The outlook for the Indian cement sector has taken a turn for the worse in recent months. Escalation in fuel and distribution costs and declining flexibility on selling price have taken a toll on the performance of leading cement players. While cement prices rose a marginal 3 per cent last quarter (January-March 2008), coal prices, for instance, spiked 31 per cent. With manufacturers backed into a corner by pressures from the Government on pricing, on the one hand, and rising in put costs, on the other, the earnings outlook has turned sedate for the next few quarters.
Sourcing takes priority
Expenditure on coal accounts for nearly 15 per cent of the total cost structure for cement companies. Coal acts as the fuel agent, firing cement kilns, and also as input in the manufacture of clinker, an intermediary product. The cement industry’s coal consumption has grown at almost 9 per cent annually over the last four years. Coal distribution is completely controlled by Coal India Ltd (CIL, a government undertaking) and its subsidiaries in the country. After the deregulation of coal distribution in 2000, supply of coal has been determined through the allocation of ‘coal linkages’ — an arrangement wherein, on application by a user, CIL allocates coal fields depending on the quality and quantity specified. But the high ash content and shortfalls in allocation of coal have led cement manufacturers to substantially supplement domestic coal with imports.
While this may take care of availability, it has adverse cost implications. Against the global backdrop of rising steel production, increasing number of coal-fired power projects and supply side issues, global thermal coal prices have seen a 120 per cent surge in the last one year; coal prices in Australia’s Newcastle port, a benchmark for Asia, have risen from US$60/t last year to US$134/t currently. Domestic coal prices too have witnessed an increase.
The Coal Ministry’s recent move to reduce supply/linkages (from 100 to 75 per cent) to cement companies has moved manufacturers to procure coal through e-auction at comparatively higher prices. The new coal distribution policy may, however, bring some relief through an assured provision of 75 per cent of the industry’s coal requirements. Coal apart, other raw material costs (limestone, slag, gypsum), accounting for about a fifth of sales, have also witnessed an upward spiral. The cost of gypsum has increased 8 per cent for UltraTech and 12 per cent for ACC.
Captive power gains
The power requirements of the cement industry average around 110-120 kiloWatt hour of power per tonne of cement produced. Reports say that the average energy cost of the industry has increased from Rs 528 a tonne in financial year (FY) 2000 to Rs 581 a tonne in FY 2007. Rising cost of power and interruptions in power supply have moved players to explore captive power generation more actively. In the end of FY 2007, nearly 53 per cent of the total cement production was powered through captive sources. Captive power generation tends to be more cost-effective when based on renewable sources (wind/thermal energy). But of the present captive power generation capacity, diesel generator sets account for almost 65 per cent. DG (diesel generator) sets and coal-fired steam turbines are an assured, but expensive, source of captive power. According to one estimate, while power from the grid usually averages Rs 3/unit, that generated from DG sets cost Rs 5/unit, while that using coal fired steam turbines costs Rs 1.5-2/unit.
The need for dependable supply and improving energy efficiency has spurred many cement manufacturers to commission wind farms. India Cements’ windmills generated 158 lakh units of power last year. ACC also commissioned a 9 MW t wind energy farm in Tamil Nadu to support its plant in Madukkarai, Coimbatore. In 2007, Ambuja Cements commissioned its 60 MW thermal power plant at Ambujanagar. A switch to renewable energy sources and fuel conservation measures could see some improvement on the power expenses front in the years ahead.
Cement being a low-value bulk product, logistics is a big cost component, both by way of transporting the raw materials to the plant and cement to its markets. The higher the lead distance between the coal/limestone mine, grinding unit and the distribution centre, the higher would be the transportation cost.
According to ICRA estimates, freight and distribution expenses as a per cent of cost of sales for the cement companies has increased from 18.4 per cent in 2002 to 24 per cent in 2007. FY 2008 saw freight costs soaring with higher petroleum and diesel prices as well as the increase in the minimum chargeable freight and surcharge by the Railways.
The 2008 Railway Budget’s 14 per cent reduction in freight charges for fly ash, waiver of busy season surcharge on bulk goods and addition of new lines to serve cement clusters in different regions, could bring some relief to cement companies on this front in the coming quarters.
The rise on the cost front was seen to take a toll on the profit of cement companies. The companies (cement) that declared their March quarter results showed a decline of 7 per cent on net profits and operating margins. With regulatory intervention effectively capping any increases in cement prices in the near future, the industry would have to work on cost-cutting measures and higher levels of energy efficiency to protect its margins.
The latest set of financial results from cement companies present clear evidence that the combination of higher raw material cost, skyrocketing coal prices and spiralling distribution costs are beginning to take a toll on profit margins.
There was, however, divergence within the pack. Ambuja Cements saw its adjusted net profits dip by 15 per cent, while ACC’s profits were down by a marginal 3 per cent. The decline can be attributed to the over 22 per cent rise in fuel cost for the companies.
Of the large cement companies that have so far declared numbers, UltraTech Cement has fared relatively better with its concentration in the Western and Southern markets, which has led to stronger growth in demand and higher prices during the quarter. The company registered a 22 per cent rise in net profits and a 300 basis points expansion in operating margins during the quarter ending March 2008 despite the 17 per cent rise in its power and fuel cost. India Cements and Madras Cements in the Southern region are yet to announce their March quarter results. However, the sequential growth in margins is expected to be muted. With regulatory intervention effectively capping any increases in cement prices any time in the near future, the industry would have to work on cost-cutting measures and higher levels of energy efficiency to protect its margins.
With manufacturers pushed into a corner by pressures from the Government on pricing, on the one hand, and rising input costs, on the other, the earnings outlook has turned sedate for the next few quarters.