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Most Profitable Sectors

The strong and sustained economic growth witnessed in India over the last couple of years has led to a sharp reversal in fortunes of certain key sectors. For instance, the iron and steel sector, which was bogged with low prices some years back has reported impressive numbers on the back of a strong rally in commodity prices.

This segment of the Insights section attempts to profile those sectors that have witnessed remarkable rise in profitability in the last couple of years. The three sectors covered here-in are Cement , Construction & Allied Activities , Iron & Steel , all of which have reported equal to or more then 40% growth in EBITDA.

The strong and profitable

Cementing the infrastructure boom through capacity addition and production efficiencies

Driven by a booming housing sector, global demand, increased infrastructure activity for roads & highways, the cement sector has seen tremendous growth over the last two years, and has been ramping up capacities to meet increased demand. It is also reaping the benefits of consolidation that was witnessed in the last couple of years. Earlier the cement sector was unorganized and scattered; the M&A activity it has undergone has instilled greater pricing discipline in the market. This has resulted in better margins for the sector. Moreover, the growth opportunities inherent in the Indian market have attracted MNCs to increase their presence in domestic market through organic and inorganic means.

The Top 500 companies list includes 20 companies from the cement sector that collectively account for 3.6% of the total market capitalization and 2.5% of the aggregate Total Income. None of these companies fall under the small cap category.

For the purpose of analysis, cement companies have been divided region wise on the basis of location of the companies’ registered offices. The companies are evenly spread with the Southern region having a slightly higher number of companies (30%).

The cement companies featured in the Top 500 companies list account for almost 80% of the total cement capacity in India. As per Cement Manufacturers Association, the total installed cement capacity of the industry as on March 07 was 166.7 MMTPA, while the cement companies on the Top 500 companies list had total installed capacity of 132.8 MMTPA.

Total production of the 20 cement companies under consideration stood at 126.5 MMT as of Mar 07, showing a growth of 11.7% y-o-y. For FY07, the total cement production in India was 155.3 MMT, with these 20 companies contributing 81.4% of that. Companies in the Western region have the largest share in total production at 55.3%

The cement sector reported over 30% EBITDA margin, chiefly on the back of firm prices and better efficiencies. For instance, the cement companies profiled reported higher capacity utilisation of 95.3% compared to the industry average of 94%. Further, North based companies show an even higher overall capacity utilisation at more than 98%.

The other interesting points include:

The graph below compares cement companies across different regions

Southern companies emerged as most efficient

Al though the Wes tern region companies have the highest share in terms of installed capacity and production, it is the companies in South that have higher EBITDA and net profit margins. The NPM for South based companies was at a high of 20%, followed by that for the West based companies, which stood at 17.5%. Besides, the Southern region companies not only saw a healthy 21.1% growth in production, but also an impressive growth in capacity utilisation rate from a modest 84% in FY06 to high 98% in FY07.

East stays away from capacity expansion

Companies across regions, apart from those registered in the East, exhibit strong growth in capital work in progress (CWIP), with an overall growth of around 166%. The rise in CWIP is mainly on account of expansion and modernisation undertaken through commissioning of clinkering plants, grinding plants and thermal plants for captive consumption, apart from enhancing manufacturing capacities.

Despite having a low share (11.1%) in overall installed capacities, companies in the Eastern region do not have expansion plans. The comparison of CWIP across companies in different region shows a very slow rate of growth in the Eastern region at about 4.1%. The y-o-y production growth was again seen at a low of 7%. This trend could be attributed to the fact that the Eastern region caters to the lesser developed markets of Orissa, Bihar, Jharkhand and Chattishgarh.

Companies in the Western region operate at high capacity utilisation rates of 95%, account for almost 47.5% of the total installed capacity in the cement sector, and yet have witnessed a whopping 265% growth in CWIP y-o-y. The boom in the real estate sector, including huge investments in housing, infrastructure and commercial projects along with export opportunities to the Middle East region has propelled the demand for cement in the Western region. The Western region emerged as the highest contributor to excise duty, which formed around 55% of the total excise duty paid by the sector.

Construction & Allied Activities riding on prosperity

Companies in the Construction & Allied Activities sector account for 5.4% of the aggregate Total Income and 2.7% of the market capitalization of all Top 500 Companies. Almost half of these companies (13) are categorized under the mid cap segment. The EBITDA margins for these companies was around 17%, with NPM at 8.7%. Riding on the sustained demand for commercial & residential properties and increased infrastructural activities, the sector’s aggregate Total Income clocked a 59.3% y-o-y growth and stood at Rs 324, 297.9 mn for FY07.

The following chart depicts the contribution to TI and PAT, based upon market cap.

Diversified project mix key to higher profitability

Companies in the Construction sector are from a diverse range of business lines, which includes roads/highways, power, residential and commercial properties, housing development, contractual projects etc. The study reveals that a well diversified project portfolio, covering different sub segment ensures better profitability, with lesser volatility in earnings. The road development projects offers low margins, but at the same time, generates higher volume of business. On the other hand, niche areas such as irrigation, water/sewage management or port development offer high margins but opportunities in this space are limited as compared to the former.

Accordingly, companies involved primarily in real estate, housing and commercial construction have EBITDA margins of around 30.5%, with NPM at around 19%. In fact these companies have generated good returns for their shareholders too, paying Rs 1.5 bn as dividends in FY07.

Further these companies reported an impressive return on capital employed ranging from 13.5% to 42% for the entire sample.

Companies involved in roads/highway development command low margins, but higher volume of business. This is clearly evident from their high order book positions and low EBITDA margins of around 11% and a NPM of 3.6%. However, these companies too generate higher return on capital employed, ranging between 10% to 40% across the whole sample.

Given the sharp increase in spending by the Government as well as the private sector in the Power sector towards capacity addition, companies involved in providing power infrastructure have witnessed a high overall growth. The EBITDA margins for these companies stood at 14.2% with NPM at 7.6%.

Iron & Steel

The Iron & Steel sector has seen a major turnaround in its fortunes in the last couple of years, after witnessing lackluster demand for a while. Soaring demand from sectors such as infrastructure, real estate, automobiles, consumer durables at home and abroad, has put India’s steel industry back on track and at the same time on the world steel map. This demand is emanating from countries such as China, African countries and other developing economies. Indian companies have gone in for major acquisitions abroad, buying not only reserves of iron ore and coal but also specialised companies that manufacture high value-added variety of steel. Apart from international expansions, there has been considerable activity within India itself, be it foreign companies carrying out green field expansion or domestic companies rationalizing and consolidating capacities.

The Iron & Steel sector in this publication includes 34 companies, viz., 6.8% of the Top 500 companies. The sector is dominated by private sector companies, with just one PSU and one MNC in the list. This sector contributed 6.1% to the aggregate Total Income and 3.3% to market capitalisation of the Top 500 Companies. Five companies in the sector are large cap companies and contribute a massive 82.4% (Rs 781,973.9 mn) to the the sector’s total market cap. The 19 companies that are small cap contribute only 4.8% to the total sectoral market cap.

The char ts below showcase the distribution of total companies on the basis of market cap size, and the EBITDA margins & NPM margins based on the market cap size.

It is observed that the small cap companies, which form 56% of the total sample, command lower margins since there product mix is made up of steel ingots, Ferro alloys, iron ore fines, CTD bars. However, large cap companies, which form only 15% of the total sample, registered maximum EBITDA margins and NPM due to their superior product segment, which includes hot & cold rolled coils/strips, steel plates, steel sheets. It was also seen that income from the large cap Iron & Steel companies accounted for 4% of the aggregate Total Income of all 500 companies.