Cement is among the most vital ingredients required for the growth of an economy. A growth in demand for cement reflects an uptick in the activities in the business, financial, real estate and infrastructure sectors of the economy. In the last decade, cement demand has grown consistently at a multiple of over 1-1.2 times of GDP growth underpinned by the rising demand for housing and infrastructure. To meet this demand, cement companies invested briskly in expanding capacities leading to increased fund need. However, innovative methods of financing is still evolving in this brick and mortar industry. The cement industry requires financing for its working capital and capital expenditure requirement. Working capital cycle starts right from the time of material procurement, production and sale of finished goods till the realisation of sales proceeds. The primary requirement is in building up raw materials, additives, fuels, stores & spares, clinker and finished goods inventory. Debtors are generally in non-trade segment of business. The sector incurs capital expenditure for its regular capex requirement, expansion of existing capacities and setting up of new capacities.The development of industry post decontrol was dependant on fiscal incentives, financing from international institutions (IBRD, etc) and local developmental financial institutions. With the passage, just as the industry has evolved, the development financial institutions too have become banks.During the early stages, capacity addition was dependent on promoters and leveraging capabilities. The debt equity ratio of sector used to be 2 to 2.5 times of debt to equity. The sector profitability was weak so promoter/companies used to survive on fiscal incentives provided by the government. The construction activities were weak and companies were not having the financial motivation to expand. Thus, despite being one of the oldest industry, no company could acquire/add sizeable capacities to reckon with.With the opening up of the economy in 2001, together with a flourish in information technology, communication and entertainment (ICE) sectors, the demand for cement saw a sustainable growth of over 8 per cent. The profitability improved which was ploughed back in further capacity addition.
Working Capital Financing
Working capital needs are met through traditional banking channels. Companies opt for working capital arrangements through (i) consortium banking arrangement or (ii) multiple banking arrangement. The common modes of financing working capital are cash credit, WCDL, export packing credit, etc. However, the following two products also help companies in managing working capital.Apart from use of cash credit, WCDL & packing credit, companies also use buyers credit and supplier’s credit facilities provided by various banks. Under the buyers credit facility, banks pay to the company’s import vendors and company pays to the bank on a pre-determined date with interest. Similarly companies also use supplier’s credit facility.
Channel financing: To reduce debtors in their books, companies use channel financing for its large dealers. Bankers do their own due diligence and provide credit facilities to dealers which are exclusively used for payment or clearing dues of the company. The onus on the company is the continuity of dealership. If there is disruption, companies are required to inform the banks.
Financing of Capital Expenditure
Long term financing usually takes the form of (i) equity (ii) debt and (iii) hybrid (mix of debt & equity).
Equity: It is a permanent form of money which is mobilised by the promoters and through public participation. In case of an established company promoters can invite private equity funds. Besides companies issue ADRs/GDRs in foreign capital markets.
Debt: Companies raise debt through banks and other FIs. Depending on the financial strength, companies evaluates the various debt raising options. Debt raising can be done in (i) foreign currency and (ii) rupee, and can be further segregated into secured and unsecured borrowings depending on whether any collateral has been provided to the lender.
Common Modes of Long Term Financing
For raising long term funds the industry uses various instruments in the domestic as well as the foreign capital markets depending on the interest cost, accessibility to various markets and risk appetite, etc.Debentures: Over the years industry has reduced the use of debentures as a mode of financing due to high interest as well as compliance cost. Proportion of debentures has reduced drastically from 34 per cent in FY06 to 14 per cent in FY10.
FC/Rupee Term Loan: Foreign currency loans in the form of ECBs appeals the industry due to its low cost and rupee term loan due to its relatively low cost and flexible end use. Requirement has increased as is evident from the increase in its proportion of 48 per cent in FY 06 to 57 per cent in FY10.
Sales Tax Deferment Loan: Appeal of incentives provided by various government has attracted the industry. Interest free sales tax deferment loan also improves the overall weighted average cost of theborrowings.Foreign Currency Convertible Bonds (FCCB): Some players also access international markets by issuing FCCB. It has an option to convert the bonds into equity at a pre-determined price on a specific date. Many players tie up with IFC for financing their capex needs. Companies also access ECA financing from the Exim Banks of the countries from where they are importing major equipments, ie, Hermes and Coface.
MNC’s generally borrow in local markets for local expansion and for acquisition financing they opt for offshore financing based on cost benefit analysis.
Challenges faced by the industry
- With rise in capital cost and longer time for implementation, judicious mix of internal accrual, equity and debt became critical.
- Locally long term maturity debt papers can be placed only with life insurance companies or some banks.
- Cost of borrowing in foreign currency (ECBs) is still competitive with full hedging as compared to domestic borrowings. But keeping the currency risk and interest rate risk unhedged may result/put companies into deep trouble.
- With over capacity in the sector, the equity route for mobilising money is also not cheap. Equally PE money is costlier funds require exit route at a higher price.
- Hence companies should have systematic approach of risk management relating to leveraging and debt servicing.