What are the different ways cement companies can find funds – for various aspects of running a cement manufacturing organisation? Whether it is working capital, capex or hybrid consisting of debt or equity – what are the best options? K C Birla expostulates on the various modes and explains that companies should have systematic approach of risk management relating to leveraging and debt servicing.
The demand for cement in India over the past several years has grown in tandem with domestic economic growth, making the country the second largest consumer of cement in the world, after China. In the last decade, cement demand has grown consistently at a multiple of ~ 1 – 1.2 times of domestic GDP growth underpinned by the rising demand for housing and infrastructure.
As of March, 2011, India’s cement market was the second largest in the world with a capacity of 300 million mtpa from over 165 plants owned by 52 producers. Top 6 players control more than 60 per cent of the market share. Another 100 million mtpa is expected to be added by FY15.
Indian Cement Sector Outlook:
Aggressive capacity addition resulting in overcapacity, rising raw material and energy costs is adversely affecting the profitability of cement producers. However low per capita cement consumption at 173 kgs as against the world average of 425 kgs, expected government spending on infrastructure (XIIth Five Year plan expected spending: USD 1 Trillion), demand for mass housing reflects potential for future growth. The current overcapacity in the industry seems temporary.
Financing Requirement:
The 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 promoters / 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 8 per cent. The sector profitability improved which was ploughed back in further capacity addition.
The financing needs of sector are broadly categorized into Working Capital, Capex and General Corporate purposes.
Working Capital Financing:
- Fund Based – To meet core and other working capital requirements.
- Non Fund Based – Letters of credit to be given to suppliers of raw material, fuel, spares, capital expenditure payments etc.; Bank Guarantees to be given to Railways, coal suppliers and performance guarantees, etc.
Working Capital: 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.
Buyers Credit & Suppliers Credit:
Apart from use of Cash Credit, WCDL & Packing Credit, companies also use Buyers Credit & 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 or General Corporate Purpose (Long Term Financing): Companies need Long Term financing usually for expansion, setting up of new capacities, setting up of Captive power capacities, acquisition of other companies. etc. Long Term financing usually takes the form of Equity, Debt, Hybrid (Mix of Debt & Equity).
Equity: It is a permanent form of money which is mobilised by the promoters and through public participation. Raising money through equity depends on the capital structure of the company. In case of an established company promoters can invite Private Equity (PE) funds to fund the company’s growth plans. Besides companies can also look forward to issuing ADRs/GDRs in foreign capital markets.
Debt: Companies access the Debt market through Banks and other FIs. Depending on the financial strength, companies evaluate 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 Banks/FIs for securing their exposure.
Common Modes of Long Term Financing: Local Markets: Equity, Debentures, Rupee Term Loan etc. Foreign Markets: ECB, Buyers Credit, ECA, FCCB, GDR etc.
- Capacity expansion in the industry is funded through a mix of internal accruals and Long Term loans.
Determinant of Financing Mode:
For raising Long Term funds the industry uses various financing instruments in the domestic as well as the foreign capital markets depending upon the ultimate interest cost, accessibility to various markets and risk appetite etc.
Besides that various State Government also provide incentives for capital investments in their States in the form of Interest Free Loans (Conversion of Sales Tax Liability into interest free loan). In the recent past Sales Tax Deferment loan have constituted a significant portion of the total loan component.
Credit Rating:
Credit rating plays an important role in deciding a company’s access to capital markets and the overall cost of financing. Companies in the sector frequently get their Long term and Short Term debt rated by the rating agencies which support their quest for financing. Under Basel II norms Banks are required to make provision based on credit rating of the companies. Higher rated (investment grade) companies get cheaper financing relative to companies with lower rating.
- 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 as a % of total loan portfolio has reduced drastically from 34% in FY06 to 14% in FY10.
FC/Rupee Term Loan: Appeal of Foreign currency loans in the form of ECBs 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% in FY 06 to 57% in FY10.
- Sales Tax Deferment Loan: Industry players often put up Projects in States where in fiscal incentives are provided by State Govt. Appeal of incentives provided by various government has attracted the industry which is evident from the increase in Sales Tax Deferment loan as a % of total loan. Interest Free Sales Tax deferment loan also improves the overall weighted average cost of the borrowings.
- Foreign Currency Convertible Bonds (FCCB): Some of the players in the sector also accessed the international markets by issuing FCCB. It had an option to convert the Bonds into equity at a pre-determined price on a specific date. The companies faced lot of problem in converting these into equity due to fall in share prices, hence these continued as loan.
- Many players have tied up with International Finance Corporation (Washington) for financing their capex needs. Companies can also access ECA financing from the Exim Banks of the countries from where they are importing major equipments i.e. Hermes and Coface .
- The companies in recent past also used equity route to finance their growth plans. The private equity players played key role in development or expansion of some of today’s large cement cos.
MNCs Financing Pattern:
MNC’s generally borrow in local markets for local expansion and for acquisition financing they opt for offshore financing based on cost benefit analysis.
Risk Management:
Risk management is becoming an integral part of financing decisions. Companies borrow in foreign currency at cheaper rates, however the same has inherent interest rate and currency fluctuation risk. These risks can be limited / eliminated with the use of various derivative instruments viz. Interest Rate Swap (IRS), Currency Swaps, Options etc. The sector has started the use of various derivative instruments as part of their risk management strategies and financing decisions.
However the sector faces the following challenges:
- 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 mobilizing money is also not cheap. Equally PE money is costlier as PE funds require exit route at a higher price.
Hence companies should have systematic approach of risk management relating to leveraging and debt servicing. K C Birla is a professional working with a listed public company. The views expressed in the article are personal.
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