres & near the limestone reserves.

3.3) Raw material/product mix of cement companies:

The third major component of the cost of cement manufacturing is the raw material, primarily limestone. Cement manufacturers usually get limestone in the form of mining access to limestone mines.

An investor would note that mining rights are allotted by govt. and the allotment process as such creates a barrier to entry for newer players. Moreover, the govt. charges royalty and lease rent on limestone mining. Therefore, cement companies continuously attempt to find out an alternative to limestone, which can reduce the quantity of limestone in cement production.

The cement industry has found many alternative products, which are waste products for other industries; but prove very beneficial for cement companies. Some of these products are fly-ash produced by thermal power plants, slag produced by steel plants.

An investor may note that the cement made with the addition of these alternative materials like fly-ash, slag etc. is called blended cement and has further many types like Portland Pozzolana Cement (PPC), Portland Slag Cement (PSC) & Portland Blast Furnace Slag Cement (PBFSC). On the contrary, the cement manufactured without the addition of these alternative materials i.e. unblended cement is called Ordinary Portland Cement (OPC).

An investor would appreciate that the waste products like fly-ash, slag etc. cost less than limestone. Therefore, producing blended cement is cheaper than producing Ordinary Portland Cement (OPC).

Rating guidelines for cement industry by CRISIL, February 2021, page 9:

India has transitioned into a blended cement market that accounts for 80-85% of the total cement production. This shift could be advantageous as blended cement not only conserves valuable limestone resources but also reduces the fixed cost associated with power and freight, thus significantly improving cost competitiveness.

Rating guidelines for cement industry by ICRA, August 2019, page 2:

PPC allows a manufacturer to produce more cement using the same amount of limestone and clinkerisation capacities

An investor may note that the trend of cement companies using the waste products of other industries is an established practice globally to reduce costs as well as to make cement plants more sustainable.

In developed countries like Japan where consumption of cement is in a long-term downtrend for the last 3-decades, the cement companies earn a substantial fee for consuming waste material and making protecting themselves from closure.

Rating guidelines for cement industry by Japan Credit Rating Agency, May 2020, pages 2 and 3:

Together with processing the cost cut, cement companies makes fees for waste and byproducts into raw materials and fuel for cement into one of the large source of earnings.

some cement plants also support local economy and act as waste treatment plants for their communities, and they cannot easily be shut down.

Rating guidelines for the cement industry by the credit rating agency, Rating and Investment Information, Inc., Japan, August 2019, page 3:

other wastes and by-products such as sludge, surplus soil from construction sites, woodchips and waste plastic are also being used as a partial source of raw materials and fuels for cement manufacture. Not only does this help lower the cost of raw materials and fuels, the processing fees received underpin cement manufacturers’ profits.

Therefore, an investor would note that cement being an industry with undifferentiated, commodity products with low customer retention and being a price-taker has to continuously find ways to lower its costs.

The pressure to be highly efficient in operations is so much that inefficient cement producers are not able to survive. Factors leading to a lower cost of production of cement are the most essential barriers to entry for the cement industry. If a company has a long-term lease/tie-up to access coal and limestone and is located near its raw material sources and customers, then it has strong barriers to entry of competitors within its region.

CCI-2007-report, page 38:

The possible barriers to new entrants are the raw material (limestone reserves, gypsum etc. for lease), availability of coal, which accounts for 15-20% of the cost.

Rating guidelines for cement industry by India Ratings, September 2012, page 3:

Reductions in freight costs due to location give a long-term competitive advantage to companies and act as a natural barrier to entry for new competition.

Advised reading: How to do Business Analysis of Thermal Power Plants

3.4) Economies of scale in cement manufacturing:

An investor would appreciate that in commodity industries, one way to decrease the cost of production is to create a large manufacturing capacity, which helps in operating leverage i.e. spreads the fixed costs over a large amount of production. This, in turn, reduces the per-unit cost of production.

Over time, the cement industry has also evolved into a place that is dominated by large players who have an advantage in terms of benefits of economies of scale and therefore, more efficient operations.

Rating guidelines for cement industry by CARE, May 2020, pages 2 and 3:

Large cement plants enjoy better economies of scales with respect to the operational costs and overheads.

Therefore, an investor notices that in India as well as in the global cement markets, there has been a lot of consolidation where a few large players control a bulk of the cement production. The main reason for the same is that the larger players are more efficient in controlling their costs due to operating leverage as well as comparatively better bargaining power with suppliers & customers.

In India, the top 20 companies controlled about 70% of the cement production capacity of the country.

FY2021 annual report of Heidelberg Cement India Ltd, page 64:

Also, the top 20 companies account for more than 70% of the country’s capacity / markets.

In contrast, in developed countries like Japan, the industry is more concentrated where the top three companies generate about 80% of Japan’s cement sales.

Rating guidelines for the cement industry by the credit rating agency, Rating and Investment Information, Inc., Japan, August 2019, page 2:

oligopoly prevails in which the three leading companies have captured a sales share of roughly 80%

Therefore, it seems that in India, the phase of consolidation would continue further due to the benefits that large companies get in their operating efficiencies.

The economies of scale benefits are further enhanced when cement companies have plants, which are spread across the different regional cement markets in the country. This is because; due to regional demand-supply dynamics, the company can sustain difficult business circumstances in some of the regions better if other regions are doing well.

Rating guidelines for cement industry by India Ratings, September 2012, page 3:

India Ratings considers geographical diversification an important rating factor… mitigate the effects of a decline in construction activity in a particular region

Many times, cement manufacturers enter into forward integration to establish ready-mixed concrete units; however, most of the time are loss-making or very low profit-making units. They usually only help as the selling avenue for the core cement manufacturing units of these companies.

Rating guidelines for building material industry by S&P, December 2013, page 12:

ready-mix concrete is typically a low- or sometimes negative-margin business, but it can increase the market penetration of a vertically integrated company’s higher-margin cement sales.

Many times, cement companies enter into manufacturing of specialized cement, like oil well cement, railway sleeper cement, and sulphate resistant cement. These cement products even though being high margin products; however, have smaller markets.

Rating guidelines for cement industry by ICRA, January 2013, page 2:

ICRA views favourably companies with a demonstrated ability to develop and promote…special products such as oil well cement, railway sleeper cement, and sulphate resistant cement. Although the offtake of the special products is limited, they usually offer significantly higher margins

Nevertheless, an investor would note that managing operations efficiently is essential in the cement industry otherwise, due to intense price-based competition, it becomes difficult for companies to generate profits.

Let us see an example of a real-life cement company, which could not manage its operations efficiently. As a result, its cement division became near-bankrupt and it had to sell off the cement division.

3.5) Real life example of an inefficient cement producer: Century Textile and Industries Ltd:

While analysing Century Textile and Industries Ltd, we noticed that out of its different divisions i.e. cement, textiles, paper, and real estate division; the cement division was run very inefficiently. The cement division of the company was reporting an EBITDA margin, which was very low when compared to the peers. As a result, the cement division of Century Textile and Industries Ltd reached a stage where it could not repay its debt. As a result, the company had to sell it off.

During the conference call in May 2018, while discussing the demerger of the cement unit, the management of Century Textiles & Industries Ltd highlighted that the cement operations of the company are highly inefficient. The management said that in FY2018, the cement unit has an EBITDA per tonne of ₹367/-, which is below the industry average.

Conference call, May 2018, page 2:

Moreover, the profitability of cement division is currently not comparable to the industry average. For the year ended March 31, 2018 it has achieved revenue of Rs. 4306 crore and EBITDA of Rs. 544 crores, which includes net one-time gain of Rs. 51 crore. This translates to EBITDA per ton of around 367 based on the capacity and after adjusting for one-time gain.

When an investor compares EBITDA per tonne of Century Textiles & Industries Ltd with other cement manufacturers in its regions, then she notices that the performance of ₹367 per tonne is very low.

A competitor of the company, Heidelberg Cement India Ltd had an EBITDA per tonne of more than double of Century Textiles & Industries Ltd. In FY2018, Heidelberg Cement India Ltd reported an EBITDA per tonne of ₹781 against the EBITDA per tonne of ₹367 of the cement division of Century Textiles & Industries Ltd. Moreover, the EBITDA per tonne of Heidelberg Cement India Ltd is continuously on the rise, which had reached ₹1,108 in 9M-FY2020.

Credit rating report of Heidelberg Cement India Ltd prepared by India Ratings in March 2020:

The company has gradually increased its EBITDA/tonne to INR1,108 in 9MFY20 (FY19: INR987; FY18: INR781) mainly due to increased sales realisation…

You may read the complete analysis of Heidelberg Cement India Ltd in the following article: Analysis: Heidelberg Cement India Ltd

While analysing the business of Century Textiles & Industries Ltd and the responses of the management in the conference call, an investor notices some of the decisions by the company that make the investor think further.

The management clarified that even though it had put up a significant 2.8 MTPA new cement capacity at Manikgarh, Maharashtra, the region has immense competition with low demand. About 2.0 MTPA of cement capacity is already shut-down. The management highlighted that even if they increase the production of cement in the Manikgarh plant, then they do not know how to sell it.

Conference call, May 2018, page 8:

Management: I will just come to the power efficiency, but basically demand is also not there in that area. There is huge competitive intensity in that area and we are not able to sell that. That is why that utilization level is low.

Conference call, May 2018, page 7:

Management: It is not 2 million it is 1.2 million ton. Presently there is a very limited market potential in that area and we are operating at only 64% capacity. 2-million plant capacity is non operational since last 3-4 years because there is no market available. Other than that the plant is also cost ineffective at that location

From the above statement, an investor thinks whether it was the right decision to put ₹1,600 cr of additional capital in the Manikgarh, Maharashtra region to create capacity when the company is not able to sell the cement in the region.

In addition, the company highlighted that the cement plant established in West Bengal does not have any consistent economical source of clinker. As a result, it has to send clinker from Maharashtra to West Bengal, almost halfway across the country, so that the West Bengal plant can produce cement. This transportation of clinker over long-distance increases the cost of cement production and in turn reduces the profitability (EBITDA per tonne).

Conference call, May 2018, page 17:

Gunjan Prithyani: I just have one clarification there is this grinding unit in West Bengal from where was you feeding the clinker to that grinding unit?

Management: So in that grinding unit clinker was largely getting supplied from Manikgarh unit incurring a huge logistic cost.

An investor would appreciate that the high transport cost of sending clinker from Maharashtra to West Bengal has hurt the company a lot. The end result of all the business decisions in the cement division was that in FY2018, Century Textiles & Industries Ltd had less than half of the EBITDA per tonne than its competitors. As a result, it landed up in a situation where it could not service its debt from its cash generation.

The credit rating report of Century Textiles & Industries Ltd by CRISIL, February 2019:

While the repayment obligations came down with debt reduction post Grasim transaction, the annual cash generation, is not expected to be sufficient to service the obligations in fiscal 2019.

As a result, it does not come as a surprise to the investor when she reads that Century Textiles & Industries Ltd had to sell its cement division, which was completed in Oct. 2019.

FY2020-Q3 results, page 2:

The Scheme of Demerger between the Company and UltraTech Cement Limited…was approved by the National Company Law Tribunal (NCLT) on July 3, 2019…the Scheme became effective on October 1, 2019

Therefore, an investor would note that in-efficient cement producers are not able to survive in the highly competitive cement industry.

An investor may read our detailed analysis of Century Textiles & Industries Ltd along with its cement division in the following article: Analysis: Century Textiles & Industries Ltd

Further advised reading: When a company should sell all assets and invest money in FDs?

4) Capital intensive nature of cement industry:

Creating a cement manufacturing plant demand a large sum of money. As a result, globally, the cement industry has proved to be a very capital intensive business.

Rating guidelines for cement industry by ICRA, August 2019, page 5:

cement industry is highly fixed capital intensive in nature and the companies that pursue an aggressive financial policy, including heavy reliance on debt financing, are likely to be more vulnerable to cyclical downturns

Rating guidelines for building material industry by S&P, December 2013, page 4:

The building materials and products industry is moderately capital-intensive (high in some subsectors like cement), and ongoing investment in efficient production is often necessary to maintain a company’s cost position.

A large amount of capital required to establish a cement manufacturing plant acts as an entry barrier for the new players.

Rating guidelines for building material industry by S&P, December 2013, page 4:

Barriers to entry are high across the sector. Materials companies (aggregates, cement, concrete) are often subject to lengthy and stringent permitting requirements and very large investments in plant and equipment.

Moreover, an investor would appreciate that in a cost-competitive industry, a company needs to keep upgrading its plants to maintain its cost-efficiency. Old plants over time, lose their cost competitiveness as newer plants with the latest technologically advancements bring higher efficiencies in consumption of raw material as well as fuel/power.

Rating guidelines for cement industry by ICRA, February 2019, page 4:

older plant enjoys the advantage of lower capital cost, such benefit is usually offset by higher power and fuel costs, significant repair and maintenance expenses, and generally higher manpower expenses.

As a result, cement companies need to continuously keep investing money in their plants for maintenance and upgradation.

For example, in the past, most of the cement plants used to produce cement using the wet process. The wet process was energy-intensive and thus cost-ineffective. Thereafter, the newer plants started using the dry process of cement manufacturing, which is cost-efficient. As a result, most of the old plants had to invest money to shift to the dry process of cement manufacturing.

Rating guidelines for cement industry by CARE, May 2020, page 3:

Older cement plants were initially based on wet process but the modern plants invariably adopt the dry process…The dry process is superior in terms of fuel economy and is cost efficient and therefore is widely used. Majority of the older wet process plants have moved to dry process

In many cases, the old plants may need such a large investment for upgradation that the companies owning them may prefer to shut them instead of making large investments.

For example, in the case of Century Textiles & Industries Ltd, an investor notices that many cement plants of the company were very old and inefficient. The company had kept these plants shut instead of spending money to upgrade them.

The company highlighted that the old plant at Manikgarh, Maharashtra of about 2 MTPA capacity is currently shut down as it is highly inefficient and is effectively an economically unviable plant.

Conference call, May 2018, page 8:

Rajesh Shah: Out of the existing capacity of 4.8 million tonnes at Manikgarh, 2 million is the old capacity and shutdown. It’s an old plant and it has lot of inefficiencies relating to power consumption, heat consumption and to upgrade that it needs a huge investment.

Similarly, another cement plant of the company in Chhattisgarh is very old and is nearing the end of its life. As a result, an investor would appreciate that the plant would have many inefficiencies in its operations.

Conference call, May 2018, page 8:

Management: Again about the Chhattisgarh Plant that is the oldest plant that is a 44 year old plant. And the current life of the plant left is around 6-7 years’ time and maybe after 7 years it need complete new line will have to be put up so that will again call for huge investment…

In light of the huge amount of investment required in the old plants, the company preferred to sell them off and exit the cement business instead of making more investments.

Therefore, an investor would appreciate that the initial large capital investment to install cement plants, as well as continued mandatory investments, need to maintain and upgrade old cement plants makes the cement sector very capital-intensive. No wonder the capital intensive nature of the industry acts as a barrier to entry for the new players.

Further advised reading: Operating Performance Analysis: A Simple & Complete Guide

5) Price fixing/cartel formation in the cement industry:

From the above discussion, an investor would remember that cement players make an undifferentiated, commodity product where the stickiness of the customer is low and she can easily switch from the cement of one company to another. As a result, in the cement industry, there is a lot of price-based competition.

An investor would note that in the situation of price-based competition, all the players would attempt to maximize their production capacity so that they may benefit from operating leverage and produce cement at the lowest per-unit cost of production. Only when the players maximize production, then they would be able to achieve the lowest cost and perform better than other cement players.

The urgency to run cement plants at a high utilization level is so high that in markets like Japan, during the downturn, to control their costs, companies shut down a part of their production capacity so that whatever remaining production capacity is running, works at decent utilization levels.

Rating guidelines for cement industry by Japan Credit Rating Agency, May 2020, page 2:

When demand for cement decreases, companies close their plants or stop their kilns to prevent a decline in plant utilization ratio.

Rating guidelines for the cement industry by Japan Credit Rating Agency, July 2011, page 2:

If supply becomes excessive, then, production must be adjusted to maintain prices.

However, in sharp contrast, while analysing the cement manufacturing capacity and production data of India over the last 10-years (FY2011-FY2021), an investor gets to know that the capacity utilization of the cement industry has continuously been low in the 60s.

(Source for production data: Statista; Source for manufacturing capacity data: Annual reports of Heidelberg Cement India Ltd and IBEF)

Looking at such a low capacity utilization of cement plants, an investor would expect that either the companies would close down a part of their capacities or at least avoid adding new capacities so that the demand for cement may catch up and their existing plants can run at high utilization levels.

However, an investor is surprised to notice that despite a low capacity utilization, the cement industry has been continuously adding capacity year after year.

This comes as a sharp contrast to the common assumption that any industry usually adds capacity when the utilization levels increase to a high level. Then why is it that the cement industry is continuously adding capacities despite low capacity utilization levels?

An investor would appreciate that more capacity additions in an industry, which is facing an oversupply will further erode the pricing power of the manufacturers. Therefore, in a normal market, it is in the favour of the suppliers to use their existing capacities fully before they resort to capacity addition.

Another normal market practice, which usually occurs in commodity industries with large unutilized capacities is that the manufacturers attempt to run their plants at a utilization level, produce a lot of goods, carry a high inventory and give a higher credit period to the customers in order to increase their sales. Effectively, such industries are working capital intensive.

However, in the case of cement manufacturers, the companies carry limited inventory and most of the time, the receivables days are also under control. As per ICRA, the cement industry, even though is fixed capital intensive, is not working capital intensive.

Rating guidelines for cement industry by ICRA, February 2019, page 5:

cement industry is not significantly working capital intensive as the inventory levels and the credit period to the dealers is generally limited.

Further advised reading: Receivable Days: A Complete Guide

However, an investor would notice that in the cement industry, these normal market assumptions have not worked.

The failure of normal market forces of supply and demand and their impact on the price of cement was noticed many years back by the Builder Association of India (BAI), which primarily consisted of the consumers of the cement industry. When BAI noticed that despite significant underutilized capacity, the cement manufacturers are not producing cement in sufficient quantities. As a result, there was an artificial shortage situation for cement in the market, which has led to an increase in the price of cement.

Therefore, the BAI complained against the cement industry to the Competition Commission of India (CCI) about the cement manufacturers acting as a cartel by producing a lower amount of cement and keeping the prices higher. CCI asked the Director General (DG) to conduct an investigation. After the investigation, CCI found that indeed, the cement manufacturers were coordinating with each other to restrict supply and keep the prices higher.

As a result, CCI held the cement companies guilty of acting in collaboration with each other to distort the market and in turn hurt the consumers, the market, and the economy. CCI put a steep penalty of about ₹6,700 cr on various cement manufacturers as well as their industry body, Cement Manufacturers’ Association (CMA). CMA was held guilty of providing the platform where the cement players met and coordinated their production and pricing strategies in order to keep the prices higher.

Competition Commission of India order on the Cement Manufacturers:

The CCI order on August 31, 2016, downloadable from the CCI website (click here) is very interesting reading. We have incorporated the key aspects from the order below, as the order is a very important resource to understand the cement industry and its dynamics.

Key aspects of the complaint by the Builders’ Association of India (BAI):

• Page 10: Cement manufacturing units had deliberately reduced their production and produced much less than their installed capacity to create an artificial scarcity and raise the prices of cement in order to earn abnormal profits.

Key findings of the investigation conducted by the Director General (DG)

• Page 22: The nature of product being almost homogeneous in nature facilitates oligopolistic pricing. Further, the cement industry has witnessed a lot of consolidation and concentration of market in the last decade. However, in terms of market power, none of the companies has the strength to operate independently. The DG has submitted that the price of cement charged by all the companies is not at competitive levels and the cement manufacturers have been operating at a profit margin of more than 25%.
• Page 22: there has been a continuous divergence between the cement price index and the index price of various inputs like coal, electricity and crude petroleum and the gap has widened since 2000-01. The price of cement is rising faster than input prices.
• Page 23: It has been noted by the DG that the price of cement has been on rise since 2004-05 from about Rs.150/- per bag to close to Rs.300/- in March 2011, whereas during the same period, the cost of sales has only increased about 30%. As such, the price of cement has been independent of the cost of sales. The price of cement is changed frequently by all the companies. Sometimes, the price changes are made twice a week.
• Page 27: The Opposite Parties were not able to substantiate reasons for low capacity utilisation even during the period when the demand was high.
• Page 27: According to the DG, reduction in capacity utilisation is not in line with the overall growth of Indian Economy. Further, as far as consumption is concerned, whatever is produced by the cement manufacturers is consumed in the market. Therefore, the argument of cement manufacturers that the capacity utilisation has been lower in recent years because of low demand is not tenable.
• Page 29: Hence, the DG has concluded that the reduction in capacity utilisation during 2009-10 and 2010-11 was deliberate in order to limit the supply of cement in a concerted manner to charge a higher price.
• The DG, during the investigation found instances where the prices of cement were increased after the cement manufacturers met in their industry body (CMA) meetings. Page 106:

Key parts of the order by CCI:

• Page 144: The Commission notes that evidently the growth rate in production lagged substantially in 2010-11 as against the growth rate of capacity additions. Installed capacity witnessed an increase in growth rate by 16.06%, but the production grew marginally by 2.85% only. In comparison, in the year 2009-10, the growth rate in capacity addition was 19.80% and growth rate in production was 12.87%.
• Page 151: From the data tabulated above, it is evident that during November 2010, all the cement companies including the Opposite Parties had reduced production, although in 2009, in some cases, there was drop in production and in many cases there was increase also.
• Page 161: The Commission further observes that the third and fourth quarter of 2010-11 witnessed a GDP growth rate of 8.3% and 7.8% at factor cost respectively and the construction industry witnessed a growth of 9.7% and 8.2% in Q3 and Q4 of 2010-11 respectively. However, the cement industry registered a negative growth rate of 5.43% and 3.41% in cement production in November and December of 2010-11, respectively.
• Page 161: Thus, the Commission observes that the cement companies reduced production and dispatches of cement in a period when the demand from the construction sector was positive during November and December, 2010 and thereafter raised prices in the months of January and February, 2011,
• Page 161: Thus, it is evident that the cement companies have been limiting and controlling supply in periods just before the peak demand season to create artificial scarcity in the market in order to sell cement at higher prices in the peak season.

As a result, the CCI observed that:

• Page 175: The Commission notes that the impugned action of the Opposite Parties was not only detrimental to the interests of the consumers but the Opposite Parties also earned huge profit margins by acting in concert and co-ordination upon prices, production and supplies. Such conduct deprives not only the consumers but the economy also from exploiting the optimal capacity utilisation and thereby reducing prices. Further, the act of the Opposite Parties is also detrimental to the whole economy since cement is a critical input in construction and infrastructure industry vital for economic development of the country.

From the above order of CCI on the cartelization of the cement industry, an investor notices that:

• The cement manufacturers reduced production even when there was a demand. After all, whatever they were producing was getting completely sold in the market.
• Cement manufacturers reduced cement production even at times when the Indian GDP, as well as the construction industry, was growing at a fast pace.

The cement companies appealed against the CCI order in National Company Law Appellate Tribunal (NCLAT). However, the NCLAT dismissed their appeal in July 2018. (Source: Cement firms lose cartel case: The Telegraph).

Currently, the cement companies have appealed against the CCI order in the Supreme Court of India (Source: SC stays CCI penalty of ₹6300 crore on cement firms: Livemint)

Investors would notice that the CCI order explains the unique situation observed in the cement industry where there was continuously a low capacity utilization. However, still, the cement manufacturers were adding new capacities. This goes against the normal market behaviour where any company first attempts to utilize its existing manufacturing capacities fully before it puts up a new manufacturing plant.

Moreover, when an investor looks at the history of the cement industry across different countries, then she notices that almost everywhere the cement industry has created cartels and done price-fixing and as a result, the industry has been penalized heavily for its anti-competitive behaviour.

Germany:

• Bundeskartellamt imposes fines totalling 660 million Euro on companies in the cement sector on account of cartel agreements, 2003.
• The German cement cartel – a landmark decision for private damages actions, 2018

China:

• China fines three cement makers $18.6 million for price fixing, 2014

Taiwan:

• Cement cartel fined NT$210m by FTC for anti-competitive trade, 2005
• Far Eastern New Century, Asia Cement fined in China (update), 2021

Romania:

• Romanian Competition Council fines cement cartel members EUR 27 million, 2005

Therefore, an investor would note that price-fixing and cartelization by cement companies is a global phenomenon where almost all the countries are struggling to keep the cement cartels under check.

In fact, the cartelization and price-fixing are so normal that the credit rating agencies consider it a positive factor while rating cement companies because the cartelization helps in coordination of production volumes (control of cement supply) and pricing strategy (does not let cement prices fall).

As per CRISIL, in the cement industry, the companies operating in areas of oversupply can run their operations profitably by developing cohesiveness, production sharing and pricing discipline. Therefore, CRISIL takes a favourable view a few large players dominate the production.

Rating guidelines for cement industry by CRISIL, February 2021, page 8:

…profitable operations are possible even in surplus scenario if there is production sharing or pricing discipline… So, while analysing plants in regions with surplus, CRISIL Ratings takes a favourable view if the region is dominated by a few large players as it is easier to develop cohesiveness among a few players than among many.

The rating agency, ICRA, has also acknowledged that as the consolidation in the cement industry has increased, it has witnessed supply rationalization. Also, now, the cement prices do not drop much despite oversupply.

Rating guidelines for cement industry by ICRA, February 2019, page 2:

Such consolidation has also brought in a degree of supply rationalisation among manufacturers. As a result, cement prices tend to be steady despite significant supply pressures over the past few years. Thus, while rating a cement manufacturer, ICRA also takes into consideration the degree of consolidation that exists in the region(s) concerned, as that determines the extent of supply rationalisation and the intensity of pricing pressures.

Rating guidelines for building material industry by S&P, December 2013, page 5:

operating profit margins for most building materials companies have been fairly stable. This, we believe, is because the industry is relatively concentrated among a small number of producers, which leads to fairly rational pricing and competition in most segments.

In India, the Competition Commission of India had commissioned a study to access the state of competition in the cement sector by Professor Manoj Pant of JNU, which submitted its report in March 2007 (click here). The report had a few important observations.

• P34: There is huge difference between capacity installation and capacity utilization with the capacity utilization much below than installed capacity.
• P43: Despite wide variations in margins, prices tend to lie between Rs. 1800-2200 per ton. In other words firms with 0 to 10 percent margins charge the same price as those with margins above 30 percent. A similar story is observed in the case of PPC grade cement. Such price fixation (if done by covert or overt agreement) would be construed as anti-competitive under Section 3(3)(a) of the Competition Act.
• P45: Cement industry is dominated by a few big companies and is patently cartelised…anti-competitive cartelisation is more clearly established in the Cement industry.

Therefore, an investor would appreciate that the CCI had been observing the presence of anti-competitive cartels in the cement industry for a long and imposed a heavy penalty when it received a complaint from the Builders’ Association of India about price-fixing by cement companies.

An investor would appreciate that the intention of the regulatory action by CCI and the penalty of about ₹6,700 cr put by it on the cement manufacturers is to break their cartel. The message from CCI to the cement manufacturers and their industry body, CMA, is to follow normal market behaviour where different players attempt to maximize their production even if they have to give discounts to the customers to sell higher volumes. If CCI/the govt. were able to succeed, then an investor would appreciate that the supply of cement would increase and the prices of cement may decline.

In markets like Japan, the markets and govt. seem to have succeeded in breaking the cement cartelization as currently, the cement players do not seem to have the power to do price-fixing.

Rating guidelines for the cement industry by the credit rating agency, Rating and Investment Information, Inc., Japan, August 2019, page 2:

cement manufacturers have been unable to demonstrate power to control selling prices to the downstream ready-mixed concrete industry.

Therefore, in India, the current cement prices and thereby the profit margins and the return ratios of cement companies may seem inflated to the extent of price-fixing done by the companies. If the cement companies follow normal market practices and increase production to achieve high plant utilization levels and quote lower prices to sell as much cement as they can, then the prices of cement in the market are expected to go down.

Considering the 66% capacity utilization of the cement industry in FY2021, an investor can understand that the cement production can increase to 1.5 times of the current production without any additional investment in the industry only by making the cement manufacturers follow the fair market principles.

The resultant reduction in the selling price of cement will affect all the players in the industry. The current high operating profit margins of cement manufacturers may not be sustainable in the normal market scenario.

Therefore, an investor should keep a close watch on the developments related to the appeal of the cement manufacturers in the Supreme Court of India. In addition, she should keep a close watch on the signs of the return of the fair market principles in the cement industry like:

• Cement manufacturers trying to offer discounts to the customers in order to fully utilize their installed cement capacity.
• Cement manufacturers installing new capacities only after their existing capacities are fully utilized.

It is important to monitor these dynamics. This is because a return of fair market principles in the cement industry would lead to a sharp increase in the supply of cement along with a possible decline in its prices.

6) Competition from overseas cement manufacturers:

An investor would remember from the above discussion that cement is a bulky commodity, which cannot be transported over long distances because the high transportation costs make such sales economically unviable. As a result, the cement industry is not threatened by imports.

Rating guidelines for cement industry by CRISIL, February 2021, page 8:

High freight costs make sustained imports unviable.

However, the non-viability of competition from imports does not mean that the cement industry is protected from competition from overseas cement manufacturers. In the cement industry, overseas cement manufacturers create competition in the country by establishing their manufacturing plants within India either by installing new plants or by buying out existing cement companies and increasing their capacities.

Such competition from overseas cement manufacturers is going to intensify in the future because; in many developed markets like Japan, the consumption of cement is in a declining trend. For the cement companies of developed countries in areas like Europe, Japan etc., the cement markets of emerging countries like India offer a lot more profitability.

Rating guidelines for the cement industry by Japan Credit Rating Agency, July 2011, page 4:

overseas expansion is a must if Japanese cement makers are to find new demand to offset the shrinking domestic market…Overseas businesses have a brighter sales outlook than their domestic counterparts. Large cement companies in overseas markets are highly profitable.

Rating guidelines for building material industry by S&P, December 2013, page 12:

during the up cycle, certain cement manufactures can earn in excess of 40% EBITDA margins in some emerging markets, while EBITDA margins might be closer to 20% in mature markets.

Therefore, an investor would appreciate that on an overall basis, the cement players of countries like India would have to face competition from domestic players as well as large global players who seek to grab a share of profitable emerging markets.

You may read our detailed fundamental analysis of some of the cement companies and those with cement divisions below:

• Analysis: Heidelberg Cement India Ltd
• Analysis: Rain Industries Ltd
• Analysis: Century Textiles & Industries Ltd

Summary

The cement industry produces a product, which is a commodity. Cement produced by one producer is not differentiable from another. As a result, a customer can easily switch cement manufacturers without a significant impact on her business. Therefore, in the cement industry, there is a lot of price-based competition.

Under the situations of intense price competition, only the players with the lowest cost of production survive. As a result, all the companies continuously focus on reducing operating costs. The focus is on reducing the major costs like power and fuel by way of assured supply of coal by way of linkages or using alternate fuels. Reducing transportation costs by locating plants near consumption centres or by splitting plants into two parts with clinkerization near limestone reserves and grinding near consumption centres. Reducing raw material costs by blending limestone with waste-products of other industries like fly-ash, slag etc.

Another way of reducing costs is to use operating leverage by increasing the size of operations. Companies acquire other players, announce capacity expansions, go for forward integrations like ready-mix concrete (RMC) units etc.

At the end of the day, the companies aim to become the lowest-cost producer in the industry because, in the long-term, the market price is decided by the lowest-cost producer. Many inefficient cement players shut down or sell off their businesses fearing the large investments in their old plants to upgrade them.

The cement industry is cyclical as its end-user industries like housing and construction/infrastructure are very cyclical in nature. In addition, many cement companies simultaneously announce expansion projects during the upcycle, all of which get completed at the same time leading to an excess supply. This in turn accentuates the cyclical nature of the cement industry.

The cement industry is highly capital intensive with a large amount of capital needed to install a new cement plant. Most of the time, high capital requirements coupled with established fuel and raw material linkages of existing players act as barriers to entry for new players.

Large cement players are usually more cost-efficient than smaller players. As a result, large players tend to focus on becoming larger. This has resulted in an oligopoly situation in the cement industry where a few large companies control the majority of cement production. Such a situation has led to the formation of cartels globally including in India.

The cement cartels control the cement supply and do not let the prices decline even during downturns. At times, the cement companies had reduced supply when the demand was growing, in order to increase prices. Therefore, the Competition Commission of India has put a hefty penalty on cement manufacturers, which is currently under appeal by the companies. In case, the CCI/govt is able to break the cement cartel, then the prices of cement may see moderation.

India is an attractive market for cement players, which shows good profitability. As a result, most of the large global companies have entered India by way of acquiring local players. The cement demand in many developed countries is declining. As a result, overseas companies see emerging markets like India as a key avenue for their growth. Going ahead, competition from such overseas players is anticipated to increase.

Overall, while analysing a cement player an investor should specifically focus on the following points in cement manufacturers:

• Low-cost producers with raw material, fuel and location-based benefits who can survive the price-based competition
• Cost-efficient plants, which run on the latest technological processes
• Financially strong to survive the cyclical downturns
• Sufficiently large size to benefit from economies of scale
• High profitability that can sustain the reduction in case the artificially high cement prices due to cartelization come down.

We have used the following framework to learn about new industries: How to Analyse New Companies in Unknown Industries?

All the best for your investing journey!

Regards,

Dr Vijay Malik

P.S.

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Disclaimer

I, Vijay Malik, am a SEBI-registered Research Analyst (Regn. No. INH100008364). This article is for educational purposes only and does not constitute investment advice or a recommendation to buy or sell any securities. Investors should do their own research before making any investment decisions.

I, or my immediate relatives, do not have any financial interest in the companies discussed as on the date of publication of this article, nor do we hold one per cent or more of the securities of such companies at the end of the month immediately preceding it. I do not have any material conflict of interest and have not received any compensation or other benefits from the companies or any third party in relation to this article during the 12 months preceding its publication. I have not served as an officer, director, or employee of the subject companies, nor have I been engaged in market making activity for them.