Cement demand is expected to grow at a healthy pace over the next 5 years, led primarily by demand from the

infrastructure segment. However, over the next 2 years, capacity additions are expected to significantly outpace consumption, resulting in a dip in the cement industry's operating rates. Consequently, despite a marginal increase in cement prices during this period, the industry operating profitability is likely to decline sharply.

Infrastructure to propel cement demand

CRISIL Research expects cement demand to grow by around 9 per cent CAGR over the next 5 years, primarily led by demand from the infrastructure segment. Between 2011-12 and 2015-16, the infrastructure segment is expected to account for around 27 per cent of the overall cement demand, up from almost 20 per cent in the previous 5-year period. An increase in independent housing projects, particularly in the urban areas, is expected to further boost cement demand over this period.

Supply additions to outstrip cement demand

CRISIL Research expects around 89 million tonnes of cement capacities to be added from 2011-12 to 2015-16, of which around 65 per cent is expected to be added over the next 2 years (2011-12 and 2012-13). With capacity additions significantly outpacing cement demand, operating rates are expected to bottom out at 72 per cent in 201213. However, thereafter, operating rates are expected to gradually recover to around 85 per cent by 2015-16.

Cement prices to remain almost flat in the near term

The cement industry is in the midst of a cyclical downturn. Over the next 2 years, along with a weak operating environment, the industry is also set to witness a sharp rise in input costs. During this period, cement prices are expected to remain relatively flat as cement players will lack the flexibility to pass on the cost increases.

Cement profitability to halve over the next 2 years

CRISIL Research expects the cement industry's operating profitability to halve to around 10 per cent in 2012-13 from around 20 per cent in 2010-11. The key reason for this decline is the 30 per cent hike in coal prices by Coal India Ltd in February 2011, which is likely to escalate the energy costs of cement players over the next 2 years. Further, an increase in lead distance is likely to translate into higher freight costs. Increase in these costs is expected to outstrip the marginal 1-2 per cent cement price increase, leading to a sharp fall in cement profitability over the near term.

Cement demand to grow at a robust pace over the next 5 years

Cement demand is expected to post a robust CAGR of around 9 per cent from 2010-11 to 2015-16, led by infrastructure spending and independent housing, particularly in the urban areas. Over the 2005-06 to 2010-11 period, demand for cement grew by 8-9 per cent CAGR. However, growth was subdued in 2010-11, primarily on account of lower demand due to the extended monsoons and slower pace of construction and housing activity.

Growth in cement demand

P: Projected Source: CRISIL Research

Key demand drivers

North: Infrastructure and housing projects
CRISIL Research expects demand for cement in the northern region to grow by 8-9 per cent CAGR from 2010-11 to 2015-16, as compared to a growth of 7.9 per cent from 2005-06 to 2010-11. Rajasthan, Punjab, Haryana and Delhi will remain the key cement consuming centres in this region.

Cement production and consumption in the North

P: Projected Source: CRISIL Research

There has been a spurt in independent housing projects in the semi-urban and rural areas in the northern region, especially Punjab and Haryana. Investments in urban infrastructure projects in cities like Delhi and Chandigarh are also expected to boost demand for cement. Further, in Himachal Pradesh, several hydel power projects are likely to be implemented over the next 5 years; cement intensity is high for hydel projects. Further, strong demand has been anticipated from road projects in the region over the coming years.

South: Irrigation and government projects

CRISIL Research expects demand for cement in the southern region to post a CAGR of 6-7 per cent from 2010-11 to 2015-16. During 2005-06 to 2010-11, demand had risen by 7.5 per cent CAGR. Growth in the IT/ITeS sectors in the southern region has led to an increase in residential and commercial construction, resulting in healthy demand growth for cement. However, in 2010-11, demand growth in this region declined by around 1 per cent. Limited cement offtake in Andhra Pradesh fuelled by political issues coupled with subdued investments by NRIs in Kerala negatively impacted demand growth during the year.

Cement production and consumption in the South

P: Projected Source: CRISIL Research

Going forward, investments in roads, irrigation and government programmes like the National Rural Employment Guarantee Scheme (NREGS) and low-cost housing schemes like Jawaharlal Nehru National Urban Renewal Mission and Indira Awas Yojna (IAY) are expected to provide a thrust to cement demand. With a substantial capacities commissioned in the South, this region is witnessing a supply glut. This has led to players offloading cement to other regions, especially the western and the central regions. Over the next 5 years, we expect outbound movement from the southern region to increase.

East: Housing, infrastructure and industrial investments

CRISIL Research expects demand for cement in the eastern region to grow by 10-11 per cent CAGR from 2010-11 to 2015-16, as compared to a growth of 9.2 per cent from 2005-06 to 2010-11. Demand in the East is set to be largely driven by investments in housing, infrastructure projects and industrial investments.

Cement production and consumption in the East

P: Projected Source: CRISIL Research

Demand in the eastern region is expected to be driven by various industrial projects that are being implemented in the mineral resource-rich states such as Orissa, Jharkhand and Chattisgarh, as well as housing projects in the rural and semi-urban regions, particularly Bihar and West Bengal. Additionally, infrastructure projects such as power and roads will provide further impetus to cement demand in this region.

West: Infrastructure and housing in urban areas

CRISIL Research expects demand for cement in the western region to grow by around 10 per cent CAGR from 201011 to 2015-16, as compared to a growth of 9.6 per cent from 2005-06 to 2010-11. Going forward, CRISIL Research expects demand for cement to be primarily driven by housing and infrastructure investments, especially in the urban areas. Growth in demand is expected to be largely urban-centric with rural demand growing at a slower pace.

Cement production and consumption in the West

P: Projected Source: CRISIL Research

Demand in the western region has increased, mainly on account of the real estate boom in cities such as Mumbai, Pune, Ahmedabad and Surat. Apart from this, there has been a strong demand from the infrastructure and commercial construction segments in Mumbai, Ahmedabad and Pune. Pune has emerged as an important destination for India's major IT companies, which has led to large investments in the commercial real estate space. Additionally, investments in urban infrastructure projects, roads and the metro rail project in Mumbai are likely to further propel demand for cement.

Central India: Rural projects, infrastructure and industrial investment

CRISIL Research expects cement demand in the central region to report a CAGR of around 9 per cent between 2010-11 and 2015-16. From 2005-06 to 2010-11, demand rose by 10.3 per cent CAGR. Demand in this region will be primarily driven by rural (housing and infrastructure) and hydel power projects being implemented in Uttar Pradesh. Road projects in this region are expected to further propel demand for cement.

Figure 6: Cement production and consumption in Central India

P: Projected Source: CRISIL Research

Rural housing is expected to contribute to healthy growth in demand for cement as a large section of the population in the region is expected to benefit from higher farm incomes, loan waiver schemes and alternative avenues of income generation due to higher government spending through NREGS. This region will also witness higher traction in implementation of key central infrastructure projects like Pradhan Mantri Gram Sadak Yojna (PMGSY) etc, coupled with rural infrastructure schemes like Bharat Nirman and IAY. CRISIL Research expects cement demand to grow by around 9 per cent CAGR during 2010-11 to 2015-16, primarily driven by: Infrastructure demand in mainly urban areas Independent housing projects in mainly semi-urban and rural areas

Infrastructure main driver of cement demand

From 2011-12 to 2015-16, the infrastructure segment is expected to grow by a robust 16 per cent CAGR, supported primarily by the government's renewed thrust on infrastructure development. CRISIL Research expects this segment to account for approximately 27 per cent of the total cement demand over the next 5 years. Between 2006-07 and 2010-11, infrastructure accounted for around one-fifth of the total cement demand in India. During this period, the segment registered a CAGR of around 12 per cent.

Break up of cement demand by end-user segments

P: Projected Source: CRISIL Research

Higher investment in improving the road network and increased cement intensity in road projects is expected to remain the key growth driver for the infrastructure segment. Moreover, continuing investments in the power sector, railways and increasing spend on urban infrastructure projects is expected to continue to provide impetus to growth. The increasing number of irrigation projects (especially in the southern region) is expected to further propel infrastructure growth.

Roads segment to propel cement demand growth in the infrastructure segment

Cement demand from the roads segment is expected to increase by 18-19 per cent CAGR from the 2006-07 to 201011 period to 2011-12 to 2015-16 period. As a result, the percentage contribution of roads in overall infrastructure demand is likely to increase to around 38 per cent from approximately 35 per cent over the same period.

Break up of cement demand for infrastructure segment

Source: CRISIL Research

Cement consumption in road projects is likely to increase primarily on account of: Higher spends on road projects owing to greater private sector participation on build-operate-transfer basis. Increased cement intensity in construction of roads due to: - Increase in the proportion of concrete roads as compared to bituminous roads - Use of paver blocks and concrete tiles - Construction of flyovers and structures

Housing segment to continue to account for a major share

While the housing segment accounted for almost two-thirds of the cement demand over the past 5 years, CRISIL Research expects its contribution to drop to around 57 per cent during the 2011-12 to 2015-16 period. During the past 5 years, urban housing propelled cement demand in the housing segment. While demand from rural housing grew by 5-6 per cent CAGR, urban housing demand witnessed a notable CAGR of 13-14 per cent from 2005-06 to 2010-11. The urban housing market has boomed over the last few years on the increasing affordability, change in the demographic pattern and growing number of nuclear families due to urbanisation and increasing finance penetration. From 2010-11 to 2015-16, demand from urban housing is estimated to grow by 8-9 per cent CAGR, largely on account of new housing projects in the urban areas. Rising rural income and higher government investment in rural areas have boosted cement demand in these regions. Rural housing is expected to contribute to healthy growth in cement demand, as a large section of the population in the region is expected to benefit from higher farm incomes,

loan waiver schemes and alternative avenues of income generation due to higher government spending through the National Rural Employment Guarantee Scheme (NREGS). This region will also witness higher traction in implementation of key central infrastructure projects like Pradhan Mantri Gram Sadak Yojna (PMGSY) etc, and rural infrastructure schemes like Bharat Nirman and Indira Awas Yojna (IAY). The magnitude of shortage in housing and the higher proportion of temporary houses in rural areas, coupled with rising rural income, are expected to provide significant impetus to rural housing, providing a sustainable driver for cement consumption. Over the next 5 years, demand from rural housing is estimated to grow by 5-6 per cent CAGR.

Share of commercial construction in cement demand to decline marginally

During 2010-11 to 2015-16, demand from the commercial construction segment is expected to grow by 8-9 per cent CAGR, primarily on account of expected pick-up in hiring in the IT/ITeS sector. However, CRISIL Research expects the share of commercial construction in total cement demand during this period to decline marginally to around 12 per cent from around 13 per cent over the previous 5 years. The commercial construction segment can be broadly classified into office space, malls and multiplexes, hotels and other civil structures such as hospitals and educational institutes. Of these sub-segments, demand from office space, especially from the IT/ITeS sector, accounts for over three-fourths of the overall commercial construction demand.

Research methodology: End-user model

To estimate cement demand from the end-user segments, CRISIL Research estimated the cement consumption in various end-user industries, namely housing, infrastructure, commercial construction and industrial.

To arrive at cement demand from these segments, CRISIL Research has applied cement intensity on various subsegments.

Housing demand: A demography-based income distribution model has been used to estimate the demand for housing in sq ft terms. Subsequently, cement intensity has been applied to arrive at the demand for cement.

Infrastructure demand: The expenses on various infrastructure segments such as roads, power, irrigation etc has been estimated, and then cement intensity for these segments applied to arrive at demand for cement from infrastructure. Infrastructure investments have been estimated based on CRISIL Research's internal coverage in many of the sub-sectors.

Commercial construction: Demand for cement has been estimated on expected consumption in construction projects of segments such as office space, retail space, educational institutions, hotels and hospitals.

Industrial demand: Industrial demand is based on the expected capital expenditure in various industries.

Bulk of capacity additions expected over the next 2 years

CRISIL Research expects around 89 million tonnes of cement capacities to be commissioned from 2011-12 to 201516. This is close to one-third of India's current cement capacity (India's total cement capacity stood at 284 million tonnes in 2010-11). Of this, a significant proportion (almost 65 per cent) is expected to come on-stream over the next 2 years. The pace of capacity additions is expected to taper off in the subsequent years, marking the end of the investment cycle in the industry. During 2006-07 to 2010-11, around 118 million tonnes of capacities were added in the country.

Installed capacity additions

P: Projected Source: CRISIL Research

At an aggregate level, the capacities announced by cement companies have exceeded CRISIL Research's estimate of around 89 tonnes over the next 5 years. The lower supply is due to: Equipment orders not placed with manufacturers Issues of land acquisition and limestone mining leases Deferment / cancellation of expansion plans on the back of huge oversupply in select regions

Southern and eastern regions to account for bulk of the capacity additions
Over the next 5 years, CRISIL Research expects majority of the capacities to be added in the southern and eastern regions, accounting for around 40 per cent and 35 per cent of the total capacity additions, respectively. Between 2006-07 and 2010-11, of the 118 million tonnes of cement capacities added, the southern region accounted for a major portion at around 43 per cent.

Region-wise share in installed capacity addition (2012 to 2016)

Source: CRISIL Research

Region-wise installed capacity additions

P: Projected Source: CRISIL Research

Around three-fourth of cement capacities to be added by existing players

In the previous capital expenditure cycle (during 1999 to 2003), several new players had set up cement capacities. However, in the current cycle, existing players are expected to account for over three-fourth of the total capacity additions. Moreover, with mid-sized and small-sized players collectively accounting for around 40 per cent of the incremental capacities, the market share of larger players like ACC, Ambuja and Ultratech is likely to decline slightly.

Player-wise capacity additions

Source: CRISIL Research

Blending ratio to improve marginally

Cement manufacturers blend cement to control costs and improve profitability. By blending fly ash or slag with Ordinary Portland Cement (OPC), cement producers can lower power, fuel and raw material costs, thereby improving operating margins. The blending ratio in the cement industry is expected to increase to around 1.30 in 2015-16 from 1.22 in 2010-11, as demand and operating rates improve. The increase in the blending ratio would be primarily due to higher acceptance of blended cement and an increase in blending by cement players. In 2009-10, the the blending ratio dipped to around 1.21 from 1.34 in 2008-09. Cement players had lowered the blending ratio in 2009-10, owing to a decline in cement demand coupled with increased clinker production. Also, lowering the blending ratio during the year were the large scale capacity additions witnessed over the previous 2 years.

Blending ratio and share of blended cement

Source: CRISIL Research

To forecast blending ratios, CRISIL Research has analysed the availability of blending materials, primarily fly ash and slag, in conjunction with the expected cement capacity additions. We have mapped the availability of blending materials to various cement production clusters and looked at the potential increase in availability over the next few years.

Cement supply to outpace demand in the near term

Over the past 3 years, additions to effective capacity have outpaced incremental cement demand, resulting in a decline in operating rates. Over the next 2 years as well, CRISIL Research expects cement capacity additions to significantly outpace demand. However, post 2012-13, with the end of the industry's investment cycle, this trend is expected to reverse.

Cement incremental demand and effective capacity additions

P: Projected Note: Effective cement capacity is calculated on a pro-rata basis, taking into account the month in which the capacity becomes operational. Source: CRISIL Research

Operating rates expected to bottom out in 2012-13

CRISIL Research expects around 89 million tonnes of cement capacities to be added from 2011-12 to 2015-16. Almost 65 per cent of these capacity additions are expected to come on-stream in 2011-12 and 2012-13. Consequently, CRISIL Research expects operating rates to decline, and subsequently bottom out in 2012-13. However, with the supply additions moderating from 2013-14, operating rates are expected to recover thereafter to around 85 per cent by 2015-16. CRISIL Research has calculated operating rates based on effective cement capacity. To estimate production at a regional level, CRISIL Research has forecast levels of cement exports and imports based on opportunity and accounted for inter-regional movement (inbound and outbound) across various regions in India based on distance, capacities in competing production clusters and player presence in different regions.

Cement operating rates

P: Projected Source: CRISIL Research

South and East expected to witness low operating rates

Over the next 5 years, the southern and the eastern regions are expected to witness maximum capacity additions, accounting for around 40 per cent and 35 per cent, respectively, of the expected total capacity addition of nearly 89 million tonnes over the same period. Conversely, the northern, central and western regions are expected to account for relatively fewer capacity additions - around 10 per cent, 4 per cent and 12 per cent, respectively. With capacity additions significantly outpacing incremental demand in the South, the region is likely to report the lowest operating rates, followed by the eastern region. On the other hand, the operating rates in the other three regions are not expected to fall below 75 per cent till 2015-16. The central region is likely to witness the highest operating rates over the next 5 years, followed by the western and northern regions.

Operating rates - North

P: Projected Source: CRISIL Research

Operating rates - East

P: Projected Source: CRISIL Research

Operating rates - West

P: Projected Source: CRISIL Research

Operating rates -South

P: Projected

Source: CRISIL Research

Operating rates - Central region

P: Projected Source: CRISIL Research

Profitability of cement players to plummet due to constrained pricing flexibility

CRISIL Research expects the cement industry's operating profitability to decline sharply to around 10 per cent in 2012-13 from approximately 20 per cent in 2010-11. This is because incremental cement supply is expected to outpace incremental demand over the next 2 years. Consequently, operating rates are likely to decline, bottoming out in 2012-13. According to CRISIL Research, cement players will lack pricing flexibility, with average pan-India cement prices estimated to marginally increase by around 1 per cent in 2011-12 and 2 per cent in 2012-13. One of the main reasons for the decline in the cement industry's profitability is the 30 per cent hike in coal prices by Coal India Ltd (CIL) in February 2011. Further, the Union Budget 2011-12 has proposed the replacement of existing excise duty rates with a 10 per cent ad-valorem rate and an additional Rs 160 per tonne of cement. This has effectively resulted in a 2-4 per cent increase in excise duty for the industry. The full impact of these two factors will be witnessed from 2011-12. Escalating input costs coupled with a weak operating environment prevalent in the cement industry is likely to constrain pricing flexibility of cement players, which will weigh down cement profitability over the next 2 years.

Operational performance of cement companies

Spiralling energy costs to lead to a decline in profitability

Power and fuel cost accounts for almost one-third of the total cost of sales of cement players. Further, coal costs account for almost 60 per cent of the total energy costs. While 55-60 per cent of the cement industry's coal requirement is through linkages, around 20 per cent is sourced from the open market. The remainder is met through imports. From 2010-11 to 2012-13, power and fuel cost per tonne is expected to increase by around 9 per cent CAGR, negatively impacting the industry's profitability. Owing to the price hikes by CIL, prices of both linkage and open market coal have risen by around 30 per cent. This is estimated to escalate power and fuel costs by Rs 140-150 per tonne in 2011-12 . However, in 2012-13, we expect further hikes in energy costs to be cushioned due to the efficiencies garnered from increased usage of captive power by cement players.

Higher lead distance to result in increased freight costs

Freight cost accounts for 20-25 per cent of a cement company's sales cost. Typically, cement companies prefer rail transport as it is more economical when compared to other modes of transport. However, in the recent past, the share of rail transport has declined due to constrains in the availability of railway wagons. Majority of cement dispatches (almost 60 per cent) takes place via road, which going forward is expected to remain at similar levels. Further, an overcapacity scenario in the industry will force players to transport cement accross longer distances. Consequently, CRISIL Research expects freight costs per tonne to increase by around 7 per cent CAGR from 2010-11 to 2012-13, leading to a further decline in profitability.

Review: April-June 2011

Muted demand prompts lacklustre performance
Growth in demand for cement continued to remain subdued at around 1 per cent during the first quarter of 2011-12. The low demand growth can be primarily attributed to a lower offtake of cement from the residential real estate sector. Sluggish demand coupled with overcapacity in the industry sharply pulled

down operating rates to around 74 per cent as compared to around 83 per cent in the corresponding quarter of the previous year. Despite the demand-supply imbalance prevalent in the industry, cement prices remained quite resilient. The average pan-India cement price during the April-June 2011 quarter increased by 10-11 per cent y-o-y. This increase was largely on account of production cuts resorted by players.

Revenues of both, large and mid-sized companies increased at a healthy rate of around 12 per cent y-o-y. Growth in revenues was largely driven by an increase in realisations. While volumes of large companies recorded a marginal increase of 1-2 per cent, those of mid-sized companies remained almost flat.

The industry's operating margins fell by 60 bps y-o-y. An increase in input costs, especially those of power and fuel, primarily led to this decline.

Outlook: July-September 2011

Monsoons to plague operating environment further
With the ongoing monsoons, CRISIL Research expects demand for cement to remain fairly subdued, registering 6-7 per cent y-o-y growth. Muted demand, combined with the existing supply glut, is expected to further drag down operating rates to around 69 per cent as compared to 72 per cent in the corresponding quarter last year. Despite the weak operating environment prevalent in the industry, constraints in cement supply are likely to continue to support prices during the quarter. Though the average pan-India cement price is expected to decline sharply by 11-12 per cent on a q-o-q basis, it is estimated to register a 9 per cent y-o-y increase.

The impact of the hike in coal prices by Coal India Ltd towards the end of February 2011, will continue to weigh on player profitability. Thus, industry operating margins are likely to remain under pressure, driven by rising input costs and muted demand growth.

Operating rates declined; Prices grew y-o-y

Note: The above prices are without considering discounts Source: CRISIL Research

Prices highest in the eastern region

Source: CRISIL Research

Financial analysis
Large-sized companies
Sales registered healthy growth y-o-y

Source: CRISIL Research

Profitability declined marginally

Source: CRISIL Research

Mid-sized companies
Sales witnessed robust y-o-y increase

Source: CRISIL Research

Profitability increased marginally

Source: CRISIL Research