Flush with cash

“He’s ahead of his time,” says M.L. Gupta, chairman of Everest Industries, once a subsidiary of ACC. Gupta and Bangur worked closely together in the Cement Manufacturers’ Association. “He was one of the first to become self-sufficient in power and to invest in waste heat recovery. I’m not surprised his company is the most efficient cement maker.”

Typically, a cement company wanting to raise capacity might set up a 2-million-tonne unit that costs around Rs 1,200 crore, and takes three years to build and another year to stabilise. “I’d rather set up a million-tonne unit in less than 24 months, and two 1.5-million-tonne units in quick succession in the fourth year,” says Bangur. “That won’t disturb market dynamics with a sudden spike in output, and I get an extra year to sell my initial capacity. It helps me recover my investment faster.” The company’s planned greenfield unit in Raipur will have an eventual capacity of 5 million tonnes.

Not diluting equity means shareholders get the full benefit of the company’s growth over the years, and sends a strong signal down the line that the company will have to earn its growth capital. “Most companies in capital-intensive sectors identify a big-ticket project, and then look for ways to finance it,” says Bhandari. “But we look at internal accruals and then pick a suitable project.” In the last five years, the company’s internal accruals were over Rs 3,400 crore, and it commissioned cement and power projects worth Rs 2,800 crore.
According to conventional wisdom, such conservatism hurts growth. But it has helped Shree Cement grow faster than the competition. In the last 10 years, its capacity jumped six and a half times to 13.5 million tonnes (from 2 million tonnes in 2001), and market share rose from 2% to 6%.

Some analysts appreciate the logic. “Why should we bother about a sudden fall in profit due to a one-time depreciation charge?” asks Gandhi, who has a buy rating on the stock. “It’s a non-cash expense and helps improve cash flow—a crucial thing in a cyclical industry such as cement.”

SHREE CEMENT’S SECOND BROAD GOAL after cost leadership was cash generation, rather than profit maximisation. “We believe in the old saying that cash is real, and profit is a myth,” says Bangur. He loses no opportunity to retain cash, even if it makes the profit and loss account look less good in the short to medium term. For example, the company has an aggressive depreciation allowance that lowers its reported profit, and thus its tax liability. Such a practice is unprecedented in the country, as it lowers the EPS and stock price.

Of course, the sailing isn’t all smooth. By October, Shree Cement’s power generation capacity is expected to rise to 560 MW, of which 415 MW would be for sale. But analysts expect it to be less profitable than envisaged. “It was projected to have an Ebitda margin of up to 4.0 per unit, but it may not exceed Rs 1.50, given the sharp fall in spot rates in North India,” warns Jinesh Gandhi, analyst at Motilal Oswal Securities. He says the company should plough back profits into the cement business, and stay away from power. The management seems aware of the risk. “Going forward, nearly 80% of capex will go towards cement,” says Bangur. “Power will always remain an auxiliary business for us.”

Bangur wasn’t stopping there, though. He turned power generation into a profit driver. “The cement business was generating more cash than it needed in the near term,” he explains. “The company had mastered petcoke technology, which gave it a cost advantage over its rivals, who were still using expensive coal. And rates for merchant power were soaring, because of the chronic power shortage in North India.” (Merchant power refers to electricity sold on a day-to-day basis at spot rates through power exchanges.) In 2009-10, Shree Cement’s power division accounted for more than a third of its profit before interest and taxes, and helped the company break free of its downward spiral.

But there were still the monopolies to deal with. Shree Cement was paying the state electricity board over Rs 4.20 a unit—more than twice the cost of generation. Luckily, the Electricity Act, 2003, delicensed power generation, and allowed captive power generation. Here was Shree Cement’s opportunity to use its cash surplus to generate its own power.

Bangur’s gamble paid off. By early 2000, Shree Cement became the country’s first cement company to switch to petcoke from coal. Almost immediately, the company’s power and fuel cost as a percentage of net sales began to drop (see chart).

THE SOLUTION CAME FROM Reliance Industries’ first refinery, in Jamnagar, Gujarat, commissioned in 1999. It pioneered petcoke production in India, and, as there was little demand, Reliance was willing to sell it at a fraction of the price of coal. Bangur was willing to ignore his engineers’ apprehensions and give it a try. But breakdowns at Shree Cement became frequent. “My engineers warned me that if I persisted with petcoke, the plant would collapse,” says Bangur. It didn’t scare him, though. He said he’d take complete responsibility in case of a collapse, and kept pushing for solutions. “There had to be a solution, because I knew petcoke was widely used in European cement plants,” says Bangur. “Obviously, they were doing something that we weren’t.” He sent engineers and kiln operators to Europe for training. This is remarkable because, for the average kiln operator, even visiting a state capital is the dream of a lifetime.

The second reason was more fundamental and long-range. “Cement is a competitive industry, with neither entry barriers for new firms, nor any regulatory restrictions on foreign direct investment in the sector,” says Bhandari. “This gives full play to market forces, and our prices and profits are market-determined and highly volatile. By contrast, both coal and power were monopoly industries.” Coal mining and production was, and is still, a central government monopoly under Coal India. And back then, Bhandari points out, electricity was entirely in the hands of the state government. “We all know that pricing decisions are never based on commercial considerations in either sector,” he says. He adds that commercial buyers of power end up paying the price of subsidies to other customers. “I realised this was not sustainable, and that it was a key reason for the industry’s poor profitability.”

There were two reasons why Shree Cement focussed on cutting power and fuel costs. One, coal and electricity costs equalled one-third of the company’s net sales in 1996-97. So cutting them by even a few percentage points would significantly help the operating margin or Ebitda.

Shree Cement is now experimenting with poor-quality coal from the U.S., which is even cheaper than petcoke, and developing technology to make a synthetic version of gypsum—a key ingredient of cement—by using sulphur waste from its kilns. “This will help save nearly Rs 100 crore a year,” says Bangur. Most importantly, he adds, it means freedom from the vagaries of the gypsum market. “Gypsum is a state monopoly in Rajasthan, where our plants are located, and supply and pricing are always issues.”

Bangur is willing to experiment, and has the engineering background (he graduated from IIT-Bombay) for it. “He knows the technicalities of cement-making inside out,” says S.S. Gharpure, vice president of marketing and business development at Transparent Energy Systems. Gharpure notes that at a time when other cement makers baulked at the high initial cost and potential difficulties of waste heat recovery, Bangur enthusiastically invested Rs 450 crore to set up a 46 MW green unit that now meets a third of the company’s power needs, and costs just 50 paise a unit—less than one-fifth the cost of conventional coal-fired power.

Shree Cement’s innovations of the past 10 years include a complete switchover to petcoke, a cheap alternative to coal. The company also generates its own power, and uses waste heat from the cement-making process. It’s also more efficient than its peers. For instance, it consumes 75 units of power to make 1 tonne of cement, compared to ACC’s 87 units.

Bangur is clear, however, that cost leadership is not about shortchanging any stakeholder—vendor, customer, or employee—but about being innovative and technologically superior to rivals. In a cyclical and process-driven industry like cement, he says, engineering and technical innovation are crucial to success. “Contrary to common perception, there’s plenty of scope for innovation and creativity in cement manufacturing,” he says. “You set out to achieve five improvements, and end up with 20 innovations.”

IN TURNING THE CEMENT AROUND, Bangur’s and Bhandari’s first goal was cost leadership. Then came the accounting part: cash generation, as opposed to profit maximisation. Bhandari explains: “The crisis of 1997 made us realise that the company’s top line (revenues) was beyond our control. The retail price of cement varies from week to week, and from city to city. That makes it impossible for us to make financial decisions that rely on expected revenues. The only aspect of the value chain in our control is manufacturing cost, and this can make or mar the company.”

This is the story of just how much cement means to the Bangurs.

Indeed, stodgy cement appears to be enough to fulfil the ambitions of his son and heir, Prashant Bangur, who just turned 30? “Initially I was a bit sceptical about my future in the cement industry,” says Bangur junior, who is currently joint executive president, Shree Cement. “But having worked in the company, I find the industry far more creative and innovative than most people think it is.”

Bangur concurs, and questions the need to diversify. “Cement is a growing industry,” he says. “Demand is expected to grow at 8% to 9% a year. The industry needs to add nearly 750 million tonnes in 15 years to its existing capacity of 260 million. If I capture even 10% of the incremental demand, my hands will be more than full.”

More significantly, unlike most other businessmen in India who are forever ready to leverage themselves and diversify into newer, and arguably sexier sectors, Bangur is content in cement. “Shareholders have given us money to run a cement company,” explains Bhandari. “If we decide to diversify into power or something else, it will be in consultation with them.”

He is contrarian in other ways as well. Despite owning nearly 66% of the company, he is indifferent towards its share price, which, for the record, has risen 42 times in the last decade. That’s way better than the bellweather ACC stock which rose 20-fold and the Sensex (17-fold).“Since I don’t plan to sell shares to raise money, I need not worry about the stock,” he says. Unlike most companies, Shree Cement has decided never to raise capital by issuing new shares (the last time it did so was the 1997 rights issue).

Today, the Rs 4,000 crore Shree Cement is one of the best paymasters in the industry. Salaries have tripled since the meeting with Buffett. All bills that employees submit for reimbursement are accepted, but there’s no tolerance of fraud (serial offenders’ names are made public, which, Bangur says, is a bigger deterrent than a penalty). Employee turnover has fallen, and workers go out of their way to try out new ideas. “If someone offers you a job, they’ll do everything to keep you here,” says a senior employee who joined as a trainee in 1998 and has never considered leaving. “Conventional accounting will not capture this, but it’s prohibitively expensive in the long run to let go of an experienced employee,” says Bangur.

In January 2006, Bangur got wind of a plan for IIT-Kharagpur students to meet Buffett. Some students couldn’t afford the trip to Nebraska, so Bangur offered to foot the entire bill, and went along himself. Besides conservative accounting, Buffett spurred Shree Cement’s chief to think about people. “Be generous to your employees,” he told Bangur. “It comes back to you in the long run.” The philosophy that accounting cannot capture all the value of an enterprise, nor can it reflect all the costs of a bad decision, made a lasting impression on Bangur.

The contrast with the situation in 1997 couldn’t be more stark. In 1996-97, after Shree Cement declared the dividend, managing director H.M. Bangur realised there wasn’t enough money in the bank. Not only did the company have to cancel the dividend, it also had to raise capital through a rights issue to complete the capacity expansion it launched when the market peaked in 1996. Shree Cement’s transformation is the result of a careful strategy that Bangur executed with the help of his childhood friend and the company’s chief financial officer, Ashok Bhandari. Along the way, Warren Buffett also helped: Bangur’s lunch with the investing legend in an Omaha steakhouse provided serious food for thought.

FOURTEEN YEARS AGO, KOLKATA-BASED Shree Cement was in such bad shape that it reneged on its promise of a dividend of Re 1 per share. In 2009-10, the company paid out Rs 13 per share, which totalled just 6% of earnings (it could have comfortably paid 10 times the amount, given its earnings per share, or EPS, of Rs 192). Shree Cement now has cash reserves of more than Rs 2,100 crore, and is debt-free on a net basis. Cash flows from operations have doubled every two years. The company has the healthiest financial ratios in the country’s cement sector. Indeed, it’s among the world’s most efficient cement makers. Despite being a regional player, it’s one of India’s most profitable manufacturers, and a high performer on Dalal Street.