Grasim Industries: Wind of Change
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GRASIM INDUSTRIES: WIND OF CHANGE One must guard against falling prey to the 'last mile exhaustion' in the journey of change.1 - Kumar Mangalam Birla, Aditya Birla Group Introduction It was 15th November, 2009 and Rohit Ranjan, a public shareholder of Grasim Industries, was contemplating his investment in Grasim, in which he held 10,000 shares. 43 days earlier on October 3rd, 2009, Grasim had announced a restructuring scheme under which it planned to demerge its cement business into a wholly owned subsidiary called Samruddhi Cement ltd. and then merge the subsidiary into Ultratech Cements Ltd., in which it held 55% share.2 Grasim was one of the largest cement manufacturers in the country with a total consolidated annual capacity of 41.6 million tonnes. Grasim was also into VSF (Viscose Staple Fibre), Textiles and Chemicals business.3 The restructuring move was planned to create a focused pure-play cement entity for Grasim’s shareholders and re-strengthen Grasim’s control over the cement business. The restructuring was planned such that Grasim’s shareholders would also receive direct shareholding in Ultratech once the restructuring was completed. Rohit knew that he had to perform a valuation exercise in order to find the post-restructuring value per share of Grasim industries to identify whether he should hold or sell the shares. Rohit remembered the “Sum of the Parts” valuation methodology that he learned in his MBA and was planning to use it to arrive at the valuation. He also planned to consider the value of direct shareholding in Ultratech that Grasim’s shareholders would get. However, he wondered what would be the swap ratio that Grasim would use for the merger of its subsidiary Samruddhi into Ultratech. The post-restructuring value per share of Grasim depended on this swap ratio. He was also worried about potential dilution of economic ownership due to the demerger of cement business into Samruddhi. Cement Industry Overview The history of modern cement production can be traced back to 1824 when Joseph Aspdin, an English civil engineer got a patent for “Portland Cement”. Joseph used a manufacturing process in which he fired finely ground clay and limestone until the limestone was calcined. He named it “Portland Cement” because the concrete made from it looked like Portland Stone, a limestone that was quarried on the channel coast of England. 4 In the modern Portland Cement process, cement was made by heating limestone with small quantities of other raw materials up to 1450 OC in a cement kiln. The hard material which resulted from heating limestone and chemicals was “Clinker”. Clinker formed small lumps, which were then crushed with small amount of Gypsum into a powder form. This form was the final product called “OPC” (Ordinary Portland Cement). Limestone was a key raw material as it was the prerequisite to make clinker. Indian cement production was divided into four major categories 1 1. Ordinary Portland Cement (OPC): OPC comprised 95% Clinker with remaining 5% comprising gypsum and other materials. 2. Portland Pozzolana Cement (PPC): PPC comprised 80% Clinker with 15% pozzolana and 5% gypsum. 3. Portland Blast Furnace Slag (PBFS): PBFS comprised 50% blast furnace slag, 45% clinker and 5% gypsum.5 In FY08a, 66.1% of the production was Portland Pozzolana Cement, 25.5% was Ordinary Portland Cement and 8.1% was Portland Blast Furnace Slag. In 2009, more than 65% of India’s limestone came from Madhya Pradesh, Andhra Pradesh, Chattisgarh, Rajasthan and Gujarat. Hence, companies preferred to make clinker in these states and then did the grinding of cement in the location where cement was required. This minimized the logistics cost for the companies.6 (Exhibit 1 shows the value chain of Indian Cement Industry) In 2009, India was the world’s second largest Cement producer after China.7 India as a whole produced 181.6 million Metric Tons (mMT)b of cement in 2008-09. Total built capacity was standing at 205.6 Million tonnes with a capacity utilization of the sector standing at 88.3%.8 The installed capacity had grown at a CAGR of 3.69% during 2002-2007.9 In the year 2008-09 there were 104 integrated cement plants with an average capacity per plant of around 1.6 mMT per annum. Along with this there were 35 grinding units with an average capacity of 1 mMT per annum.10 In 2007-08, India exported 2.37 mMT clinker and 3.65 mMT Cement.11 Consolidation had taken place in the Indian cement industry with 51.27% of the total capacity held by top 6 players. (Exhibit 2 and Exhibit 3 Show the trend in Market share held by major players in the industry by capacity.) In the last couple of years there had been consolidation in the industry through various transactions. Gujarat Ambuja (later renamed as Ambuja Cements) acquired 14% share in ACC and Grasim acquired cement business of L&T and formed Ultratech. Holcim acquired minority stake in GACL (Gujarat Alkalies and Chemicals Limited) and 67% stake in ACC and Heidelberg Cement acquired 50% stake in Indorama Cement. Apart from top six players, the rest of the capacity remained fragmented among other players. 12 The global Cement production in 2008 was around 2900 mMT. China and US produced 1450 mMT and 86.1 mMT respectively in 2008.13 China had roughly five times as much capacity as India.14 India’s Cement consumption per capita was standing at 148 kg compared to 1036 kg of China. (Exhibit 4 shows the country-wise cement consumption per capita in 2008) There was a huge potential for growth in cement segment as per capita consumption was below the world average of 420 kg.15 Cement being a freight intensive industry made transportation of the product over long distances uneconomical. Hence, the industry was divided into five main regions in India – North, south, east, west and the Central Region. Southern region had limestone in abundance and historically enjoyed excess capacity. Western and Northern regions had, on an average, higher income level and hence, resulted in higher demand. (Exhibit 5 Shows region-wise demand distribution in FY09) 16 Due to high growth potential, global players were also trying to enter the industry. Acquisitions had been made by Lafarge, Heidelberg and Italicementi. Holcim had acquired stake in local companies like Ambuja cement. Grasim’s 53.63% stake in Shree Dig Vijay was acquired by Cimpor, a Portugese cement a Financial year runs from 1st April of a year to 31st March of next year, abbreviated as FY08 in this case. b 1 Metric Ton = 1 Tonne 2 manufacturer. Foreign players were also facing a lot of difficulties since the market capacity was fragmented and they had to incur a lot of transaction costs in acquisitions.17 Domestic cement demand grew at 10% CAGR in the last 5 years. In FY09 the industry registered a volume growth rate of around 9-10% y-o-y. The industry went through a capacity addition of around 26.88 Tonnes in FY09. The realization (Price per unit of cement bag) increased by around 5% y-o-y. Because of constant addition of capacity and increase in supplies the realization could not increase further. The demand of cement moderated because of the global economic crisis and tightened credit conditions. In the FY09 budget, government imposed at duty of 7.5% on RMC (Ready mix concrete) cement which negatively impacted RMC manufacturers but it did not have a severe impact on the industry as RMC only accounted for 5% of overall cement consumption. The industry was projected to grow at 8-9% in the short and medium term owing to government infrastructure and housing sector initiatives.18 The best metric to measure the efficiency and profitability of a cement company was EBITDA/Tonne. Efficient supply chain management, higher bargaining power over suppliers, captive access to raw materials such as Limestone, coal, petcoke etc. and good capacity utilization drove this ratio to a high level. A comparison of this ratio across the industry players was done by the analysts to compare the management efficiency across companies. (Exhibit 6 Shows FY09 EBITDA/Tonne for major industry players with other key Margins)19 Grasim Industries Headquartered in Nagda city in Ujjain district of Indian state Madhya Pradesh, Grasim was one the largest cement manufacturers of the country. Grasim was a subsidiary of the Aditya Birla Group, one of the India’s largest conglomerates. Grasim Industries came 4th in terms of market share by capacity with a share of 9.56% (Standalone Capacity). Grasim had two core businesses Viscose Staple Fibre (VSF) and Cement. In FY09 cement business generated 74% of the gross turnover of INR 204,320 million and VSF generated 15%. The net profit of FY09 was around INR 21,870 million. Historically, Grasim used VSF’s cash flow to finance the cement business growth. (Exhibit 7 shows the consolidated financial performance of Grasim Industries over the years)20 To compete in the growing cement segment Grasim commissioned clinkerisation plants at Shambhapura and Kotputli in Rajasthan. Both plants were projected to have a capacity of 3.3 mMT per annum each. Grasim also started to work on a split-grinding 1.3 mMT per annum unit in Dadri, Uttar Pradesh. In order to support growth Grasim did a capex of INR 14,670 million in FY09 in cement business. (Exhibit 8 Shows the detailed performance of cement division) Grasim projected its consolidated capacity to increase from 41.6 mMT per annum to 48.9 mMT per annum after the undertaken projects and restructuring get completed.