CCI Penalty on Cement Players Credit Neutral

The Competition Commission of India's (CCI) penalty of INR67bn on 11 cement companies amounts to 20%-75% of the players FY16 operating profits, however the move is credit neutral on these players due to their low leverage levels, says India Ratings and Research (Ind-Ra). Most of the companies (eight out of 11) maintain a low leverage and thus will be in a position to absorb the burden, in the event the penalty has to be paid. The penalty however will put pressure on the credit metrics for companies with relatively high levels of leverage.

The CCI in its order dated 31st August 2016, imposed a penalty of INR67bn on 11 cement companies. The companies named may consider approaching the Competition Appellate Tribunal against the order. The order pertains to the potential price collusion during the period May 2009 to March 2011. Maintaining high prices in the face of declining capacity utilisation has over the past few years allowed cement companies to contain decline in profits. In the event the penalty is to be paid, Ind-Ra believes it will not affect the credit rating Ind-Ra rated Ultratech Cement (UCL, IND AAA/Stable).

 

As per the CCI order, among the large cement companiesACC Ltd (INR11.5bn), Ambuja Cements Ltd (INR11.6bn), UCL (INR11.8bn) and Jaiprakash Associates (JAL,INR13.2bn) contribute to bulk of the penalties. The amount of penalty to be paid by the companies is substantial in comparison to their EBITDA. In addition UCL has entered into an agreement with Jaiprakash Associates to acquire its cement assets (capacity of 21.2mt including 4.1mtpa grinding capacity under construction) for a consideration of INR162bn The amount of penalty for the companies named in the order as a percent of their EBITDA in FY16 works out in the range of 20%-75%. The amount of penalty as a percent of EBITDA for UCL is 24%. Ind-Ra notes that the penalty will be rating neutral for UCL, given their low leverage of 1.2x (total adjusted debt net of cash/EBITDA). UCL has cash and cash equivalents of INR42.9bn at the end of FY16. Of the remaining 10 companies most of them have low leverage (with the exception of three companies) and Ind-Ra believes that the penalty will not impact their credit profile.

The cement industry in India is unique, with around 60% of the industry's total capacity being controlled with the top eight players. The rest of the industry is highly fragmented, with small- to medium-sized companies, mostly with uneconomical size of operations. To the extent regulatory intervention limits coordinated supplier actions with respect to price and quantity, smaller firms (single or multiple plants with high geographic concentration) with uneconomic cost structures will become uncompetitive and face significant deterioration in their credit profiles. As such, the level of fragmentation in the industry is expected to reduce and larger and vertically integrated companies are likely to gain market share. Globally, most markets have witnessed significant consolidation and this move by CCI may in turn help the Indian cement industry in correcting the structural imbalances present.

Ind-Ra maintains a stable outlook for cement manufacturers for FY17 and expects the cement industry to grow in the range of 4%-6% during FY17. Ind-Ra expects capex in the sector to be muted which will lead to higher utilisation rates in the short term. The sector also currently faces headwinds on cost inflation - pet coke prices have moved up to USD75/ton from USD48/ton in March 2016. A favourable monsoon after two consecutive bad years, can give a leg up to rural demand, and governments initiatives (such as 'Housing for All' and the thrust on infrastructure activities) are expected to improve overall cement demand with a lag and show signs after FY17.

CCI imposed a penalty of 0.5x of net profit of cement companies for 2009-10 (from May 20, 2009) and 2010-11 in case of 11 cement companies amounting to INR67 bn and INR7.3m on Cement Manufacturers Association.

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