How Does A Cement Manufacturer Optimize His Profits

Given the fact that it is a commodity industry, with little or no differentiation in the end product – how does one manufacturer make a higher profit than his peers? Well let’s look at the formula

Sales – GST – Discount – Freight – Manufacturing Cost = Profit

How to Maximize Sales

So basically a manufacturer has to ensure that he realizes maximum sales price. This he can do by :

Selling in markets with Best Prices –

Demand Supply Mismatch creates better. If competition sets up a new plant in your market, the mismatch reduces and price falls.

Trying to sell high margin products such as PPC and PSC – You have to be near the source of Flyash or Slag to be able to do this

Higher Volumes – Better the demand in the market , higher the volumes

Better branding – Since it is a commodity – You need to ensure that brand recall is high when customer goes for buying the product.

Set up additional capacity

Maintain the quality of the Product, Home building services

Incentives schemes for Clearing and Forwarding Agents and Dealers

Manufacturing Costs

Limestone

• To make cement you have to first make clinker.
• So a plant has to first make Clinker
• Then Grind the Clinker with Gypsum to make Cement
• Limestone is the pre-requisite to make Clinker. Limestone is extracted from Mines. A company that has its own mines is at an advantageous position than the one which doesn’t have mines. Limestone cannot be traded, so a company which has no mines cannot make clinker.
• However limestone is a natural resource and more than 65% of India’s limestone comes from five states of Madhya Pradesh, Rajasthan, Andhra Pradesh, Gujarat and Chhattisgarh.

So companies have two options

• Make cement in the areas where limestone is available and the ship the finished good to those parts of country that want cement, or
• Make only Clinker in the state where limestone is available, and then do the grinding of clinker in the region which requires cement.

A unit which does both grinding and clinker manufacturing is called an Integrated Unit. A unit that does only grinding work is called Grinding Unit.

It may so happen that a company makes Clinker and directly sells it to another player who dies, but these situations are rare.

Mines are normally allotted through government auction and are leased to a company for time periods extending upto 99 years. After expiry of the lease term, the mines are again re-auctioned. Some companies like ACC have old legacy mines, allotted in 1960s with lease period of 99 years.

It also depends what amount of limestone reserves you have in the mines. Higher the reserves in your mines, better the prospects of your plant. Typically 1.5 Tones of Limestone, gives 1 ton of Clinker. Output from Clinker to Cement, depends on the blend of cement being manufactured (OPC, PPC or PSC)

If the quality of limestone procured from mines is not of correct quality, then a company has to add Additives (Correctives) to make Clinker of desired quality.

Since mines are allotted by Government, they typically give a right of mining (by charging a hefty sum). Companies capitalise this amount as an Intangible Asset. Hence an analyst can quickly check the Intangible Assets Section in Balance Sheet to know if a company has a limestone mine.

Intangible is depreciated on the basis of Quantity of Limestone extracted as a proportion of Actual Quantity of Reserves existing. So an analyst can actually do a reverse calculation to judge the life and quantity of reserves a company has in their mines.

Heat

• High Temperature heat is the next biggest requirement in the manufacturing process
• This high temperature can ordinarily be obtained only from Coal or Petcoke.
• Coal can be procured from open market – generally costly, or
• Cheaper coal can be obtained through Government tendering – government rations a quota of cheap coal to each industry, or
• Petcoke can be substituted for coal – which is less costly than Coal – but reduces the life of plant – and increases maintenance costs
• Use of Alternate Fuel and new trend in the industry, like Rick Husk, Liquid Solvent, TDI Tar, Etc.
• Waste Heat Recovery is a mechanism which can lead to huge cost savings in Fuel cost.

Parameters to Judge / Analyze a Cement Company

Housing forms 65% of the cement demand in India and hence this is the biggest demand driver. Housing has been growing at a steady modest pace even during lean period. The infrastructure sector adds or restricts the much needed growth. So one needs to judge uptick in demand and more specifically, the demand supply mismatch in the Micro Market where the Cement player is located.

Demand Scenario

As a metric, analysts should check the expected demand growth in the micro market and if anything is being done on housing or infra sector in the micro market, which can provide boost to volumes.

Whether competition is setting up new capacity in the company’s region of operation? It is normally observed that whenever a new player enters the micro market, they capture market share (through better incentives) thus restricting volume growth of existing players.

Whether the company has maintained or increase its market share, with respect to overall demand

Prices

• Are the overall prices in the company’s micro market, headed up or down?
• Whether the company has a brand good enough to charge premium pricing.
• Utilization levels drive the price hikes – Sustainable price hikes hinges on high utilization level. Once the utilization level starts touching 80%+, the cement manufacturers start getting a lot of pricing power. Optimal Capacity utilization can only be driven by high infrastructure demand.

EBITDA/Ton

The best metric to measure the profitability of a cement company is EBITDA/Ton. Most corporate deals also use this as a measure of payment, and management too uses this metric to judge performance. EBITDA/Ton is a result of lot of small things done right. It starts from better pricing power and ends at better raw material costs and better overhead absorption. The following factors generally drive EBITDA/Ton

Whether company has better access to key raw materials viz Limestone, Coal, Petcoke, Flyash, and Power. If a company has captive access to any or all of these factors, its cost of production is reduced and realisations improve.

Whether company is enjoying and Government incentive schemes and for what tenure

Cost effectiveness in Power and Supply Chain Management.

Larger the player, higher is his bargaining power with suppliers. So one should judge whether the company is big enough to negotiate better with vendors.

An analyst should basically check, how much EBITDA growth does he expect and what is the market building in?

Why Balance sheet Of a Cement Company Is Important 

Cement is a capex Heavy Business. The ROAs of a cement plant is close to 1. So a Cement plant with 5000 Crores of Capex can typically do a turnover of 5000 Crores only. Hence it is important, that not only does the company set up a plant in the best market (which offers best prices), it should also ensure that cost of setting up the plant is cheapest.Further since the Cost of Setting up a plant is high; it can either be done by taking debt or Through Internal Accruals

In both the cases, it is important that company should generate enough Free Cash Flows else they will not be able to service the debt or set up additional new capacities in future.

Size and spread of a company also matters because

It allows a company to negotiate better with suppliers,

More a company is spread across India, more can it minimize the freight costs and serve a higher market – thus creating even bigger brand.

Working capital management and cash from operation are vital metrics to judge in this regard