Cementing Budget Hopes

The Cement industry at is currently in a state of revival, both in terms of demand and price of cement. The industry witnessed subdued demand and lower prices in the first half of FY2012.

The revival in demand and higher prices has lead to strong topline and bottomline growth of cement companies, which are surging on the back of improved spending in the infrastructure and construction sectors. As per the latest GDP data released by the Indian government, the construction sector in Q3 has grown by 7.2% versus that of 4.2 % in the Sept 2011 quarter.

Today, the Indian cement industry is the second largest cement producer in the world, after China. As per the 11th Five Year Plan, the capacity needed to meet the demand was 269 MT. However, faster capacity addition in the last 2 years has resulted in an oversupply situation for the industry. After the consolidation seen in the last 2 years, 45% of the cement production comes from the 3 major companies – ACC, Ambuja Cement (both from the MNC, Holcim Group) and UltraTech Cement.At present, the industry has an installed capacity of 323 MT. Low demand in the first half of FY 2011-12 and an oversupply situation has forced cement players to operate at lower utilisation levels in order to maintain the cement prices. However, the sector has started witnessing some revival in the last one quarter due to a pickup in infrastructure activity, and we believe that cement companies will witness a continuous upside in cement demand and price in the coming months. This also reflects in the stock performance of Cement companies. If we look at the stock performance from the previous Budget announcement till date, the stocks are trading near their 52-week highs.

Industry’s Budget Expectations

Last year, the govt. reduced the custom duty on raw materials such as gypsum and pet coke in order to provide some relief on the input cost side. However, we believe that this has not provided any relief to the companies in terms of cost, as both gypsum and pet coke have lower usage in the industry. In fact, the industry is looking at a cut in the import duty of coal from 5% at present to nil. The cost of coal constitutes 50% of the cost of sales to the company.

In last year’s budget, the govt. increased the excise duty on cement and clinker by increasing the ad volerem rate of 10%, keeping the fixed composite rate attached to it. This added more pressure to companies on the cost side. Earlier, it was a specific rate on a Metric Tonne basis related to the retail sales price of the product. As per the industry, the excise duty structure for cement and clinker has became quite complicated in the last few years. For example, if the retail sale price of cement is more than Rs 190 per bag, and then the excise duty is 10% plus Rs 160 per MT of production. This is causing a lot of confusion for them, which is avoidable. Therefore, the industry is asking the govt. to simplify the duty structure to be based either on a specific rate per MT or on ad volorem, without relating it to the MRP. Besides this, the industry is demanding that the govt. reduce the current excise duty from 10% to 6-8%.

We, at DSIJ, are of the opinion that the govt. will not reduce the excise duty, as the industry is currently doing well in terms of demand and price. Also, with the fiscal deficit widening this year, the govt. would prefer to keep the fiscal deficit under the control, and would choose to defer any excise cuts in the upcoming budget.

Further, the Serious Fraud Investigation Office (SFIO) report has suggested some kind of cartelisation by some big cement companies to fix prices. The Ministry is currently undertaking an investigation in this regard, through the Competition Commission of India (CCI). In this situation, we do not expect too much relief to come in from the govt.

However, there are certain indirect benefits that the industry can use to its advantage. Higher infrastructure spending and easy access to funds for infrastructure development could lead to a faster take off of infrastructure projects, which should help the cement industry to report better growth. Last year’s allocation of Rs 2140 billion for infrastructure development was 23.3% higher than in 2010-11. In addition to this, the govt. also undertook significant moves last year to bring in FII money to the infrastructure bond market. All these measure will definitely work in favour of the cement industry. This year too, we are expecting higher budget allocation for the development of the infrastructure sector, which in turn, will benefit the cement companies.

What To Expect

At present, the industry is facing pressure on the input cost front. This is mainly on account of the cost of coal, which constitutes 50% of the total cost of sale. Therefore, we expect the govt. to reduce import duty on coal from 5% to 3%. As there is a shortage of coal in India due to high consumption from power companies, only 40% of the requirement is met through linkage. Also, due to low priority given to the industry for coal procurement, most companies opt for imports.

We can see the benefits in terms of higher allocations to the infrastructure sector in the budget. This should help the industry to report better growth in terms of demand. In fact, as long as the govt. does not mess with any of the rates, the industry would be happy.