The cement sector has surprised most analysts. Instead of the widely predicted fall in prices as a result of new capacities being set up and on account of a slowdown in demand as the economic downturn started to bite, cement prices are being revised upwards. That’s in spite of a reduction in input costs and lower excise duties. It’s a clear indication of robust demand, a fact underlined by the 8.7% year-on-year growth in cement dispatches in February.
In fact, a look at historical trends shows that cement has been remarkably stable over the business cycle. As data from Reliance Equities show, the annual growth in cement consumption has ranged between 8% and 10% in this decade, except for 2003-04, when it grew by 5.8%, and in 2000-01, when the growth was negative. The probable reason for the lower growth was a shortfall in agricultural production in 2002-03 and a high base effect in 2000-01. But even at the height of the boom, in 2006-07, growth in cement consumption was 10.17%, not too much above the 8.18% growth notched up during the 11 months from April to February.
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The government’s infrastructure projects and the strength of rural demand are the reasons for this astonishing stability of demand.
While demand has stayed robust, the expected surge in supply has not occurred. Against an expected capacity addition of about 30 million tonnes (mt) in 2008-09, the addition has been just 8.4mt in the first 11 months of the fiscal year.
The feared overhang of excess capacity hasn’t happened. Gaurav Dua, head of research at Sharekhan Ltd, says capacity additions are being delayed partly as a matter of deliberate policy, partly because of funding difficulties and partly because earlier, when coal prices were high, there was a problem in obtaining supply linkages.
In fact, capacity utilization has gone up in recent months. From operating at 99% of capacity in March 2008, utilization started falling, reaching a nadir of 77% in August. Thereafter, the tide turned and capacity utilization has been at 92% in December, 93% in January and 92% in February.
There’s some debate whether the improvement has been due to pre-election spending, or the strength of rural demand, or the economy bouncing off a bottom, but the fact remains that the industry has proved to be extraordinarily resilient. Perhaps the market has drawn too facile a connection between the difficulties faced by the real estate firms and the cement sector.
But while the delay in commissioning new capacities has given some breathing space to the industry, surely they will come up at some time and the supply problem will rear its head again? Most analysts say addition to capacity will be gradual and that supply should increase by about 18mt in 2009-10, with the bulk of the capacity addition shifted to 2010-11, especially because even if capacity is commissioned, it takes several months for the plants to stabilize. If demand continues to grow at 7-8%, then adding an additional 18-20mt will mean that cement plants would continue to operate at at least 90% capacity utilization in 2009-10.
In the meantime, lower input costs, especially lower imported coal prices, will prove helpful to the profits of cement companies. That is why cement companies have been outperforming the market.
Graphics by Ahmed Raza Khan / Mint
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