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Cement-makers have recently raised the price of a 50-kg bag by Rs40-50. This hike will be 15-25 per cent higher compared to existing price levels of Rs235-240 per 50 kg bag.
Many factors may have led the cement-makers to justify the price hike in January 2005.
We will have a look into these factors one by one. The outcome of these factors, whether in affirmative or contrary, will depend solely on the analytical premise taken.
Price hike in 2004: The recent price hike is not the only price increase. Production data for the period from July 2003 to June 2004 indicates an average ex-factory price increase of Rs25 per 50 kg per bag over the corresponding period of last year. This average increase in price levels came at a time when the cement sector was facing buoyant demand due to housing and construction boom, and increasing avenues of export to Afghanistan. An average cement plant witnessed sales growth of 30-40 per cent and profit margins in the range of 35 per cent, an improvement of 10 per cent over the corresponding period of last year.
The outgoing year also witnessed the soaring international oil prices, a record-high of over $50 per barrel in mid-2004. Many cement makers were proactive in shifting to coal-firing systems, which proved to be a cheaper energy source and caused a reduction of one per cent in average fuel and power costs per 50 kg bag. The production was nearly 13.6 million metric tons, up 14 per cent over the same period of last year, whereas demand growth was 21 per cent in the first six months of FY05.
Full year cement sales are forecast to rise to 16 million metric tons by the second half of fiscal 2005, which will be 17.6 per cent higher over last year. It is also expected that the benefit from savings on fuel and power expenses would have continued in first half FY05, as coal prices once again are on the downward slide.
Major cost heads: Fuel and power costs in absolute terms increased by 13 per cent, raw and packing material costs were higher by 11 per cent from July-June 2004 over corresponding period of last year. However, capacity utilization was 80.70 per cent from July-June 2004 compared to 66 per cent in the same period of last year.
As a result, economies of scale improved and a one per cent across the board reduction was seen in fuel and power expenses, and three per cent reduction in raw and packing material costs. Because of volumetric production, up 14 per cent in 2004 over last year's production of 11.9 million metric tons, the fact that fuel and power expenses and raw material and packing costs, which contribute 80-85 per cent of overall production costs, have actually improved is clearly monumental.
In the outgoing year, a number of cement manufacturers converted to a cheaper energy source by installing coal-firing systems and migrating from furnace oil based systems. As expected, this conversion led to an industry-wide reduction of one per cent in fuel and power costs per 50 kg bag.
Improvement in cost structure: Raw and packing material and fuel and power expenses in proportion to production costs were 80 per cent across the board in July-June 2004, a depreciation of three per cent from 83 percent over the corresponding period of last year.
This means that the average raw and packing material costs in proportion to production costs fell by one per cent and average fuel and power expenses fell by two per cent, contributing to an overall depreciation of three per cent in the cost structure. Despite the fear of soaring international energy prices, fuel and power had a lesser impact in the cost structure of cement makers, mainly due to substitution from furnace oil to coal.
International coal prices have started to show a reversing trend, and with coal-firing systems already in place, the substitution from furnace oil to coal will be much higher in 2005. Besides, import duty cut on petroleum coke from 10 to five per cent already in place is a further cost saving incentive.
After analyzing the performance of an average plant on the costs side, we now delve into other factors that may have led to the recent cement price hike.
Expenses down: A majority of the top players averaging a market share based on sales of 8-13 per cent have re-profiled their expensive foreign currency debt with a local currency counterpart, resulting in savings from financial expenses, down by 30-55 per cent. Apart from gain on re-pricing of loans, cement makers have also mitigated any risk of adverse movements in currency exchange rates.
Future requirements: The industry expects a supply of 34.0 million metric tons by end of 2007 from 13.6 million metric tons at present. The current utilization factor does not leave room for further production, and in order to enhance capacity, the cement makers would make heavy cash calls to fund expansion plans. Funds will come from a mixture of sources including internal cash from operations, fresh or quasi-equity, and long-term debt from banks. But for now, it suffices to raise prices of cement in the domestic market.
According to prevailing estimates, cement constitutes nearly 20-30 per cent of construction costs of an average single storey residential house. For example, construction of a 240 sq yd single-storey house in a far-flung area like Gulistan-e-Johar can cost Rs1.5-2 million at least. A 15-25 per cent hike in cement prices alone can increase the cost of construction to Rs1.6-2.2 million, an increase of Rs0.2-0.3 million over the initial estimate. The higher the cement contribution, the higher will be the cost hit. An average genuine home-builder cannot afford to sustain a provision of Rs0.2-03 million when he is living hand-to-mouth while building a house for his family.
The government has failed to keep a check on cement prices, as the recent price hike of Rs40-50 per 50 kg bag is unprecedented. As a result of this, construction costs will skyrocket again and prove detrimental for the construction and housing sector.
The House Rent Index, which is a general measure of prevailing housing rent rates, is already up 11.67 per cent in December 2004 over the corresponding month of last year. Since rising rent rates are a direct effect of rising property prices, another hike in cement prices will further aggravate the general level of rent rates.
