There is a lot of good news going round regarding the cement industry. Companies are reporting improved numbers, analysts are agog with positive forecasts, brokers are issuing "buy" advices, government data is showing impressive growth month-on-month, and almost everyone is projecting a 7 to 8 per cent demand growth in FY19, and also for the next few years. By all accounts, one can safely assume that the industry has recovered from the slump of the last few years, and is well on its way to consistent growth in coming years. The market appears to have bottomed out and is on an upward journey again. Good news indeed!
Cycles are ups and downs, crests and troughs. In scientific terminology, cycles are waveforms, and in economic terms, these represent extreme periodic volatilities, from one extreme to another, more like a swinging pendulum. The famed commodity cycles are today matters of MBA curriculum and business folklore. The genesis of these cycles, their fascinating recurrence, the certainty of these cycles as well as the mystery behind them, have all been researched and analyzed to death. In fact, sometimes this so called cyclicity in itself is considered as the hallmark of commodities. All commodities such as metals, fertilizers, fuels, cements, tend to go through this characteristic phenomenon.
Leaving aside scientific or economic semantics, what does these cycle mean, in terms of business outcomes? Some would say this signifies the inevitable swing from supply overhang to demand overhang playing out. Some others might say, these cycles mean changeover from Profit to Loss, and share market watchers will say these cycles mean bearish trend turning into bullish, and vice versa. Actually, the commodity cycles can mean all of these, but the most important visible outcome for companies, is the sharp ups and downs in their bottom lines through these cycles. I remember that we once did an empirical study of the historical profitability trends of a few listed cement companies in India over a longish period of time, based on published numbers to explore the cyclic behavior of the industry. Though rather limited in scope, the study threw up a fascinating corroboration of the classical cyclicity theory, in that we found clearly discernible wavy patterns in EBITDA numbers over a period of 9 to 10 years.
So, we know that it happens, but do we understand why or how it happens? A very simplistic answer has always been that when we have a shortage, meaning demand overhang, the industry gains stronger pricing power, resulting in better profit numbers and higher attractiveness of the sector to investors which in turn makes people rush in with new investments for creating more capacities, and the cycle repeats. The reality may be close to this explanation for some commodities, but for some others like non-ferrous metals, for example, there may be more factors in play than just pure supply v/s demand.
Staying with cement, and assuming EBITDA margin to be a reflector of profitability, one can find that between 2008-9 to 2016-17, the EBITDA margins of bellwether companies such as UltraTech and ACC have fallen drastically, from 33 per cent to 21-22 per cent for UltraTech, and from 33 per cent to 13-14 per cent for ACC. This sample is a pointer that the industry went into a trough after peaking in 2008 or 2009, and if all current projections turn out to be true, then the next peak in the cycle is not far away.
What we are about to witness is a confirmation or a demonstration of the classical decadal cement cycle.
Sumit Banerjee
Chairman, Editorial Advisory Board