CAPITAL STRUCTURE ANALYSIS OF CEMENT INDUSTRY

In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells Rs. 20 crore in equity and Rs. 80 crore in debt is said to be 20% equity-financed and 80% debt-financed. The firm's ratio of debt to total financing, 80% in this example is referred to as the firm's leverage. In reality, capital structure may be highly complex and include tens of sources.

The capital structure analysis of cement industry is given below taking Ambuja Cements, Chettinad Cements and JK Lakshmi Cements into consideration. The performance of the company within the industry as well as in comparison to the selected peers is being done. Here the industry average of the D/E ratio is taken by taking the average of D/E values of top 5 players in the industry by market share.

Financial Leverage

It magnifies the effects on earnings per share of changes in the level of sales. The higher the degree of financial leverage, the more volatile EPS will be, all other things remaining the same. Financial leverage can be defined as the degree to which a company uses fixed-income securities, such as debt and preferred equity. With a high degree of financial leverage come high interest payments. As a result, the bottom-line earnings per share are negatively affected by interest payments. As interest payments increase as a result of increased financial leverage, EPS is driven lower.

As mentioned previously, financial risk is the risk to the stockholders that is caused by an increase in debt and preferred equities in a company's capital structure. As a company increases debt and preferred equities, interest payments increase, reducing EPS. As a result, risk to stockholder return is increased. A company should keep its optimal capital structure in mind when making financing decisions to ensure any increases in debt and preferred equity increase the value of the company.

1)      AMBUJA CEMENTS

Capital Structure(in crores)
	Dec '12	Dec '11	Dec '10	Dec '09	Dec '08
Shareholders' Fund	8797.41	8,069.44	7,330.10	6,470.90	5,672.87
Total Debt	49.63	49.36	65.03	165.7	288.67
D/E Ratio	0.005641	0.006117	0.008872	0.025607	0.050886
Industry Average	0.445214	0.601223	0.635774	0.769121	0.880177

Comments

·         Ambuja Cements Ltd. is India’s third largest cement company with a total capacity of about 27 MMTPA. Ambuja Cements Ltd commands a market share of 9.6% compared to 18.3% of Ultratech Cements and 10.3% of ACC.

·         Ambuja Cements started out this decade with a Debt/Equity ratio of 1.68, this debt was raised to finance its acquisition of stake in ACC.  The company has thus over the years decreased its Debt and hence Interest cost.  All the capital expansion programs of the company have mostly been financed through its own earnings than raising of new debts or issuance of new equity.

·         The company through years has attained a comfortable debt position it is now only 0.5% of the total equity share capital. This means that the company can pay all its debtors 200 times with its shareholder wealth.

·         In comparison with the industry average, the debt-equity ratio is very low. This means that the company is financing the expansions and other operational expenses through its own earnings as it has not issued more shares in the past 5 years that much. Since the company’s debt-equity ratio is far lower than the average, company pays more tax if the for the new investments as it is not leveraging. Company can leverage a part of its expense in the form of debt so that a lot of money can be saved as tax benefit. This is because of the fact that, the tax payed to debtors is less than the corporate tax.

	Dec '12	Dec '11	Dec '10	Dec '09	Dec '08
Total Assets	12457.18	8,118.80	7,395.13	6,636.60	5,961.54
Total Equity	8797.41	8,069.44	7,330.10	6,470.90	5,672.87
Net Profit	1293.21	1,227.49	1,262.97	1,216.84	1,389.71
ROA	0.103812	0.151191	0.170784	0.183353	0.233113
ROE	0.146999	0.152116	0.172299	0.188048	0.244975
Financial Leverage Index	1.416005	1.006117	1.008872	1.025607	1.050886

·         The above table indicates some important ratios that will measure the capital structure.

·         Financial Leverage Index:  

Financial Leverage Index = ROE/ROA

This is a measure which shows the usefulness of debt financing. Since it is more than 1 for all years or the value increases from 2008 to 2012, means that ROE exceeds ROA. This shows a favourable use of debt financing.

·         Here it is observed that the return on Equity is reducing from 24.4% in 2008 to 14.7% in 2012. This is not a good sign for the company as the higher return for shareholders is the main motive of any company. So the company should leverage more and use debt financing for its future plans to increase the shareholders’ returns to an optimum amount.

2)      JK LAKSHMI CEMENTS

Capital Structure(in crores)
	Mar '12	Mar '11	Mar '10	Mar '09	Mar '08
Shareholders' Fund	1,175.19	1,046.33	1,020.70	831.25	642.43
Net Profit	108.78	59.13	241.13	178.59	223.67
Total Debt	914.59	996.99	903.68	686.74	694.88
Return on Debt	0.11893854	0.059309	0.266831	0.260055	0.321883
Cost of Debt	0.08325698	0.041516	0.186782	0.182038	0.225318
D/E Ratio	0.77824862	0.952845	0.885353	0.826153	1.081643
Industry Average	0.44521381	0.601223	0.635774	0.769121	0.880177

Comments

·         Here, it is observed that the total accumulated shareholders’ fund getting increased year by year and the debt of the company is also increasing.

·         D/E ratio is well above the industry average which is not advisable. This shows that, the company is dependent on debt for its operations or expansion plans. Even if the D/E ratio is very below the normal standard of 1, as the industry is more of an equity financed industry, the company should follow more of a equity financing than debt financing.

·         The profit of the company is decreasing at a normal rate. The cost of debt has decreased from 22% to 8% which is a positive thing for the company. This shows that the riskiness of the company has reduced.

·         The company’s dependence on debt has increased by about 30% within 5 years. This shows that the company is depending on debt financing for operations or capacity expansion plans.

	Mar '12	Mar '11	Mar '10	Mar '09	Mar '08
Total Assets	2,089.78	2,043.32	1,924.38	1,517.98	1,337.32
Total Equity	1,175.19	1,046.33	1,020.70	831.25	642.43
Net Profit	108.78	59.13	241.13	178.59	223.67
ROA	0.05205333	0.028938	0.125303	0.11765	0.167252
ROE	0.09256376	0.056512	0.23624	0.214845	0.348162
Financial Leverage Index	1.77824862	1.952845	1.885353	1.826141	2.081659

·         The above table shows the return on equity and asset. Here the return on equity is steadily decreasing from 34.81% to 9.25% within a span of only 5 years. This is not a favourable sign for the company.

·         Total equity capital raised by the company is almost doubling in 5 years. But the return percentage reduces.

·         Though the Financial leverage index ratio is well above 1, it is observed that it is reducing over the years. The danger here is that, the profit of the company is also decreasing over the years. Here ROE exceeds ROA which means that, the company is in a favourable side of debt financing.

·         As the percentage of debt in the capital structure is increasing over the years, it is obvious that company is using debt financing more.

3)      CHETTINAD CEMENTS

Capital Structure(in crores)
	Mar '12	Mar '11	Mar '10	Mar '09	Mar '08
Shareholders' Fund	1,080.41	925.71	863.72	355.15	392.49
Total Debt	989.28	896.06	758.87	997.03	436.19
Net Profit	188	75.17	96.63	-4.21	163.77
Return on Debt	0.1900372	0.083889	0.127334	-0.00422	0.375456
Cost of Debt	0.13302604	0.058723	0.089134	-0.00296	0.262819
D/E Ratio	0.91565239	0.967971	0.878606	2.807349	1.11134
Industry Average	0.44521381	0.601223	0.635774	0.769121	0.880177

Comments:

·         Here from the table above, the capital structure of the company remained almost same even though the shares of each got reversed over the span of 5 years. Both equity as well as debt increased by more than 200% in the capital structure. This shows that the company has grown tremendously over 5 years.

·         Return on debt and cost of debt are increasing over the years. Shows that the riskiness of the company is increasing.

·         The D/E ratio is well above the industry average even though they managed to bring it below 1. This is not promising for the company. They can still pay all the debtors with the capital it has raised by equity.

	Mar '12	Mar '11	Mar '10	Mar '09	Mar '08
Total Assets	2,069.69	1,821.77	1,622.59	1,352.18	828.68
Total Equity	1,080.41	925.71	863.72	355.15	392.49
Net Profit	188	75.17	96.63	-4.21	163.77
ROA	0.09083486	0.041262	0.059553	-0.00311	0.197628
ROE	0.17400802	0.081203	0.111877	-0.01185	0.417259
Financial Leverage Index	1.91565239	1.967971	1.878606	3.807349	2.11134

·         The above shown table gives the return on equity and assets as well as the financial leverage index.

·         The company is managing to increase its profits even though it incurred a loss in the year 2009.

·         The ROA and ROE are showing an increasing trend.

·         Financial leverage index is well above one, shows favourable debt financing.

PEER COMPARISON

1)      Debt as a percentage of Equity

·         Ambuja Cements keeping a low D/E ratio over the years.

·         The D/E ratio of Chettinad Cements showing fluctuations over the years, keeping it low from 2010.

·         JK lakshmi keeping the ratio below the safe value of 1 but is well above the industry average.

·         The industry average keeps reducing showing that, the companies are depending less on debt financing with changing economic conditions.

Influence of capital structure on Industry

As the industry is very much capital intensive, it incurs a lot of initial investment for the companies in building huge plants as well as for the machineries. Each company has raised a huge initial capital from the shareholders and then later they have raised money from lenders for expansion plans as well as operations, except in the case of Ambuja cements in which they are using their earnings for operations as well as expansion plans as they have very low debt compared to the shareholders’ fund in their capital structure.