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Cementarticlefinalwithgraphs.docxConcrete Times- The Future of Cement Sector in India
The Market
The global village
Globally, there has been a growing demand in construction and in the housing market due to rapid urbanization. Residential demand is on the rise. With the housing demand expected to grow rapidly, a proportionate increase is expected in the cement demand as well. Primarily, the growth is expected from new housing, however restoration projects will also have a positive impact with both public and private restoration efforts growing. Technological advancements are also expected to further fuel this demand. The expansion of global cement market is hindered by stringent regulations and depleting fossil fuel reserves.
Prices are under pressure across the world due to ongoing demand shortage since the 2008 financial crisis, while environmental regulation, sustainability concerns and the often negative image of the concrete industry are becoming major global issues. All the while, the threat of digital disruption looms over all companies.
Developing an economy
Cement companies in developing regions, which have enjoyed growth without any restrictions until now, are starting to struggle with environmental regulations and a more negative perception of the industry.
In India, the cement sector has always been infamous for sunken investments in surplus capacities. This phenomenon breathes new life in the construction industry’s slowdown. The utilization rates have fallen to as low as 70% with few avenues of sustainable recovery. Despite strong growth of domestic consumption and export activities, India cement market continue to experience the supply surplus with considerably low utilization rate of 70%.
Emerging trends
Direct sale is a new development trend in this sector expected in the next few years. To reduce the distributors’ influence, producers promote direct sales of bulk cement to large projects or to industrial customers (e.g. ready-mixed concrete, pre-cast concrete product, or infrastructure projects), as these customers insist on quality testing and technical support at sites that distributors can seldom afford.
Consolidation and use of renewable energy are likely to be a must to ensure the future of the cement sector. India has been observing an active consolidation tendency. The sector also witnessed the construction of mega cement plants to obtain the economy of scale for this sector in both production and logistics.
The Indian saga
The main raw materials for cement are limestone, coal and electricity. Limestone is used for quarrying, on which the cement companies have to pay royalty to the state governments. On coal, apart from the GST, there will be levy of clean energy cess which is not available as a credit. So, as these two factors will continue to be outside the GST, it has to be absorbed as cost of the cement production.
In contrast to the expectations of the industry, the government has levied GST @ 28% on cement as compared to 30% – 31%, previously. This has resulted in higher cement prices from the inception of the new tax regime. However, since some of the inputs have been put under 5% tax bracket (coal) and logistics costs are expected to go down, one could expect cement prices to go down once the industry settles in place. The current rise in price should be temporary but the industry is likely to get clarity on this with time.
Operationally, the GST does not impact the cement business and therefore has little or no impact on the core functions.
The number of transactions and taxation steps is likely to reduce thus requiring minor restructuring of the finance function.
Upgrading of the ERP would be required in the foreseeable future for which the talent shortage may arise as the taxes impact most industries thus increasing the demand for these professionals.
The logistics costs are likely to reduce. The number of warehouses required will reduce, bringing down costs, which may be transferred to the end consumer in the current scenario of higher demand and plant utilization. However, the impact on the logistics function within the company will be negligible. The nature of the logistics jobs in most Cement companies is such that the volume of work will have minimal impact, i.e., a person handling multiple warehouses now will handle a single warehouse but without much change in the job profiles. The impact will be felt by the logistics companies. It will impact any cement company that has integrated horizontally and manages its own supply chain.
Real Estate has been one of the most affected sectors. It is a popular bet in the fresh and resale market dominated by black money holders. The number of buyers has and will continue to come down and low demand will bring about lower prices in the short term. The vulnerability is higher for companies which derive bulk of their profitability from higher trade sales. Eastern India is likely to see the largest reduction in utilization over the next 12-18 months. While earnings in past 2-3 quarters were driven by cheaper pet coke prices, things are likely to flip at the most inopportune time for cement companies as spiking energy costs are beginning to sting at around the same time as volumes are expected to be low. The credit has turned negative in the short-run. A significant impact in the short-run is being felt on the daily/weekly wage employment in the informal sector. With housing and construction the two sectors most affected by demonetization, the much awaited recovery in cement sector could be postponed by another year. It also cautioned against a longer slump in secondary and unorganized real estate markets which drive a large proportion of cement sales.
Fostering Hope
An upturn is expected only in FY20. The increase in infrastructure sector demand may offset some weakness in demand from the housing segment. A gradual reduction is also expected in the mortgage rates, which could bring back some genuine demand. With the government's balance sheet likely to be in a much better fiscal position, the industry expect a sharp pick-up in infra demand - in line with the government's vision to push public spending. State government finances, on the other hand, may come under some pressure, as a good 5-10% of their revenue receipts come from the property sector. This is likely to be mitigated if the central government passes on a higher proportion of its improved finances to the states.
The Price of Bonding
Following demand volatility, a correction in cement prices is expected in the near term but is not likely to be a very sharp deterioration on a sustained basis. Currently, a good 30% of players are not breaking even on a cash cost basis. If this were to take into account the recent spike in fuel costs of both pet coke and imported coal, at current prices over 43% of the industry would not be at break even.
But an anticipated increase in demand Budget 2016-17 allocated INR 7,296 crore towards Urban Rejuvenation Mission – The Smart Cities project. It also allocated INR 19,000 crore for the Pradhan Mantri Gram Sadak Yojana (PMGSY) for FY17. Such large scale projects would need large tonnes of cement. NCL Industries planned to boost its cement production up to 2.7 million tonnes due to increase in demand from the construction and infrastructure sector.
Cement sector in India
Despite the note ban pain, relief on personal income tax rates and incentives for investment in housing are likely to boost the demand. Cement industry is an indirect beneficiary of the increased government spending on infrastructure as housing sector accounts for 67% - 70 % of the cement demand. The negative impact on the cement industry comes from the clean energy cess on pet coke along with coal, which will increase pet coke prices and subsequently the cost of production.
A growth story
There has been an increase in production for cement since 2008. From 2012 onwards, the cement production in India has increased at a decreasing rate. The CAGR for the cement production in India from 2012 is 5% while CAGR from 2008 is 6%. The years from 2012 – 2015 was a period with weaker cement demand and hence weaker prices. In 2013, the increase in coal prices affected the power and fuel cost for cement companies. The impact of increase in coal prices was more pronounced on companies which were dependent more heavily on domestic coal.
Managing the growth
Total expenditure as a % of revenue has increased thereby thinning margins. The increase has not been drastic due to efficiencies in processes. The per capita revenue has increased by 3.07% indicating more productive employees. The employee costs as a % of total expenditure, while low, has been increasing at a higher rate than employee productivity. To prevent it from becoming a concern, companies are increasingly focusing on reskilling and upskilling of workforce. The number of on roll employees has been decreasing in the last few years. This is largely due to a part of the workforce being contracted out. This ties in with increasing expenses.
Total Revenue and Operating Revenue have been increasing but not in the same proportion as the operating cost. Consequently, profitability has seen a decline. As prices of cement have stayed fairly constant due to high regulation, this has led to thinning margins with increasing costs. Increased people productivity and operational efficiencies will make a difference and enable players to overcome the dipping profitability.
Salary Increase- Crushing numbers
Aon’s latest salary increase survey sees a dip in the projected salary increase numbers for FY17 across sectors. The consistent 9-10% average increase in the last 5 years has dipped significantly. The sectors for which transactions are not cash driven to a large extent remain unaffected. In line with the expectations, the sectors that have reacted most aggressively are Real Estate, Infrastructure, Building Materials, Cement and Metals.
The Cement sector has seen a dip of close to 2.1 percentage points in the projected salary increase figures, from 9.8% in FY16 to 7.6% in FY17. There has been no correlation with the salary increases and inflation numbers. While CPI is considered at the time of increment cycle, the final numbers are more dependent on business and industry performance. The real wage increases (inflation adjusted) have been decreasing over the years.
The performance distribution curves are tighter with lesser population in the top two ratings. The companies are also taking a more aggressive approach towards the bottom rated performers as with regards to the increases given. The cement industry shows more socialistic tendencies as the delta between the top performer and the average performer is just 1.36x as compared to an all India delta of 1.8x. As the demographics have shifted to include millennials as a large part of the workforce, and the availability of jobs has been rapidly increasing, there is a real risk of losing key talent.
Executive Compensation
Executive compensation has always opened the floor for debate across all the industries. Within Cement, the wage ratio movement between the average labor compensation and average CEO compensation, in the last 3 years has seen a jump in the ratio by 5 times. This gives way to the question on the effectiveness of CEO compensation in driving business. On analyzing the data over last 5 years, it was observed that the Pearson Correlation Coefficient between Revenue and CEO compensation is 0.51. This shows a positive correlation between business results and executive compensation, however, it is not as strong as one would expect.
What metric of business performance is most closely related to Executive Compensation?
**EPS has the closest relation with Executive Compensation
Variable Pay- Clinking Expectations
In an attempt to justify the additional employee costs while simultaneously driving a meritocratic culture, the manufacturing companies in general and more recently the Cement companies in particular, have been moving towards a pay mix leaning towards higher variable pay even at lower levels of management.
The junior management has seen an increase from a nominal 3-5% to an 8-10% in proportion of Variable Pay to Total Fixed Pay. The proportion is observed to be increasingly higher at higher levels of management going as high as 30% at top and senior management.
This is a double edged sword as though the organization manages to control employee costs in the unstable environment, the employee productivity may suffer with high degree of uncertainty in what promises to be a hard to control future.
Attrition- Quarrying Talent
While the numbers for FY16 have been one of the lowest in the last few years, this is likely to change in the coming years. Attracting and retaining good talent may become a challenge in the coming times as a recovery for the sector on the whole may take time. As the demographics have shifted to include millennials as a large part of the workforce, and the availability of jobs has been rapidly increasing, there is a real risk of losing key talent. The major risk will be seen in the jobs that are fungible in nature across industries.
Correlation of Attrition with business metrics
**GDP has the closest relation with Attrition
The human in the resources
The organizational structure in cement is witnessing a bulge in the middle management. This bulge is the result of a decade long concentration of incumbents at the same level due to reasons such as – close approaching retirement, undefined roles and responsibilities, disparity in internal grade structures etc. The industry has seen an increase in capacity by a compounded annual growth rate of 19% in the last five years. However, the capacity utilization is just 70% - 72% of the total capacity today. This resonates with the trend seen – higher growth rate of employee cost vis. a vis. the growth rate of the revenue. The employee compensation cost in the industry has grown at twice the rate of growth of the industry’s top line.
A study conducted on 800+ respondents from the sector shows that three-fourths of workforce regards pay, recognition and benefits as the most important criteria in selecting employers. However, it is these hygiene factors that are also responsible for the dissatisfaction amongst employees. Another key finding was that employees who are happy about their employers’ positions on social issues are more likely to be engaged.
Conclusion
The cement industry as we know has been a perennial focus post the tax reforms and demonetization. With the recent economic and political changes, cement prices will be volatile under purely competitive price-setting. The incremental cement production costs (raw materials and energy) are low relative to minimum average total cost until full capacity utilization on a 24-hour-per day basis is approached. On the other hand, we have seen the employee costs increasing at an exponential rate. As we know, the demand for cement is cyclical and probably quite price-inelastic over plausible price ranges. Hence, effective HR initiatives and retention of key talent has become imperative to be able to support the spur in growth anticipated in the coming decade and a half. As the pressure on the sector to go green increases, companies need to be proactive in this regard. Investment will therefore be need to also be made in acquiring the right skill set to support these changes. Lastly, as the sector encounters one of its biggest challenges of supporting an ageing population, redundancies need to be planned for and cost control measures are of paramount importance.
Attrition
Adjusted R Squared
F - Test
Significance F
Revenue
0.02523
1.05176
0.49196
GDP
Salary Increases
- 0.44597
0.02309
0.90399
0.383155
0.647141
0.95485
Adjusted R
F
Revenue
0.229
8.757
0.006
Significance
PAT
0.131
4.946
0.035
EPS
Non Profit Margin
0.821
11.61
0.004
0.293
8.786
0.004
CAGR in Past 5 years
Total Revenue Operating Cost Compensation Cost Profit Before Tax 7.6499999999999999E-2 9.6000000000000002E-2 0.1678 -9.7000000000000003E-2Cement Production in 2016 - 2017
(Thousands of Tonnes)
Cement Production in Thousands of Tonnes25692
42461 42491 42522 42552 42583 42614 42644 42675 42705 42736 42767 42795 24692 24887 26064 23330 22283 22627 24626 20516 22001 22489 21454 25208 Cement Production in Million Metric Tonnes 2008 2009 2010 2011 2012 2013 2014 2015 2016 174 186 206 216 230 248 255 270 282
