Column : Why cement is weakening

Written by Smita Joshi Saha | Updated: Jun 30 2010, 02:52am hrs
The 270 million-tonne Indian cement industry, witnessing demand growth of 9-10% on the back of the infrastructure sector, is likely to witness the most unfavourable phase in the next six months. The demand growth in the industry will not be sufficient to absorb the incremental capacities that companies had lined up in the past.

Even before the industry enters the phase of a seasonally weak demand growth (from June-September), the excess capacity in the system has started exerting downward pressure on prices nationwide. According to industry experts, the story of excess capacity and sharp decline in prices and margins will spread across all regions in FY2011. In fact, prices started correcting much before the monsoon started.

A significant margin compression in the second half of the current FY is expected since it will be difficult for cement makers to pass on the higher fuel and freight cost. Indian cement companies, on average, import 35% of their total coal requirement and with international thermal coal prices expected to increase by 40% in FY2011, a significant rise is expected in both power and fuel costs of companies. Similarly, the recent hike in fuel prices was a dampener because the industry transports 60% of its products by road. Freight costs account for about 18-20% of the operating costs of cement companies. So, as competitive pressures increase, companies will have to sell in more geographically distant markets, pushing up costs. Also some major projects, like the Delhi Metro, Commonwealth Games and irrigation projects in Andhra Pradesh that had kept demand growth at 11-12% in the past few quarters, are nearing completion.

In FY2010, about 40 million tonnes of new capacity was commissioned across India. While capacity additions early last year were primarily in southern India, the recent wave of additions are in the northern region, making the entire nation vulnerable to structural excess supply, says a Goldman Sachs report. New capacity has been skewed, the repercussions of which will be producers diverting despatches to more lucrative regions, in an attempt to maximise realisations. With the addition of about another 40-50 million tonnes in FY2011, the demand-supply mismatch is likely to intensify, leading to widespread price declines across all regions.