FINANCIAL MANAGEMENT

PROJECT REPORT
on
CEMENT INDUSTRY

SUBMITTED TO:
Dr. Madhusudan Karmakar

SUBMITTED BY: GROUP 10

Anubha(PGP33262)|Astha(PGP33266)|Satyam(PGP33292)|Shaily(PGP33294)|
Naveen (PGP33301)
 Contents
INTRODUCTION............................................................................................................... 3
OBJECTIVES OF THE STUDY ............................................................................................ 4
LITERATURE REVIEW....................................................................................................... 5
METHODOLOGY.............................................................................................................. 7
FINDINGS ........................................................................................................................ 8
CONCLUSIONS ................................................................................................................ 9
REFERENCES ................................................................................................................. 10
APPENDIX ...................................................................................................................... 11
 INTRODUCTION

This project was undertaken for the completion of the course requirements for the Financial
Management course taught by Prof. Karmakar in IIM Lucknow.

Out of the given topics, we chose to analyse the impact of financial leverage on the profitability
of different firms. We wanted to understand the implications of taking debt among a set of
companies with similar performance level, to identify the impact of financial leverage &
understand its contribution to profitability.

We chose the cement industry for our analysis since the sector has a large number of firms
which supply similar kind of product with little scope of firm level differentiation, which
ensures that their performance is broadly governed by similar factors, leading to many
companies achieving fairly similar returns on the capital employed.

Once we selected companies with similar ROCE, we calculated their financial leverage and
tried to assess the link between financial leverage and profitability using correlation analysis.
We also tried to learn about the rate of debt in the sector through secondary search to add to
our understanding based on financial analysis.

Based on our findings, we have drawn conclusions and made recommendations for the chosen
firms to achieve higher profitability from a financial perspective.
 OBJECTIVES OF THE STUDY

1. To understand the impact of financial leverage on the performance of selected firms in the
cement industry.
2. To study the relation between the financial leverage and profitability of various firms in
cement industry in India and to analyse if the findings are in tandem with theoretical
learnings.
3. To analyse the relation between ROE (return on equity) and ROCE (Return on capital
employed) for these selected firms, and understand the interrelation between ROCE, loan
rate and ROE.
 LITERATURE REVIEW
A lot of research has already been conducted to study the impact of financial leverage on a
firm’s profitability. The theory of business finance in modern sense starts with the Modigliani
and Miller (1958) capital structure irrelevance propositions. Their result suggested that the
leverage of the firm has no effect on the market value of the firm.The M&M capital-structure
irrelevance proposition however assumed no taxes and bankruptcy costs. They showed that the
weighted average cost of capital would remain constant with changes in the company’s capital
structure.

Titman & Wassels (1988) concluded in his study that firms which use their earnings instead of
taking outside capital earn more profit because of less leverage as compared to the firms which
rely more on outside capital. Firm performance can also be determined by the price of its stock.
If the stock price of the firm is high, then firms prefer to issue equity instead of taking outside
capital that helps them to maintain their leverage.

Wald (1999) in his study suggested that debt to assets ratio has a significant negative relation
with the profitability of a firm. He did his study on the firm’s capital structure which operates
in United State, United Kingdom, Japan, France, and Germany. He used factors such as firm
size, growth and firm’s riskiness as independent variables.

Tariq & Hijazi (2006) explained that interest payments are a tax-deductible expense and
decrease the tax liability of a firm thus providing cash savings. If the firms incur losses, this
tax benefit will fade away. So, if the operating earnings are enough to meet the interest expense
then firms will get the benefit of tax deductibility of interest expenses. However, the chance of
default also increases as the level of debt increases, so there exists an optimal level of debt. If
the firm goes beyond this optimal point, it is more likely that the firm will default on the
repayment of the loan.

Sanjay J. Bhayani (2009) studied the impact of financial leverage and cost of capital for the
and valuation of the firm for the Indian Cement Industry for the period from 2001-02 to 20017-
08. His studies suggested that there is no impact of financial leverage on cost of capital for the
Indian Cement Industry. He further concluded that there is no correlation between the financial
leverage and total valuation within the cement industry i.e., financial leverage does not affect
the total valuation of a firm in the cement industry in India.
Dr. Atul A. Agwan (April, 2015) in his analysis of financial leverage and its components for
The Ultratech Cement Industry suggested that the Industry has very professionally utilised its
debt capital for earning profit. His studied showed a negative relationship between the degree
of financial leverage and EPS, return on investment, debt equity ratio and debt ratio except rate
of interest of the firm. This was due to the excess dependent on Debt capital thereby diverting
the funds towards interest payments. Therefore, he recommended that the company should
maintain a proper mix of debt and equity capital so that proper cushion of funds is available at
the time of emergency and the interest liability can also be reduced.
 METHODOLOGY
We have taken the cement industry as the debt composition is high in this sector. There is
plethora of players in the industry. We also got enough sample space for various debt &
profitability levels in this industry.

We have taken the companies with high market capitalisation. The financial leverage effects
are evident in high market cap companies. Ultimately, we wanted to do analysis on bigger
companies.

Data

For the data, we chose money control. Money Control is linked with Securities and Exchange
Board of India to get the updated data. So, the data we obtained is reliable.

In the data cleansing part, we have put a filter on the operating margin to get comparable
number of companies to analyse. The operating margin we worked upon is between 8.9% to
15.5%.

Calculations

From the cleansed data, we calculated financial leverage for each company. As our major
objective is to analyse the relation between the profitability and financial leverage of the
company, we have use correlation tool. We applied correlation on financial leverage and
profitability.
 FINDINGS
We found that there was a negative correlation between financial leverage and profitability of
the cement companies chosen for our analysis. This we suspect is primarily because the average
rate of interest for the cement industry is around 15% as per annual reports whereas all the
companies we selected in the sector had an ROCE of less than 15%. Thus, financial leverage
of these companies has been hurting their profitability.

Financial
Company Leverage Profit Sales Profitability
UltraTechCement 1.2 3,129.4 23,891.4 13%
J. K. Cement 1.9 292.7 3,797.3 8%
Shree Cements 1.1 1,022.9 8,429.2 12%
Ambuja Cements 1.0 1,367.5 10,446.9 13%
KCP 2.0 47.3 818.3 6%
India Cements 2.4 260.0 5,794.0 4%
Heidelberg Cem 2.0 89.9 1,717.5 5%
ACC 1.1 1,195.8 13,284.6 9%
Mangalam Cement 2.4 33.6 908.6 4%
Correlation between
Financial leverage and
profitability -93%

We also found that for all the companies the ROE was lower than the ROCE. This is because
instead of giving a higher growth in net income, the financial leverage of the companies is
dragging their profitabilitydown as the interest rate is higher than their ROCE. So, we can say
that trading on equity is having a negative impact on the return on equity of the companies. We
can also observe that companies with higher financial leverage have lower ROE compared to
their ROCE, since the high financial leverage has had higher damaging impact on their
profitability.

Company RONW ROCE

UltraTechCement 11% 15%
J. K. Cement 14% 14%
Shree Cements 17% 18%
Ambuja Cements 5% 7%
KCP 7% 14%
India Cements 3% 8%
Heidelberg Cem 8% 13%
ACC 7% 11%
Mangalam Cement 7% 12%

Note: Shree Cements is an exception due to a difference in calculation methods of ROE and ROCE.
 CONCLUSIONS
Based on the findings above, we can draw the following conclusions:

1) Profitability of chosen cement companies has been affected negatively by financial

leverage.
2) This is happening since the rate of outstanding debt is higher than their ROCE return.
3) Negative impact of financial leverage is much more for companies with higher financial
leverage.

Based on these conclusions, we believe the companies in the sector need to focus on reducing
their outstanding debt to improve profitability, or ensure that they are able to achieve higher
ROCE return on their assets.
 REFERENCES

1. Bhayani, S. J. (2009). Impact of Financial Leverage on Cost of Capital and Valuation of

Firm: A Study of Indian Cement Industry. Paradigm,13(2), 43-49.
doi:10.1177/0971890720090206

2. Cheremushkin, S. V. (2011). Capital Structure Irrelevance: The Modigliani-Miller

Model. Capital Structure and Corporate Financing Decisions, 151-169.
doi:10.1002/9781118266250.ch9

3. Dr. Agwan Atul A. (2015). An Empirical analysis of financial leverage and it’s components
with special reference to Ultratech Cement Industry, 5(4), 56-68.

4. Dr. S. Saravanan Dr. S. Saravanan, & Ramganesh, S. R. (2011). An Empirical Study on

Effects of Working Capital on Profitability (With Special Reference to Associated Cement
Companies Limited). Indian Journal of Applied Research,3(3), 46-48.
doi:10.15373/2249555x/mar2013/16

5. Hijazi, Syed Tahir and Bin Tariq, Dr. Yasir (2006) Determinants of Capital Structure: a
Case for Pakistani Cement Industry (2006). Lahore Journal of Economics, Vol. 11, No. 1,
pp. 63-80, 2006 doi: https://ssrn.com/abstract=892157

6. Titman, S., & Wessels, R. (1988). The Determinants of Capital Structure Choice. The
Journal of Finance,43(1), 1-19. doi:10.1111/j.1540-6261.1988.tb02585.x

7. Wald, L. A., & Wald, D. J. (1999). The 1998 Southern California Seismic Network
Bulletin. Seismological Research Letters,70(4), 404-416. doi:10.1785/gssrl.70.4.404
 APPENDIX
Calculation of Financial leverage & correlation between Financial leverage
and profitability