Cement Sector - Results Preview - Volumes Improve; Higher Costs and Dismal Realisations to Play Spoilsports
Having seen subdued sales volumes in 1HFY18, cement industry is expected to witness a healthy comeback in terms of sales volume growth in 3QFY18 mainly due to low base effect and benign construction environment. Further, favourable monsoon for two successive years is also expected to have aided rural demand. However, dismal realisations (-2% YoY and -3% QoQ at all-India average price) and higher fuel cost (owing to soaring petcoke prices in general and ban on petcoke usage in Rajasthan, UP and Haryana in particular) are likely to take a toll on the profitability of the cement companies. While we expect companies under our coverage universe to report a stellar average volume growth of ~16% YoY and ~9% QoQ, EBITDA and PAT are expected to register an average growth of ~15% YoY and ~8% YoY, respectively.
Companies having higher exposure to Western and Southern regions are expected to see a sharp drop in their profitability owing to steep price correction. We expect the large-cap cement companies to deliver 13-60% YoY growth in EBITDA with ACC likely to witness the highest growth of 60% YoY followed by Ambuja Cements (31% YoY). Further, India Cements, Sagar Cements and Ramco Cements are likely to report dismal operating performance led by sharp deterioration in Southern realisation. UltraTech Cement, Shree Cement and Ramco Cements are expected to lead the pack with higher EBITDA/tonne in the range of Rs870-1,140. Notwithstanding the cost pressure in the quarter, we foresee 2HFY18 would prove to be strong for the cement companies mainly owing to: (a) low base of volume growth; (b) likely recovery in realisation; (c) continuous traction in infrastructure projects; and (d) potential of further pick-up in rural consumption led by favourable monsoon and improving rural economy.
Sales Volume Growth Expected to be Impressive
Cement demand improved moderately in 3QFY18 after seeing continued sluggishness for last 3-4 quarters owing to DeMo and subdued real estate market post RERA implementation. Despite persistent sand crisis in several states, a low base and favourable monsoon boosted cement demand in 3QFY18. Notably, the companies under our coverage universe are expected to record an average volume growth of ~16% YoY (+9% QoQ) owing to low base and moderate pick-up in construction activities across the country. The companies having exposure to Eastern and Northern regions are expected to report better volume growth due to relatively better demand environment. Barring Shree Cement and India Cements, all companies under our coverage are expected to witness stellar doubly-digit volume growth on YoY comparison.
Realisation Continues to Remain Sluggish
Like 2QFY18, realisation environment remained soft in 3QFY18, while steep price correction in Western and Southern regions led to~3% QoQ decline in all-India average price. Price hike undertaken by companies in the beginning of quarter was not absorbed due to lack of strong demand rebound. However, price hikes in Dec’17 in select regions are expected to aid margins in the current quarter. Historically, 3Q has always been better in terms of sequential pricing, as the prices tend to rebound post seasonal correction. However, we have not seen the trend continuing in this fiscal and believe that the prices would move northwards in the ensuing quarter with the anticipation of better demand.
Higher Fuel Prices to Drag Margins
Cost savings due to improved utilisation led by demand pick-up is likely to be set off with the persistent increase in petcoke prices. Average petcoke cost per tonne in 3QFY18 hovered at ~US$100-105, as against average price of US$90-95 in 2QFY18. Higher fuel prices and dismal realisations are expected to be the major headwinds for margin improvement. Further, ban on petcoke usage in Rajasthan, Haryana and UP during the quarter is likely to bloat power and fuel cost further, as the companies having plants in these states had to shift to coal as fuel. Though the ban was subsequently withdrawn by the SC, the companies are still awaiting final directives from Pollution Control Board to resume petcoke usage.
Outlook & Valuation
While demand environment was impacted in 1HFY18 due to GST roll-out, seasonal overhangs, RERA implementation and sand crisis in several pockets, cement companies have reported decent operational performance amid cost pressure. However, we expect demand scenario to improve in 2HFY18 mainly on account of likely pick-up in rural demand with well-distributed and back-to-back normal monsoon, government’s infrastructure boost and low base effect. While withdrawal of petcoke usage ban by the Supreme Court offered sigh of relief to cement companies (though they are still awaiting Pollution Control Board’s directives to resume petcoke usage), a meaningful spike in operating cost due to hardening of fuel prices amid subdued realisation are expected to hurt 3QFY18 performance of cement companies. However, government’s positive approach to revive agriculture/rural economy is likely to augur well for the cement industry in FY19E.
Notably, slower capacity addition, incremental demand from the proposed “Housing for All” projects and commencement of construction activities of Metro/Irrigation projects are likely to aid utilisation and profitability of the industry in the long-term. However, in our opinion several mid-cap stocks are still available at comfortable valuations and trade at a huge discount (30-60%) to their large-cap peers. Looking ahead, we expect that likely improvement in return ratios to aid mid-cap counters to get re-rated. We maintain our positive stance on UltraTech Cement and Shree Cement in the large-cap space, while we prefer J.K. Cement, Ramco Cements, JK Lakshmi Cement and Sagar Cements in the mid-cap space.
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Having seen subdued sales volumes in 1HFY18, cement industry is expected to witness a healthy comeback in terms of sales volume growth in 3QFY18 mainly due to low base effect and benign construction environment. Further, favourable monsoon for two successive years is also expected to have aided rural demand. However, dismal realisations (-2% YoY and -3% QoQ at all-India average price) and higher fuel cost (owing to soaring petcoke prices in general and ban on petcoke usage in Rajasthan, UP and Haryana in particular) are likely to take a toll on the profitability of the cement companies. While we expect companies under our coverage universe to report a stellar average volume growth of ~16% YoY and ~9% QoQ, EBITDA and PAT are expected to register an average growth of ~15% YoY and ~8% YoY, respectively.
Companies having higher exposure to Western and Southern regions are expected to see a sharp drop in their profitability owing to steep price correction. We expect the large-cap cement companies to deliver 13-60% YoY growth in EBITDA with ACC likely to witness the highest growth of 60% YoY followed by Ambuja Cements (31% YoY). Further, India Cements, Sagar Cements and Ramco Cements are likely to report dismal operating performance led by sharp deterioration in Southern realisation. UltraTech Cement, Shree Cement and Ramco Cements are expected to lead the pack with higher EBITDA/tonne in the range of Rs870-1,140. Notwithstanding the cost pressure in the quarter, we foresee 2HFY18 would prove to be strong for the cement companies mainly owing to: (a) low base of volume growth; (b) likely recovery in realisation; (c) continuous traction in infrastructure projects; and (d) potential of further pick-up in rural consumption led by favourable monsoon and improving rural economy.
Sales Volume Growth Expected to be Impressive
Cement demand improved moderately in 3QFY18 after seeing continued sluggishness for last 3-4 quarters owing to DeMo and subdued real estate market post RERA implementation. Despite persistent sand crisis in several states, a low base and favourable monsoon boosted cement demand in 3QFY18. Notably, the companies under our coverage universe are expected to record an average volume growth of ~16% YoY (+9% QoQ) owing to low base and moderate pick-up in construction activities across the country. The companies having exposure to Eastern and Northern regions are expected to report better volume growth due to relatively better demand environment. Barring Shree Cement and India Cements, all companies under our coverage are expected to witness stellar doubly-digit volume growth on YoY comparison.
Realisation Continues to Remain Sluggish
Like 2QFY18, realisation environment remained soft in 3QFY18, while steep price correction in Western and Southern regions led to~3% QoQ decline in all-India average price. Price hike undertaken by companies in the beginning of quarter was not absorbed due to lack of strong demand rebound. However, price hikes in Dec’17 in select regions are expected to aid margins in the current quarter. Historically, 3Q has always been better in terms of sequential pricing, as the prices tend to rebound post seasonal correction. However, we have not seen the trend continuing in this fiscal and believe that the prices would move northwards in the ensuing quarter with the anticipation of better demand.
Higher Fuel Prices to Drag Margins
Cost savings due to improved utilisation led by demand pick-up is likely to be set off with the persistent increase in petcoke prices. Average petcoke cost per tonne in 3QFY18 hovered at ~US$100-105, as against average price of US$90-95 in 2QFY18. Higher fuel prices and dismal realisations are expected to be the major headwinds for margin improvement. Further, ban on petcoke usage in Rajasthan, Haryana and UP during the quarter is likely to bloat power and fuel cost further, as the companies having plants in these states had to shift to coal as fuel. Though the ban was subsequently withdrawn by the SC, the companies are still awaiting final directives from Pollution Control Board to resume petcoke usage.
Outlook & Valuation
While demand environment was impacted in 1HFY18 due to GST roll-out, seasonal overhangs, RERA implementation and sand crisis in several pockets, cement companies have reported decent operational performance amid cost pressure. However, we expect demand scenario to improve in 2HFY18 mainly on account of likely pick-up in rural demand with well-distributed and back-to-back normal monsoon, government’s infrastructure boost and low base effect. While withdrawal of petcoke usage ban by the Supreme Court offered sigh of relief to cement companies (though they are still awaiting Pollution Control Board’s directives to resume petcoke usage), a meaningful spike in operating cost due to hardening of fuel prices amid subdued realisation are expected to hurt 3QFY18 performance of cement companies. However, government’s positive approach to revive agriculture/rural economy is likely to augur well for the cement industry in FY19E.
Notably, slower capacity addition, incremental demand from the proposed “Housing for All” projects and commencement of construction activities of Metro/Irrigation projects are likely to aid utilisation and profitability of the industry in the long-term. However, in our opinion several mid-cap stocks are still available at comfortable valuations and trade at a huge discount (30-60%) to their large-cap peers. Looking ahead, we expect that likely improvement in return ratios to aid mid-cap counters to get re-rated. We maintain our positive stance on UltraTech Cement and Shree Cement in the large-cap space, while we prefer J.K. Cement, Ramco Cements, JK Lakshmi Cement and Sagar Cements in the mid-cap space.
Next Read: Godrej Agrovet:On way to its multi-year secular growth journey
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