All these factors portend a bullish trend for cement, even without the impetus provided by the proposed government withdrawal of the sales tax incentive.

Prices drive profits
The bottomline then is that the above-mentioned factors will result in the prices firming up. Average prices for October are already near their four-year highs in Mumbai, Chennai and Bangalore. However, the prices in the north (Delhi) and east (Calcutta) have softened slightly in the last few months. But, that should not be a cause for worry considering the conducive supply scenario emerging in the country in the next couple of years. Region-wise distortions however -- long distance transportation makes it uneconomical -- will remain.

Go long on north: There is no new capacity addition taking place in the northern region in the current fiscal except for a small 0.8 million tonne expansion by ACC. Moreover, there are no capacities slated to commence commercial production in the next two years in the northern states. And, demand in this region has been growing at a higher rate than even the western or southern regions. "The north will close the year with around a 18 per cent growth rate," opines Jain. If the growth continues at double digits, producers would have to raise their capacity utilisation levels to over 90 per cent, the highest ever reached by this region.

Sell east: The scenario is not very encouraging in the eastern region. The problem here, unlike in the other regions, is not a fallout of continuous capacity build-ups. In fact, there has been no major Capex in this region, in the last two years except for small expansions by ACC (0.31 mt in Bihar and 0.27 mt in West Bengal).

The basic problem is the slow growth in demand. The average growth rate in consumption, in this region for the last five years has been only 6.6 per cent. Last year saw demand slump to 2 per cent and Bihar and Assam recorded double digit growth rates. The rest of the states either clocked negative to very low growth rates.

This region is expected to remain bearish for a long time. Already, prices in eastern MP, in the Bilaspur limestone belt which supplies cement primarily to the eastern states, are experiencing a slump. Cement prices, which are usually lower here than elsewhere, have touched an all-time low of Rs 75 per bag. Net realisation after considering freight too is lower due to the fact that most of the cement is despatched from eastern Madhya Pradesh. As such, there seems to be no hope for this region.

Medium term prospects for south: The north and the south have always been high realisation regions (except for Gujarat and Andhra Pradesh). Rapid growth in capacities has, however, been the bane of these regions. Even after the end of the entrepreneurial boom of the mid-nineties, this region has been witnessing continuous capacity growth. Capacities in the south, in the next two years, are expected to increase by 3.1 mt (1.1 mt in the current year). Apart from this, most of the capacities coming up in Maharashtra (2 mt each by GACL and ACC) will feed the south, especially Andhra Pradesh and Karnataka. Another 2 mt capacity by Gujarat Ambuja is slated to come up in Andhra Pradesh latest by 2003.

A large chunk of the capacity, however, will emerge only after 2001. For the next year and a half, supply could be tight especially in Kerala and Tamil Nadu. Prices in these states are already ruling at their highs and will stabilise.

Mixed fortunes for the west: The western region (only Gujarat and Maharashtra as Madhya Pradesh supplies mainly to the northern and eastern regions ) will also witness higher realisation in the near future, especially in certain pockets of Maharashtra. The scenario, however, will not be similar in both the states. Gujarat is a cement surplus state with an average capacity utilisation of a mere 78 per cent in 1998-99 and rock bottom prices. Moreover, the cement capacity is scheduled to increase with GACL expanding its capacity by 1 mt and Saurashtra Cement setting up a 1.1 mt plant. This will maintain the pressure on realisations. And with the Sanghi Cement’s 2.5 mt capacity plant unlikely to get commisioned, will only increase the pressure on realisations in Gujarat and the neighbouring states.

Cautious approach
Promoters are taking no chances. For new capacities to be proposed, prices will have to improve substantially. But trends show that capacity additions will no longer be a flexible option in a couple of years. "In the last two years no orders have been placed for new cement plants other than for routine expansions. And, the surplus over demand is gradually getting reduced," asserts Karnani.

As the demand-supply gap narrows next year, capacity will have to grow at least as much as the demand grows, that is, at 8 per cent. In absolute terms, it would mean an annual capacity addition of at least 8.5 mt in 2002-03, with the figure progressively increasing with each year. This, however, seems a bit difficult for even during the peak capacity-addition period (the last five years) the average annual capacity increase was only 7.7 mt.

Assuming a capital cost of Rs 300 crore per mt, investments needed each year would be in excess of Rs 2,250 crore. So far, there are no indications of such a colossal investment. Moreover, the bitter lessons learnt during the last two years, when the production capacity increased largely in excess of the demand growth, will prevent the entrepreneurs from taking hasty decisions.

The focus would then largely be on consolidation. In 1998-99 itself, nine acquisitions took place. The AV Birla group went in for restructuring bringing its cement business under Grasim Industries. Further, its acquisition of Dharani Cements in Andhra Pradesh gave it an opportunity to utilise Dharani’s vast limestone reserves by embarking on a one mt expansion programme. A spate of acquisitions also helped India Cements become the largest player in the south.

Nevertheless, India is still among the few countries where the cement industry is still highly fragmented. There are many players with varied interests who would do a lot of good by selling out their cement business to more serious and efficient players. There are many small players (read single unit companies with less than 2 mt capacity) as well. With no one having a controlling stake (ACC has the largest marketshare at around 12%), a price discipline is next to impossible.

For instance, in the limestone rich state of Andhra Pradesh 13 players, with a total capacity of 16.70 mt, are vying for a minuscule market of 6.36 mt. In addition, AP also has the largest number of mini-cement companies. A significant portion of the production(5.6 mt) has to be transported to neighbouring states. No wonder then the cement prices in Hyderabad have never looked up.

A major fallout of demand matching supply would be increasing levels of capacity utilisation thereby giving economies of scale to companies currently working at sub-optimal utilisation levels. Top cement companies might not benefit much as they are already working at high capacity utilisation levels. With the mini cement companies on their way to a natural demise, the medium plants (not the leaders) could provide good growth and decent stock returns.

Though the prices and utilisation levels are expected to increase, so are the costs. Companies have not been able to pass on the recent hefty (40%) diesel hike -- it has increased the outward freight costs, power costs and fuel costs -- to the consumers.

In the short term, the price increases will go a long way in offsetting these incremental costs even as the margins stay put. The major beneficiaries would be those who have been able to cut costs in the last six months -- GACL, ACC and India Cements. However, for Grasim and ACC, their concentration in the east is likely to prove disadvantageous considering the adverse demand-supply scenario there.