Riding the Cycle – Cement Industry

Last Updated on March 11, 2024

I was analyzing the cement industry and realized for the first time what cyclicality means in its true sense. This industry posed a lot of challenges, it chew my head, made me study harder, and finally gave me a better understanding! I would like to share some of that wisdom and experience with all of you.

I analyzed some 12 companies from the cement industry which belong to BSE 500. I’m a value investor so I started by looking at the past 10 years growth rates. As I glanced through each company, I realized that there was a red patch (implying growth rates either negative or less than 10% YoY) and a green patch (implying growth rates in excess of 10% YoY) in a similar pattern. It became highly difficult for me to predict a future growth rate for the next ten years based on the past 10 year’s performance.

I then followed a different approach and checked the year of incorporation of all these companies. Most of the companies were more than 30-40 years old. In spite that, their performance was so bad for some 4 to 5 years was unbelievable. That’s when I realized that the cement industry last went through a down cycle from around 1998-2004 (some companies had already recovered during 2004). Whereas the upturn started around 2004-05 and went right up till last year, i.e. 2008. And we all know the current scenario, so needless to say what is happening right now. Yes, another down cycle has begun!

The weirdest part of this industry is that during the downturn, most of the companies’ performance was pathetic; they even posted negative growth rates YoY. At the same time during the uptrend, these same companies performance was stupendous. They’re like the best performers, completely green with high growth rates!

So you’ll be swept off your feet if you look only at these years and tempted to buy them. Moreover when you are looking at a ten year horizon which comprises a downturn of around 5 years and an upturn of approximately the same number of years, you’ll get a feeling as if these are all turnaround companies! But they are not. It’s just the cycle. It presents a picture as if these companies performance was pathetic and then they did a magical turnaround and started posting high growth rates, i.e. started looking green. Just have a look at JK Laxmi’s past ten years YoY growth rates:

Year 2003’s data is missing, but the overall picture is clear and I hope that my point about them looking like turnaround companies is also clear. You’ll realize that the company’s performance from 1998 to 2002 was pathetic (including negative growth rates). While, during the good years, the returns are spectacular!

So, what next? Let us first study some of the hard facts about the cement industry:

Key Positives:

1. Construction industry is set to grow in the future.
   
2. There is an increasing trend of M&A‘s
   
3. There is a coal regulator set up by the government – beneficial for the industry
   
4. Imposition of CVD (countervailing duty) on imported cement
   
5. Capacity addition has already taken place – will be beneficial to meet the demand once it bounces back
   

Key Negatives:

1. Coal is the major input – has a lot of government intervention + regulation
   
2. Competition is increasing – direct entry of global players
   
3. Exports are banned – at least in the short run
   
4. Cost of production has gone. E.g. transport cost has gone up due to higher freight charges
   
5. A lot of government intervention
   

What do these facts imply?

First, it implies that you cannot base your judgment about these companies future growth prediction on the basis of past 10 year’s performance. At the same time, the prediction cannot be for the next 10 years. You probably need to take a smaller time horizon of say 5-7 years, which will include current downturn and another up cycle (hopefully!!!).

Second, you need to make a prediction keeping the cyclicality in mind. You need to first study the industry thoroughly and its current cycle phase.

The next question that props up in anyone’s mind (it did occur to me!) is what is the duration of the cycle? Well given India’s new growth trajectory and it being a more resilient economy, it seems that one can discount the duration of a down cycle to may be just 2-3 years. You can study more and read what the industry analysts and experts say.

Thus once you have done enough study of the industry’s current situation, you can then proceed to a company. Look for companies which have performed better than the rest during the downturn. Study the company’s business, its future plans, its customers, etc. etc. In short, do a thorough qualitative analysis before investing in a company and invest in it! 

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