Global cement trades

India suffers with significant idle capacity in its cement works

Deceleration in economic growth, high inflation refusing to go away and policy paralysis as parliamentary elections are due next year has left the Indian cement industry, the world’s second largest after China, with considerable idle capacity, writes Kunal Bose. According to a report by India Ratings & Research, a unit of global rating agency Fitch, cement capacity use in India fell to 71% in the year ended March 2013 from a high of 89% in 2009/10. In the calendar year 2012, as much as 34mt (million tonnes) of new capacity was commissioned to take the total to 360mt. Ahead of India feeling the impact of global economic meltdown starting 2008 second half, Asia’s third largest economy was growing at a stunningly high rate, next only to China.

Cement demand here is primarily driven by the housing sector with a share of 67% of the total, followed by infrastructure (13%), commercial construction (11%) and industrial construction (9%). It was in response to strong demand growth for housing and also commercial construction predominantly in the pre economic downturn that the local cement industry went for a major capacity expansion drive both by way of greenfield ventures and expansion of existing mills. This will explain the creation of more than 100mt of capacity in the last five years.

In the past too, since the withdrawal of licensing and marketing and distribution controls in phases, the country witnessed large new capacities coming in a bunch at regular intervals of five years, causing low capacity use, price falls and regional price disparities. In a sense, then, history is continuing to repeat itself in cement. Industry woes will not be over too soon. Capacity overhang notwithstanding, the industry will be commissioning new capacity of up to 25mt by the final quarter of 201/14. This new capacity is resulting from projects launched some three years ago. Like in steel, the demand for cement depends largely on how well or badly the economy behaves over

a period. No wonder, the industry’s capacity utilization last year was distressingly low as the economy grew only 5%, against an 8% growth during 2007/11.

What also impacted cement demand negatively were persistently high inflation and interest rates and local currency value eroding vis-à-vis the US dollar in which energy prices are denominated. Rural and semi-urban house building and other construction are influenced to a large extent by the behaviour of Indian south-west monsoon that occurs during June-September period. Last year, the monsoon deficit on long period average basis was 8%. Incidentally, more than half the country’s cultivated area is still dependent on monsoon rains. The 2012 summer crop suffered a setback because of deficient rains and drought in some states. Farmers and also the ones involved in agriculture allied activities invest in house building and other construction work when the crop is good and prices for crops are fair. This was not the case last year.

A natural fallout of this was rural cement and steel demand contraction in the second half of last year. “Rural India will account for less than 25% of total Indian cement demand. What has kept cement demand in rural centres low is the use of cheaper building materials for making non-permanent structures. The growing idle capacity in the industry should motivate major cement manufacturers to work unitedly in framing a strategy to educate rural folks why they should be using cement for building permanent structures and save money in the long run,” says leading industry analyst Mahesh Choksi. In any case, as Chandra Shekhar Verma, chairman of India’s largest steelmaker SAIL says “success in marketing in rural India is much about taking products, steel or cement virtually to the doorstep of people living there and convincing them about the benefits of using them. The point is use of more steel will create incremental demand for cement and other building materials. You can say a 

case of symbiotic relationship. That there is scope for all building materials piggyback riding on steel as low cost rural housing of permanent kind gets a leg up is a given.” In fact, the government too wants that cement and steelmakers should work with architects and builders to promote low cost housing across urban, semi-urban and rural breadth of the country.

Cement company margins are under pressure for a while. The industry’s largest UltraTech Cement, part of Aditya Birla group, saw its fourth quarterly profit fall 16.3% year-on-year basis. The two Indian subsidiaries of Holcim of Switzerland ACC and Ambuja Cements could not make much headway in 2012. According to Thomson Reuters SmartEstimate data, UltraTech will slash capital expenditure by as much 50% in the next 12 months compared with estimated spending of Rs44.3bn ($806m) during 2012/13. Surplus capacity weighing heavily on prices and homebuilding and construction far from gaining the desired pace are leading other cement industry constituents also to settle for a highly modest capital expenditure programme for this and next year. This certainly is not the ideal time to push the pedal for expansion. Cement exports are also becoming increasingly challenging with deceleration in economic growth in neighbouring countries too.

The industry suffered a double-whammy last year. Fall in capacity use was accompanied by sharp rises in input costs and muted cement prices. Ambuja Cement says “costs on account of raw materials consumed (by it) increased by 18% over 2011. Power and fuel costs registered an increase of around 16%. These account for approximately 30% of total operating costs of the company.” A common refrain of cement producers irrespective of sizes of their operation is that their costs are staying ahead of benchmark levels largely because of irregular

coal supply from mines with which they have official linkages. This is forcing them to buy coal which is auctioned by government-owned Coal India Limited and/or import the fuel. Local coal supply is becoming particularly difficult for the units commissioning new capacity. A disturbing development in the industry is Builders Association of India having an issue with cement makers supposedly acting in concert to rig prices of the building material. In fact, on the basis of a complaint by the Association for alleged violation of competition law by some cement groups, the Competition Commission of India has levied penalties totalling Rs63bn. The ones inviting penalties have sought stay of the order.

The industry is waiting for the Indian economy to get back the bounce of the past so that over a period of time, capacity use comes to optimum level. According to most industry officials, the economy growing at 6% this year will create conditions for cement demand rising between 7.5% and 8%. The industry optimism is based principally on government commitment to spending $1 trillion in the 2012/17 plan period, urbanization gaining in pace and pick up in house building activity in both urban and rural centres. Much, however, will depend on India transiting from high to low interest regime incentivizing house building sector.

Analysis of balance sheets of cement makers shows that the ones successful in consolidating capacity and with presence in the principal consumption centres are better placed to ride out the present difficult market with less damage than industry constituents with capacity ranging from 1mt to 5mt. No doubt many small players are waiting for the next upturn in cement leading to improved valuation of cement capacity to sell their units to large groups.

Both companies have plants or joint ventures in most of Brazil’s neighbours, notably in Argentina. Votorantim has plants in both the United States and Canada, while Camargo Correa, one of Brazil’s largest construction companies, is building a 1.6mt (million tonne)-capacity cement plant in Angola.

Under pressure from Brazil’s regulatory body, Cade, which has suggested that several leading companies have formed a cartel to fix prices and reduce competition, the two companies, which in 2010 together bought 51% of the Portuguese Cimpor group, a company with mills in 13 countries, completed a series of asset swaps last year.

Votorantim transferred to Camargo Correa the Cimpor shares it bought in 2010, in exchange for Cimpor assets in China, Spain, India, Morocco,Turkey,Tunisia and Peru.

In turn, Cimpor, whose headquarters will remain in Portugal, will take control of Camargo Correa’s assets in Brazil, Argentina, Paraguay, Bolivia and Angola, and will retain assets in South Africa, Mozambique and Egypt, which will form part of the new InterCement grouping.

Votorantim, along with Camargo Correa and four other leading cement companies in Brazil, Holcim, Cimpor, Itabira and Itambe, have come under pressure from Cade, which insisted that Votorantim, the only company with mills in all Brazil’s five regions should dispose of its share of Cimpor.

In 2010 the two Brazilian cement giants together outbid the National Steel Company, CSN, to gain control of Cimpor. CSN is a relative newcomer to cement, but which now makes about 3mt a year at mills next to its steel works. CSN is apparently seen by allies Votorantim and Camargo Correa as dangerous rival.

CSN had also tried to buy Votorantim’s share of the Usiminas steel mill, the proceeds of which sale were used by Votorantim to buy Cimpor shares. But in this case, the bid by CSN was topped by that from the Italian–Argentine Techint group.

Whether Votorantim really wanted Cimpor’s assets, or just joined forces with Camargo Correa to block CSN is not clear in the light of what has happened since.

Ideally Cade would like no company to have more than a 20% share of the cement market in any region, but this is not practical in many of the states.

The two Brazilian giants have little to worry about from the two other large international cement companies active in Brazil, Lafarge and Holcim.

The majority of the ten mills in the Joao Santos group, which makes about 7mt a year, are in the north east where the company has five mills, or in the north where it has three. Joao Santos also has one mill in the south east.

Only two companies have plants in Northern region, basically Amazonia, where about 3.6mt were produced in 2011. The Joao Santos group has three mills there, as does Votorantim, Brazil’s largest cement company by far.

Five companies have plants in the North East region, still Brazil’s poorest, but which has been growing faster than average in the past 15 years, partly because labour

intensive companies have re-located there from the congested and high wage South East and South. There are 21 plants in the region, and Votorantim has five of them, where it produced about 4mt in 2011, while the Joao Santos group produces 3mt at its six plants there. Cimpor, which has now merged with Camarga Correa to form the InterCement group, produces about 2.5mt from its four plants in the Centre West. Lafarge produces about 1.4mt at two plants, while a Camargo Correa mill there makes about 300.000 tonnes. There are three plants belonging to smaller groups in the region.

There are seven plants in the sprawling Centre West region, between them making about 7mt. The Votorantim group produces about 3mt from its three mills in this region, the local Ciplan group makes 2mt, while Cimpor, Camargo Correa and Lafarge each have one plant in the region.

About 50% of all the cement produced in Brazil is made at the 37 mills in the South East region, where 32mt was made in 2011. Votorantim made 8.4mt at its eight mills, the Holcim group made 4.4mt at its five mills in 2011, and Camargo Correa made 5.4mt at its five mills. Lafarge has six mills in the region, where 4mt was made in 2011, while there are ten mills belonging to smaller companies in the region.

Votorantim dominates production in the Southern region, where it has six mills, where 9.4mt were made in 2011. Cimpor has two mills in the South, while the Itambe group has one mill.

Estimates as to how fast the Brazilian economy will grow in 2013, vary considerably, ranging between little more than a repeat of the disappointing 1% of 2012, half what the government had promised, to a maximum of 4%.

If industry looks like having another poor year in Brazil, with little new investment planned, record grains crops in the past two years, have put intense pressure on the country’s crumbling transport system. The government has finally been forced to take action which will favour the construction industry and boost demand for cement.

Last year, Brazil exported an all time record 22mt of maize, which helped fill the gap left by the

fact that the US harvested 100mt less than usual.

Because far less soya was grown last year than usual, the ports were able to ship maize in the second half 2012

But a massive soya crop of 84mt this year, means that at least 10mt more soya will be exported than in 2012. The oilseed will continue to be shipped until October or November this year, leaving no space for lower value maize.

Because of a shortage of both trucks and drivers, and because new laws mean drivers must halt more frequently than in the past, as well as a hike in the price of diesel, freight rates are up to 50% higher this year than in 2012.

Grains, sugar and meats now generate 40% of Brazil’s export earnings, so are vital to the countries economic health.

Less than 1.5% of Brazil’s g.d.p has been spent on building or maintaining roads, railways and

ports in the past 25 years, when just to prevent them from deteriorating, at least 3% needs to be.

The result of the neglect has been that roads are crumbling and bottlenecks have built up at ports and on the railways.

The government has now launched a crash programme, with up to US $100 billion to be spent building 8,000km of new roads, or adding a second lane to existing ones, building or upgrading 10,000km of railway tracks and expanding ports each year.