The Hindu Business Line : Cement: Lower valuations trigger M&A

With a volume growth of over 9 per cent per annum in the last three years, the Indian cement industry has drawn the attention of many foreign bigwigs over the years. The stimulus for entry into the Indian cement sector is getting stronger with valuations tumbling sharply.

From the peak of 12 times (trailing 12 month earnings) in December 2007, the industry’s average PE is down to 7 times currently. Falling valuations are making the small and medium-sized players in the industry more vulnerable to foreign acquisitions.

Measured in terms of capacity, specific examples give a picture of falling valuations. Vicat’s stake buy in Sagar Cements valued at $98/tonne in June this year is much lower than what Holcim paid for a stake in Ambuja Cement ($214/tonne) in 2006. Ambuja Cement’s PE has fallen from its peak 22 times in 2006 to 11 times now.

Margin Pressure and Falling Valuations

Rising input (coal, fuel and power) costs and regulatory measures to check cement prices have left limited room for players to benefit from a strong demand scenario to improve their margins.

This has hit cement stocks badly since January this year. Adding to the concerns are expectations of large new capacities coming on-stream from mid-2009-10, which may lead to a demand-supply mismatch.

The near term outlook for the sector is also modest with the onset of monsoon months.

With the uptrend in cement prices arrested (only prices in the South have firmed up in 2008), since January and a significant increase in costs of inputs such as coal (up from 60$ per tonne last year to 164$ currently), players have witnessed substantial margin erosion in the March 2008 and June 2008 quarters. The bleak outlook on prices, combined with deteriorating quarterly numbers, has seen many cement stocks come down to their 52 week lows in July.

The decline in valuations has also trimmed the enterprise value per tonne of the major cement companies, down by an average 42 per cent since the beginning of this year. Smaller companies have suffered a sharper de-rating than larger companies. Mangalam Cement’s EV per tonne has fallen 50 per cent (from Rs 4,384 per tonne in December 2007 to Rs 2,167 currently). Prism Cement too saw its EV per tonne fall by over 52 per cent between December’07 and June’08.

These could be a further trigger to domestic consolidation or acquisitions by foreign players.

M&A deals this year

La Farge (France), Holcim (Switzerland), CRH (Ireland), Cemex (Mexico), Italicementi (Italy), Vicat SA (France) are some of the foreign players who have reportedly been on the prowl for acquisitions of late. Switzerland’s Holcim, one of the early entrants into the Indian market, now holds a 41 per cent stake in ACC and a 36 per cent stake in Ambuja Cements, two of the largest cement manufacturers in India. Further, the Swiss major has also declared intentions of increasing its investments in the country over the next five years.

Not to be left behind, La Farge acquired the RMC (Ready-mix concrete) business of L&T in May this year.

The other recent instances of M&A related to smaller companies are: CRH’s acquisition of My Home Industries and Vicat’s buyout of a 6.6 per cent stake in Sagar Cement. CRH announced a 50 per cent stake acquisition in My Home Industries in March for a consideration of $452 million, which worked out to Rs 5,692/tonne. The company’s (My Home Industries) capacity then was 3.2 million tonnes which it proposed to increase to 4.2 million tonnes. Vicat, which has presence in countries including the US and Switzerland, took over 6 per cent stake in Sagar Cements (capacity: 2.5 million tonnes per annum) for Rs 70 crore, paying Rs 4,214/tonne. Heidelberg too consolidated its holdings by bringing Mysore Cement and Indorama Cement under its fold.

The cases of overseas players buying into Indian firms have also been accompanied by internal consolidation.

A few instances: L&T’s cement division taken over by Grasim, ACC taking over IDCOL Cement, Grasim taking over Shri Digvijay Cements, Gujarat Ambuja taking over stake in DLF Cements and Modi Cement.

Case for Consolidation

Acquisitions in the Indian cement space have happened through business cycles, consisting of both boom and lean phases. During lean times, volume growth plays a significant role in earnings performance prompting larger players to add capacity through acquisitions. The previous such lean phase between 2000 and 2003 saw many smaller companies exiting the business. During boom phases, promising growth prospects end up attracting new entrants, as was the case in the 2004-2005 period.

The only difference is M&A deals in the boom times fetch the acquired company much higher valuations than those struck at lean times.

In the current scenario, with price increases capped by regulatory intervention as well as impending supply, better operational efficiency and geographical diversification may be crucial for players to deliver growth over the next few years. Acquisition may be the quickest route for larger players to add capacity. On the other hand, capacity expansion and de-bottlenecking exercises, which can aid volume growth, obviously call for additional capital investment which smaller companies may find difficult to mobilise in the environment of rising interest rates.

Larger domestic and foreign players bring with them better technology (in usage of alternate fuels) and access to more avenues for capital mobilisation. All this suggests that though the earnings outlook for cement companies is not too bright at this juncture, they may still hold potential as consolidation plays out.

The attractive valuations at which smaller players are available may set the ball rolling for further consolidation in the industry.