Tuesday, November 24, 2020

Cement Sector seems set for revival

Wiki definition of cement is “A cement is a binder, a substance used for construction that sets, hardens, and adheres to other materials to bind them together. Cement is seldom used on its own, but rather to bind sand and gravel together. Cement mixed with fine aggregate produces mortar for masonry, or with sand and gravel, produces concrete."

Here is a brief video from Lafarge explaining the production process of Cement.

In short, limestone is extracted from mines, is grinded to a manageable size before being heated using coal / petcoke/ lignite to produce clinkers. Roughly 1.4 tonnes of limestone produces 1 tonne of clinker which along with other additives transforms into 0.8 tonne of cement. Nearly 100-110 kWh of power is required for producing one ton of cement.

There are different types of cement types available in the market depending upon the kind of strength, longevity, or other requirements (See link). Higher the presence of clinker, stronger is the cement, but lower is the margin.

Companies also sell blended cement which partially replaces the usage of clinker with waste products like fly ash and slag. So, blended cement is a more environmentally friendly and a higher margin product. Slag is the waste product of steel plants and fly ash is of coal-based power plants.

Industry Overview

The Indian cement industry is only second to China in cement production, accounting for 8% of total global capacity. The per capita consumption of cement in India is also low ~225 kgs compared to a global average of 575 kgs, indicating headroom for growth in the cement industry.

India has abundant limestone reserves and it’s production comprises of 90%+ of all non-metallic production in India. India has seven clusters which houses majority of cement plants in the country: Chanderiya (Rajasthan), Satna (Madhya Pradesh), Chandrapur (Maharashtra), Bilaspur (Chhattisgarh), Gulbarga (Karnataka), Yerraguntala (Andhra Pradesh) and Nalagonda (Andhra Pradesh).

Despite the abundance of the mineral, key limestone bearing lands/mines are already being taken up by the incumbent players. Sourcing of new mines and erecting a cement plant on greenfield basis has become increasingly difficult and time consuming.

In terms of domestic market, South accounts for 34% of total production while Central India enjoys highest utilization (82%).

Being a capital-intensive industry, it is dominated by a few companies. It is not easy to consistently add capacity to stay relevant in a price sensitive, commodity market where even big players struggle to set prices sometimes. The top 20 cement companies account for almost 70% of the total cement production in the country.

For a new player, the barriers to entry stay high as the processes right from procuring limestone mines, lands, setting up plant, getting environmental clearance is time consuming and expensive process. It takes anywhere between 5-7 years from concept to start of the first production and between $130-140/tonne for a Greenfield integrated project, while for a brownfield grinding project the average project cost was ~$50/tonne.

Cement is also an energy-intensive industry. Nearly 100-110 kWh of power is required for producing one tonne of cement. This constitutes 15-20% of the total cost of sales.

The other major cost for a cement company is the freight cost, which accounts for 15-20% of the total. Cement companies rely extensively on transportation for moving coal from the coal pitheads to the cement plants and for dispatching cement from the plant to the market.

As freight costs are a big component of cement company’s operating cost, it becomes imperative for a player to balance its distance between the limestone mines and its nearby markets. That is one of the main reasons that cement is a regional play. There are only handful of players like Ultratech, ACC which have pan India presence.

There has been a continuous shift towards blended cement because it helps save limestone by replacing some clinker requirement and blending fly ash or slag with OPC (which are available at marginal cost vs. Limestone). There are also savings on power and fuel (due to lower consumption of clinker) and freight cost (lesser clinkers needs to be carried from one place to another).

Industry Performance

Indian cement demand grows along with improvement in general economic activity. Long term demand growth of the sector is roughly 1.2x GDP growth.

Industry, after enjoying a healthy demand growth of ~ 13% in FY19, exhibited a decline in growth in this financial year. During FY20, cement demand was sluggish due to the general economic slowdown, lower capex on infra and road activities and financial stress in the NBFC and housing sectors.

The govt. did its bit with taking steps to rationalizing income tax rates to boost fresh investments by corporates in the country. RBI on its part also undertook much needed measures of rationalizing its policy rates and increased the liquidity in the banking system.

All these measures are yet to bear any fruit due to outbreak of COVID-19.

The sector also reels under overcapacity as Shree Cements highlighted in their AR 2020. There is some 150MT excess capacity in the sector as highlighted by Ultratech in its Nov 2019 presentation.

Life since Covid-19 breakout

Outbreak of coronavirus dealt a blow to already reeling cement sector as economy came to halt as government announced lockdown.

Since the relaxation of lockdown restrictions, cement companies had undertaken an average price hike of Rs 30-35/bag (8-10%), which largely sustained until June 15. Industry has seen some rollbacks to the tune of Rs 10-15/bag from June 15.

Cement demand growth continues to play hide and seek as western and southern region saw heavy monsoons and extended localized lockdown also curtailed supply and logistics.

The growth in cement has started picking up as NHAI continued to execute its planned work under its roads and infra projects; private demand to finish off pending construction work and govt sponsored scheme to provide work to migrant labour in rural and semiurban areas.

In summary, outlook for the economy in the near term is not encouraging. However, as structural long-term growth story of India remains set on its path and merging of both fiscal and monetary response from the govt and RBI, the Indian economy will emerge stronger from this crisis.


After arriving at the conclusion that the cement sector is facing headwinds for the short term and long-term structural story of the sector is intact, one can deep dive into individual stock stories. 

There are several good companies from the house of Birlas, Holcim-Lafarge, Dalmias, Bangurs available for investment.  

For my purpose, I intend to keep an exposure to the sector by allocating small capital to top ideas that come out of my screening.  I filtered out all the companies from the listed cement universe which were less than INR 1,000 crores market cap and are loss making. I am left with 14 companies that fit my criteria. These 14 companies account for more than 90% of listed market cap in cement universe in India.

Afterwards, I proceeded to rank all these companies on the basis of EBITDA / tonne – a measure of operating efficiency for cement companies, higher the better; Net Debt / tonne – how levered the company is, specially important metric for cyclical stock, lower the better; ROCE – measure of capital allocation skills of the management, higher the better.  

Here is the larger cement universe that fit my initial screen attempts.

And in the final step, I remove all net debt positive firms from the remaining list.

Final screen consists of only three firms – Star Cement, Ambuja Cement and Heidelberg Cement with average EBITDA/ton ~ 1600, net cash firms with 3y average RoCE ~ 20%. 

Here is a quick snapshot of the cement stocks performance in past one year.

Although I am confident about the fact that revival in the cement sector is on cards, I do not have conviction in single cement stock for buy and hold for long term investing. However, I do intend to build small trade position in these stocks at the current levels to take exposure to play sector recovery and continue to monitor and update my portfolio based on the developments.

One can argue that stocks have run up quite a bit since hitting lows in March. However, the companies with low/negligible leverage, better capital allocation skills and cost efficiencies can grab market share from small players. Much remains to be seen how the covid19 recovery trade players out and whether all these anticipation rallies actually lead to recovery in activity in coming year.

Saturday, August 22, 2020

VIP Industries - All my bags are packed and I am ready to go

What does the company do?

VIP Industry is a household name in India when it comes to luggage and travel accessories. It is India's largest luggage company (46% market share) and world's second largest company just behind Samsonite. The company has been in the business since 1971 and operates across categories of hard luggage (the ones with rigid exteriors) and soft luggage ( ones with fabric exterior) along with travel accessories (a toiletry bag for example). During recent times, company has transformed itself from a sleepy briefcase/suitcase, buy once and forget brand to a strong, flexible, trendy and more youthful brand.

How does company earn its money?
VIP has a formidable presence across all price ranges. It sells its luggage under Alfa brand in mass market segment in <Rs. 3000 range, Carlton in premium range > Rs. 6000 and other brands such as entry level Aristocrat, trendy backpack brand Skybags and most popular VIP brand in mid Rs. 3000 - 6000 segment. They also added a ladies handbag brand Caprese in their portfolio which is gaining good traction in the market achieving Rs. 100 crores sales target in 2018.

Company sources its products from China, third party vendors in India and manufactures own products in India and Bangladesh. It has recently started reducing its dependence on China as wage inflation there was hurting its gross margins. Moreover, VIP has less inventory control as they sourced finished goods from China. Move to Bangladesh although was started earlier, however, it has accelerated with the spread of coronavirus and govt. imposition on Chinese imports.

Imposition of GST has also been of great help as business is shifting from unorganised (~60% of total market) to organised retail and also presents a massive room for company to grow and gain market share.   

The Indian luggage industry is pegged at more than Rs. 8000 crores and has grown at CAGR of 13% in FY14-19. The organized market is oligopolistic in nature and is dominated by VIP, Samsonite and Safari Industries. Marriages and travelling are main drivers of its sales and rising trends in tourism and Indians travelling abroad has given a major thrust to the industry. With leisure travel taking a backseat, FY21 is going to be a challenge for the industry, although some signs of revival are seen in European countries.

The industry is slowly moving away from a utility based product to a lifestyle product which is leading to growth towards fashionable, premium products which are leading to better realizations. Many market surveys have indicated that customers are becoming brand conscious and are willing to spend few extra bucks to carry a brand and luggage design which suits their taste. Recent trends are also pointing towards increase in number of luggages per family as members travel with their individual luggage and also carry different luggage as per occassion (business travel vs. casual travel).

As GST implementation has reduced the cost advantage of unorganized players, the market share gains of organised players is inevitable. Among the organized players, leaving aside new entrants like Wildcraft, Da Milano etc, almost 90% of the market is split among VIP, Samsonite and Safari. These brands compete in almost all segments, with Safari having stronger presence in mass market segment and Samsonite in premium segment. VIP earns better margins than Safari (the only other listed player in the industry), which is only going to increase as cost base move from China to Bangladesh. The return profile of VIP (5y RoE avg of 23% and 5y RoCE avg of 34%) is also better than Safari (5y RoE avg of 6% and 5y RoCE avg of 10%). 

Past Performance and Look ahead
VIP Industries has shown decent revenue growth of 12% during FY11-19 period (10% CAGR in FY11-20) due to its established brands, strong distribution network and more than 1500 SKUs. Covid induced lockdown has hampered sales everywhere with 1Q21 sales being only 5% of what company budgeted and company shutting down stores, the current FY looks challenging for the company and it is expected that FY21 sales maybe 20 - 30% of FY19 sales.

Company is expected to improve its margin profile as sourcing from China was mostly of finished goods which generated lower margins than manufactured goods from Bangladesh and India.  Govt policy, rising wage inflation in China and Covid situation has compelled the company to reduce its dependence on China. In current year, due to reduced demand, the company has to hardly import anything from China. Once the demand side recover, VIP would be able to earn better margins from its products.

To overcome this reduced demand scenario, the firm has plans to borrow around Rs.300 Crores to have a war chest for these tough times. Although company is zero net debt till the end of July 2020, it has prepared for the scenario where it honours its commitments to its creditors and debtors and sustain for few months without revenue in worst case scenario.

Conclusion - Accumulate. Current Market Cap: ~Rs. 4000 crores.
As Morgan Housel pointed out that Jeff Bezos' success lies not in predicting what will change in next 10 years, but what will remain the same (like fast delivery of better products at lower costs). Same principle applies to travel industry and everything that goes and grows with it. Traveling and exploring new places is a basic human need and sooner than later, people are going to move out and travel at the first opportunity they will get. 

As the market bounces back, so will the aspiration of people. India, with its young population, rising living standards, many first time travelers and brand consciousness provides a huge growth opportunity to luggage players. Replacement frequency for luggage bags has also dropped from 4-5 years to 2-3 years now. 

Organised players like VIP Industries have been constantly upgrading their offerings and improving better after-sales services which will help them wrest market share from unorganized players. With unorganized players still holding ~80% share in volume terms, the opportunity size for VIP is huge.

As the world slowly starts emerging out of Covid 19 induces lockdown, VIP industry is a good proxy play on recovery of travel and tourism industry in India. With its better distribution network, strong brand and ability to earn better returns on capital, VIP is a long term buy

Risks related to travel bans, second wave of Covid 19 and inability of the company to gain market share when market recovers can create headwinds for the company. It is prudent for investors to closely monitor the travel related announcements, any commentary on operating performance from the company or any other industry development that can affect the growth prospects.