Construction Materials - Are the conglomerates back?

During 1990-2000, more than 55% of the country's cement capacity addition came from conglomerates, led by L&T, Grasim, Tisco (steel), Raymonds (textile) and Zuari Industries (fertiliser). Following this, the industry saw disappointing returns over 1997- 2004. This period also saw the exit of most conglomerates, which laid the foundation for a structural boost to industry margins. In the past few months, a few conglomerates - JSW Steel (which generates slag from steel, which can be used to make blended cement) and Reliance Power/ RNRL (which would generate fly ash from the upcoming thermal power plants, which can be used to make blended cement) - have hinted at adding cement capacities through the greenfield route. Most recently, ABG International (holding company of ABG Shipyard) said it plans to set up a 4.6mmt facility in Gujarat and leverage the group's shipbuilding knowledge to transport cement via coasts in India/ Gulf.

Improved margins are attracting conglomerates
While the sales-tax exemption regime of the 1990s, which made new cement capacity more viable than existing capacity, is no longer operative, the step jump in EBITDA margins to Rs1,100/mt in FY08 (vs an average of Rs570/mt for the preceding 15 years) is again attracting new players. Clearly, the return profile of the industry is very healthy – we estimate the ROCE on greenfield investment at peak capacity is a healthy 20% today, compared to
10% during 1996-2004.

However, past experience shows entry of conglomerates is a negative
The collective move by conglomerates into the cement sector in the 1990s had seen margins collapse below justifiable levels, with a prolonged period of poor margins over 1997-2004. We believe this is due the ability of the conglomerates to cross-subsidise returns/profitability longer than a pure cement company can.