Southern firms’ margins improve through production control

Southern firms’ margins improve through production control

The tale of excess capacity amid lower-than-expected demand in the cement sector is not new. But beginning last quarter when demand contracted and cement prices hit the abyss, the big southern producers led a price hike to prevent further erosion in margins that threatened closure of most units.

The December quarter results of two southern firms, Madras Cements Ltd (MCL) and India Cements Ltd (ICL), clearly reflect this trend. Sales volumes of both firms dipped by an average of one-fourth from the year-ago period and the preceding quarter. Lower volumes pulled down revenue of MCL and ICL to 583 crore and 781 crore, respectively.

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However, what helped the beleaguered firms is the sudden price hike taken in early September, backed by production discipline. This kept supply tight and improved realizations during the December quarter. MCL’s was up 26% year-on-year (y-o-y) and 36% quarter-on-quarter (q-o-q) to about 3,900 per tonne. Likewise, ICL’s was higher by 20% y-o-y and 25% q-o-q to around 3,654 per tonne.

Hence, after a steep fall in the last two quarters, operating profit margins (OPM) looked up this quarter. ICL’s OPM jumped 270 basis points (bps) y-o-y and 1,280 bps q-o-q to 16.2%. MCL’s OPM, which has been among the most robust in the industry due to high quantum of captive power, rose 700 bps and 800 bps, respectively, to about 26%. One basis point is one-hundredth of a percentage point.

But concerns remain as southern India will see capacity additions leading to greater supply in markets. ICL’s management, while lowering its sales volume guidance for fiscal 2011 and 2012, said that it does not expect any major demand growth until the first quarter of fiscal 2012.

Further, the southern companies’ efforts to push cement into neighbouring states due to excess supply in the south will entail higher freight costs that, in turn, will hurt profitability. The grim scenario also reflects in MCL’s and ICL’s stock prices, which have underperformed the broader market indices over the last one year.

However, net profit of both firms improved over the preceding quarter. At 43 crore, MCL’s net profit was up 2.5 times y-o-y. ICL’s net profit contracted 25% y-o-y to 21.5 crore mainly due to higher interest costs arising from working capital.

For the near term, the one positive could be lower downsides to cement prices from these levels. But unless demand growth gains momentum, revenue and profit growth will be subdued implying limited upsides to the stock prices of these two southern cement giants.

Graphic by Yogesh Kumar/Mint