Growth in cement demand in 2013-14 may improve as the economy is expected to grow faster during the year and also because the governmentÂ’s policy initiatives may promote infrastructure sector, writes Raja Iyer.
While growth in cement production and consuÂmÂÂption in 2012-13 was not at all encouraging, there is some hope of recovery in the ongoing fiscal because of expected revival in the economic growth in general and construction sector in particular.
Cement output grew just 4.24 per cent to 233.3 million tonne (mt) in 2012-13 compared to 7.34 per cent (223.8 mt) in the previous fiscal. Growth in consumption eased to 4.2 per cent in 2012-13 from 7.1 per cent in the earlier year.
While the decline in the growth of cement consumption is attributed mainly to the slowdown in the real estate industry, particularly the housing segment, other factors like the fall in capital expenditure, patchy implementation of infrastructure projects, and rise in prices have also tempered demand.
Over 60 per cent of the cement demand in the country comes from housing sector with rural housing accounting for 40 per cent of the total. Slowdown in the housing sector in 2012-13 is mainly due to high interest rate which affected mortgage financing.
Since early 2009, there has been an increase in the number of infrastructure projects where implementation has stalled. As of December 2012, six sectors accounted for about 80 per cent of all stalled projects Â— electricity, roads, telecommunication services, steel, real estate and mining. Thus, the slow pace of project implementation also caused decline in cement consumption.
Growth in the demand for cement in 2013-14 may improve as the economy is expected to grow faster during the year and also because the governmentÂ’s policy initiatives may promote housing sector.
According to the recent Economic Survey, the Indian economy may grow around 6.5 per cent in 2013-14, more than the estimated 5 per cent in 2012-13 because of the easing of monetary policy by Reserve Bank of India (RBI), fiscal consolidation by the central government, fall in the global commodity prices, among other things.
Recovery in the construction sector may contribute to the growth in the cement demand in 2013-14. Growth in the construction sector is expected to be 7 per cent in 2013-14 compared to just 5.9 per cent in the previous financial year.
One of the key drivers of housing sector in the coming months would be the initiatives of the central and the state governments to promote affordable housing. Both the central and state governments are taking steps to provide low-cost housing and rural housing, all of which require Â‘puccaÂ’ (and therefore cement) houses. A study by India Ratings shows that almost 85 per cent of the cement demand for rural housing stems from Â‘puccaÂ’ houses. In the short run, the impending general election (scheduled in mid 2014) may spur populist spending on mass housing projects.
Some analysts feel that cement demand from rural India may grow because of the housing schemes of the central and state governments and also because individuals are upgrading houses to Â‘puccaÂ’ houses with their own resources. According to financial services firm Credit Suisse, the expected strong growth in rural housing, roads and railways may raise growth in cement demand from 5 per cent in 2012-13 to 7 per cent in 2013-14.
But there are some challenges in the housing market which may temper the impact of government initiatives. One of the challenges is the weak demand for houses. Home buyers are still waiting for the prices to decline before buying property. Home prices are stubbornly high because of elevated level of land prices, construction cost etc. Also, credit growth to housing sector has moderated because of high interest rate. India Ratings expects the cement demand to grow between 5-8 per cent on a year-on-year basis in 2013 given the slight moderation in credit growth in the housing and commercial real estate sector.
Even though there is possibility of cement demand growing faster in 2013-14 than that in the previous fiscal, margins of many companies may come under pressure because of high transportation cost, weak pricing power owing to excess capacity.
In 2013-14, the cement industry is expected to add 30 mt of production capacity, which currently stands around 313 mt. However, the pace of capacity addition may decline in 2013 since large capacity additions in anticipation of demand growth have already taken place during 2008-2011, India Ratings said. Thus, the slow growth in capacity addition may improve capacity utilisation going forward.
Data from ICICIdirect.com Research shows that capacity utilisation remained around 74 per cent on an average across the country in 2012-13. However, this was lower in south India, at 57 per cent as production capacity rose far in excess of demand in the region. Thus, even if there is some recovery in the growth of cement demand during 2013-14, margins of cement firms in southern region may continue to be under pressure because of below average capacity utilisation.
Owing to excess capacity and weak demand, cement producers had to reduce prices slightly towards the end of 2012-13. Thus, pan India average cement prices declined to Rs 300 per bag of 50 kg by the end of March 2013 from Rs 312 in March 2012.
It remains to be seen whether the expected improvement in the growth of cement demand gives elbow room for manufacturers to raise prices to make up for the increase in the rail freight charge. The Railway Budget 2013-14 proposed a 5.79 per cent hike in freight charge. The operating margin of cement companies are expected to contract by almost one per cent if they are unable to pass on the rail freight cost hike. But the magnitude of this impact may not be uniform across all firms as some large integrated cement producers can absorb part of the freight hike owing to economies of scale. Rail freight constitute almost two third of the freight cost of a typical cement company. This is essentially 15-18 per cent of total cost of a cement producer. After coal, cement is the largest contributor of freight revenue to Indian Railways.
Given the overcapacity situation and the challenging cost and pricing environment, it is expected that weaker cement companies would merge with their peers in order to achieve economies of scale. India Ratings expects consolidation in the cement industry in the medium- to long-term with large merger and acquisition (M&A) activities in the sector. It may be noted that the cement industry is highly fragmented and skewed with the top five companies constituting around 50 per cent of the industry capacity. These five companies, which have favourable cost structure and better access to raw material sources and market, are expected to weather the challenges in the industry.
The author is Research Analyst, First Infocentre.