Cultural revolution to gain better momentum

Last year, in February 2019, Ground View (GV) wrote about the rising importance of supply-chain efficiencies in the cement sector. Though cement supply-chain is a vast topic, in this GV, it pertains to the industry’s business practices in outward logistics and marketing. Supply-chain efficiencies will be a long-term fundamental ‘game-changer’ for the industry and in the after effects of the COVID-19 pandemic, the industry will have to re-look at related business practices in greater depth and improve them. So, the pandemic is in fact a blessing in disguise and provides a golden opportunity to the industry to structurally change the culture and behaviour of the on-the-ground participants – as highlighted in the previous edition of GV titled “Cement: A Cultural Revolution”.

The Hypothesis

• Existence of five cement companies – Alpha, Bravo, Charlie, Delta, and Echo – that differ in size, scale and area of operations. • These five companies account for over 51% of the industry’s current capacity and are therefore a fair representation of what is happening in the industry. • These companies are also among the leading cement manufacturers of the country.  

Background

It is widely believed that understanding the cement industry is about analysing demand, prices, and operating costs. If the demand is adequate, costs are low, and cement prices are high, it is believed that the sector or a company is well placed in terms of its earnings; and this is largely true. The reality is that over the last 10-15 years, almost all cement manufacturers have worked extremely hard on improving plant efficiencies. They have done this by making them more power efficient, installing waste-heat-recovery power plants, lessening heat consumption by reducing kcal/kg of clinker production, increasing overall fuel consumption parameters, improving blending ratios, upgrading production technologies regularly, debottlenecking, etc. Over this period, cement prices increased largely in-line with cost inflation, though they were at times volatile. But then, the final net realisations and operating costs of cement manufacturers are highly dependent on their individual supply-chain efficiencies. Despite the sector improving its cost efficiencies and cement prices rising in this period, the underlying profitability of cement companies in terms of EBITDA/tonne was almost stagnant; rather it contracted at times. Adjusting for the time-value of money for the past 10-15 years, profitability has diminished, implying the efficiency improvements at the plant level have not delivered desired results. Most times, the blame falls on cement prices – that they haven’t risen enough. However, regions where cement prices are the highest, delivered the lowest profitability, and regions where cement prices remained relatively low have been stable, sustainable, and better off in terms of profit matrix. These discrepancies raise questions about missing elements to improve operating earnings that have not drawn the desired attention of cement makers, over the past many years. Production cost for the industry stands at c.42% of total realisation structure (inclusive of Goods & Services Tax (GST)) and the balance c.58% falls under supply-chain – marketing and outward logistics. This forms a significant cost for the industry and needs greater attention from cement manufacturers to improve operating earnings, which has unfortunately not been a case in the past for all.

Reasons for increasing importance of supply-chain efficiencies

Looking for an earnings delta beyond production is now a natural move The last GV highlighted that stricter production compliance would lead to very limited incremental production gains. Be it limestone mining procedures, monitoring of trucks and other transport vehicles at plant operations, emission and environmental norms, social responsibilities, regulations and stringent monitoring mechanisms by state and central governments would make it very difficult for cement manufacturers to get an additional earnings delta from plant operations.
Stricter production compliance will make earnings delta from plant operations more challenging.
Because of this, cement manufacturers would naturally search for earnings delta beyond production efficiencies. The obvious answer is that it can only come from better cement prices, but this is only partially true. Cement manufacturers are always looking to increase cement prices, with or without an improvement in demand, to capture an additional delta for their operating earnings. The blame game among cement manufacturers over price wars is an additional negative for the sector. Therefore, the key underlying to estimate and track operating earnings is always largely price increases or rollback announcements. Coincidentally, one of the arguments presented in this supply-chain thesis is also that some cement companies with the lowest cement realisations, have the highest EBITDA. Conversely, some companies with very high realisations, have dismal EBITDA.
Supply-chain efficiencies are internal business practice improvements, independent of quoted cement prices and market forces.
Getting better on supply-chain is a matter of individual choice The best part about supply-chain efficiencies is that they are more dependent on internal improvements in ongoing business practices of companies, and less dependent on market forces. At a constant market price, how can a company improve its EBITDA/tonne? This earnings delta (which is immense) can come from improvements in supply-chain efficiencies and it is a directional journey. It can be driven by ‘desire’ or ‘intent’ on the part of the company through better vigilance and execution.