Kotak Mahindra Bank - Result Update - Strong Traction in Earnings to Continue

Kotak Mahindra Bank (KMB) has reported a healthy performance in 3QFY18. Its standalone PAT grew by 19.7% YoY and 5.9% QoQ to Rs10.5bn aided by healthy growth in customer assets (23.4% YoY and 3.3% QoQ), best-in-class NIMs (4.2%) and strong growth in core fee income (14.3% YoY and 2.3% QoQ). Further, its consolidated PAT surged by 28.2% YoY and 12.7% QoQ to Rs16.2bn led by strong bottom-line growth in Kotak AMC (137.5% YoY and 65.2% QoQ to Rs380mn), Kotak Capital (414% YoY to Rs360mn), Kotak Securities (81.2% YoY and 30.5% QoQ to Rs1.5bn) and Kotak Life (42.6% YoY to Rs970mn). Customer assets growth was aided by 22.4% YTD and 8.6% QoQ growth in CV & CE portfolio, 20.7% YTD and 3% QoQ growth in Corporate portfolio, 18.5% YTD and 5.1% QoQ  growth in Home Loan & LAP portfolio, and 32.0% YTD and 9.8% QoQ growth in Small Business & Personal Banking portfolio. Notably, KMB has started getting benefitted from full integration of erstwhile ING Vysya Bank especially in post demonetisation period.

Management Commentary & Guidance

• KMB witnessed a strong improvement in profitability from its financial services and life insurance business subsidiaries. Notably, it owns 100% stake in these subsidiaries. Recently, it completed process of buying back the remaining 26% stake in Kotak Life from Old Mutual.
• Fresh slippages/new inflows to stressed assets portfolio declined considerably to the Bank’s comfort level. Currently, only 0.19% of its loan book is 60-day overdue and classified under SMA 2. Further, only 0.4% of its loan book is classified as standard restructured loan book.
• KMB will launch consumer finance business through its NBFC subsidiary i.e. Kotak Prime, which will help the Bank to optimally utilise the excess capital available at Kotak Prime.
• With the positive initial response to Digital 811 Account, KMB expects the traction to continue in FY19 as well. However, standalone opex was partially impacted due to higher promotional cost for same. The Management has clearly indicated that apart from organic growth, the Bank will be continuously exploring suitable inorganic growth opportunities as well.

Outlook & Valuation

KMB has undoubtedly proven its competitive edge over its private sector peers with higher fee income, superior asset quality management and effective management of financial business arms. It continues to witness moderation in SMA-2 balance, which clearly suggests a stable trend on asset quality front. Looking ahead, we expect strong traction in earnings to continue owing to robust growth in loan book, moderate credit cost and healthy margins. Introducing our estimates for FY20E, we expect KMB’s earnings to witness 24% CAGR through FY17-20E.Valuing standalone entity at 4.2xFY19E adjusted BV and expecting subsidiaries to fetch Rs257/share after deducting holding company discount of 15%, we maintain our BUY recommendation on the stock with a revised Target Price of Rs1,172. 
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Q3FY18-Sector Review:
Pharmaceuticals Sector -Q3FY18-Results Preview
FMCG Sector-Q3FY18-Results Preview
IT Sector-Q3FY18-Results Preview
Banking Sector-Q3FY18-Results Preview

Cement Sector-Q3FY18-Results Preview

ITC - 3QFY18 Result Update - Results Largely In-line

ITC - 3QFY18 Result Update - Results Largely In-line; Budget – A Key Event to Watch Out For

ITC has delivered largely an in-line performance in 3QFY18. While reported net revenues grew by 5.7% YoY to Rs96.7bn (vs. our estimate of Rs100.5bn), EBITDA increased by 10.4% YoY to Rs38.1bn (vs. our estimate of Rs37.4bn). Reported net profit surged by 16.8% YoY to Rs30.9bn (vs. our estimate of Rs28.3bn), mainly due to exceptional income of Rs4.1bn (Rs2.7bn post tax) pertaining to reversal of Entry Tax levied by Tamil Nadu following a favourable Supreme Court order. Adjusted for this, net profit came in line with our estimate.

We expect ITC to post 9.6% revenue and 10.8% earnings CAGR through FY17-20E. Based on expected EPS of Rs11.4, the stock currently trades at 24.2x FY20E earnings, which is at a 35% discount to sector multiples and 45% discount to Hindustan Unilever. Attractive valuation provides adequate margin of safety, in our view. Considering ITC as a value pick than a growth stock, we maintain our BUY recommendation on the stock with an SOTP-based Target Price of Rs320.

Cigarette Business Performance in line

Cigarette volumes for the quarter are estimated to have fallen by ~3-4% in line with our estimate compared to decline to the tune of 7% and 2% in 2QFY18 and 3QFY17, respectively. Cigarette EBIT grew by 7.8% YoY to Rs32.7bn. Notably, reported revenue growth is not comparable due to accounting changes post GST roll-out, as base quarter figures include Excise Duty. Segmental margins stood at 70.6% compared to 72.3% in 2QFY18. We expect sequential recovery in volumes in coming quarters, although forthcoming Union Budget would be the key event to watch out for.

Improved Growth Momentum in non-Cigarette Biz

Non-cigarette FMCG business posted revenue growth of 11.8% YoY (16.2% on comparable basis) to Rs28.7bn, while the business witnessed segmental profit of Rs470mn vs. 197mn loss in the base quarter. Revenue from Hotels segment grew by 9.2% YoY to Rs4bn, while segmental EBIT surged by 30% YoY to Rs548mn on the back of increasing room rates, F&B and higher operating leverage. Despite 4% YoY decline in revenue to Rs12.8bn, EBIT from Paperboard segment grew by 9% YoY to Rs2.7bn due to benign input costs. Revenue from Agri business fell by 22% YoY to Rs15.3bn due to limited trading opportunities, while segmental EBIT remained largely flat at Rs2.3bn.

Outlook & Valuation

Looking ahead, we believe that regulatory issues would continue to remain an overhang for ITC in the coming years. In spite of GST and Cess levy, the Central Government still has the right to separately impose Excise Duty on cigarettes, which could act as a spoiler. However, attractive valuations at 24.2x FY20E earnings provide adequate downside protection, in our view. Hence, we maintain BUY recommendation on the stock with a Target Price of Rs320.
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Q3FY18-Sector Review:
Pharmaceuticals Sector -Q3FY18-Results Preview
FMCG Sector-Q3FY18-Results Preview
IT Sector-Q3FY18-Results Preview
Banking Sector-Q3FY18-Results Preview
Cement Sector-Q3FY18-Results Preview

IT Sector-Q3FY18-Results Preview

IT Sector - 3QFY18 Results Preview - Steady Quarter Likely

Sector Preview

We expect the USD revenue of the IT firms under our coverage universe to post a combined 1.9% QoQ rise in 3QFY18. Top-5 IT firms are expected to post 1.5-3% QoQ rise in USD revenue in reported terms (1.6-3.2% in CC terms) with HCL Technologies (HCLT) likely to lead. Mid-sized firms will see variation, with Cyient and Mindtree likely to lead (3% and 2.8% QoQ USD revenue growth, respectively). Cross-currency movements were varied in 3QFY18, with the USD largely remaining flat against the EUR, appreciating against the AUD (2.7%) and depreciating against the GBP (1.5%).

The IT sector continues to face disruptive trends in terms of SMAC leading to cannibalisation of revenue, apart from pricing pressure in commoditised services, and automation. The IT industry body, NASSCOM projects 7-8% growth in IT-BPO exports in FY18 with the announcement coming as late as June 22, as against its traditional practice of providing industry growth guidance in February, owing to global uncertainty. We do not expect the industry to surpass this growth target and believe high single digit growth is realistic in the near-term.

On margin front, we expect a stable performance despite seasonal weakness owing partly to INR depreciation against key currencies including the USD (0.7%), EUR (0.9%) and GBP (2.1%), and partly due to operational efficiencies and automation. Among top-tier IT firms, we expect Tech Mahindra (TechM) to post 69bps QoQ margin expansion, followed by Infosys with 53bps expansion. TCS, Wipro and HCL Technologies are likely to see range-bound margins. Within our mid-cap coverage universe, we expect Mindtree and KPIT Technologies (KPIT) to post the maximum margin improvement of 224bps and 76bps QoQ, respectively aided by revenue growth and improved operational efficiency. We expect continuous focus on levers like utilisation and cost efficiency. On YoY basis, margin performance is likely to improve, with 6 companies of our 13 IT coverage universe likely to post expansion to the tune of 44-172bps.

We would watch for sustainable margin outlook going forward, and IT budget trend for CY18E. Focus on return of cash to shareholders is also a theme playing out, with TCS, Infosys, Wipro, HCLT, Hexaware, Mindtree and eClerx all resorting to share buy backs in order to make better usage of their cash balances. Impact of the recent US tax change is also another focal area. We continue to believe Indian IT is a bottom-up sector and stock picks will play a key role in driving alpha.

Our Top Picks: HCLT and CDSL (India).

Revenue Expected to be Steady

We expect 1.9% sequential revenue growth for the IT firms under our coverage universe. On YoY basis, growth is likely to remain in single digit at 4.2% with the exception of KPIT (12%), as the IT sector continues to get affected by disruptive trends, increasing competitive intensity and pricing pressure. This quarter, there will not be any major impact of cross currency movements with CC revenue growth likely to be in 10-20bps range to reported USD revenue growth. Company-wise, we expect HCLT to lead the top-tier IT firms, while Cyient and Mindtree are likely to lead the mid-tier firms.

Margins to See Steady-to-Improving Trend

We expect IT firms to report small expansion in EBIT margins in 3QFY18E aided by currency and operational efficiency and automation focus. Among top-tier IT firms, TechM is likely to outperform with 69bps QoQ improvement, while Mindtree is likely to post a strong 224bps QoQ expansion among mid-tier firms.

Eyes on CY18E IT Budgets, US Tax Change Impact

In our view, the street’s attention will be focused on the likely trends in CY18E IT budgets. While finalisation may still take some time, some clarity on the likely direction of spend is a key focus area, in our view. Vertically, the key BFSI and Retail verticals will be watched. Apart from this, the potential impact of the recent US tax changes is also likely to be another focus area. The increasing role of automation and other margin levers are also critical factors, in our view.

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Q3FY18-Sector Review:
Pharmaceuticals Sector -Q3FY18-Results Preview
FMCG Sector-Q3FY18-Results Preview
IT Sector-Q3FY18-Results Preview
Banking Sector-Q3FY18-Results Preview
Cement Sector-Q3FY18-Results Preview

Banking Sector-Q3FY18-Results Preview

Banking Sector - 3QFY18 Results Preview - Multiple Headwinds to Impact Performance

Performance of Banking & Financial Service (BFS) sector is likely to remain under stress in 3QFY18 led by: (a) sharp decline in profitability from treasury operations; (b) higher MTM provisioning on non-HTM portfolio of the bank (benchmark 10 year Gsec yield increased by 65bps QoQ in 3QFY18); (c) higher provisioning on existing NPAs as well as additional provisioning on loans referred to NCLT/IBC; and (d) weaker business growth. However, the banks/NBFCs with relatively higher exposure to Retail and MSME segments will continue to deliver strong numbers.

Earnings profile of the corporate focused banks to remain subdued: We expect the banks with significant exposure to corporate term loans to report elevated level of provisioning. Further, ageing of existing NPAs and write-down of security receipts from sale to the ARC will keep their credit cost elevated in 3QFY18. However, fresh slippages are expected to decline, as recognition of stressed assets is peaking out across the banks. Continuing to remain firm on NPA recognition, the Reserve Bank of India (RBI) has asked the banks to refer 25 out of total 28 cases from the second set of larger stressed corporate accounts to NCLT/ IBC proceedings post the expiry of Dec’17 deadline. Further, the RBI has also asked the banks to provide more than 50% on all these accounts, which will negatively impact their profitability. Several cases referred to NCLT/IBC in first list indicated relatively higher haircut (in range of 60-80%) by the banks and hence, we expect provision expenses to remain elevated.

Further, few banks to report higher asset quality divergence in Annual Supervision Audit conducted by the RBI for FY17, which will be keenly watched by the market participants. Within that, we expect accelerated haircut/write-off by the Public Sector Banks as the Government of India has given final nod for much-needed capital infusion to the tune of Rs880bn in 4QFY18. However, the banks with higher retail/consumer portfolio will continue to show stable trend in their asset quality.

Credit growth revived marginally: After touching multi-year low in 1HFY18, credit growth revived marginally to 10.7% in fortnight ended 22nd Dec’17. We expect major part of incremental credit growth may flow into private banks helping them to improve their operating performance further. Further, deposit growth remained higher led by massive inflow of deposit during the demonetisation drive. Lending rate fell sharply owing to liquidity overhang, which resulted in moderation in Net Interest Margins (NIMs). This along with pressure on NIMs will curb NII growth for these banks in 3QFY17E as well as in FY18E.

Rising Gsec yield play spoilsport: Further, the sector has got negatively impacted by sharp rise in bond yield due to deteriorating conditions on fiscal deficit front. Fiscal deficit of the Central Govt. touched 112% of Budget Estimate for FY18 as of Nov’17-end, as the Govt. continued spending spree to support the economy. Resultantly, the benchmark G-Sec bond yield jumped to 7.33% as of 3QFY18-end from 6.66% as of 2QFY18-end.

Increase in G-Sec yield will result in MTM loss on non-HTM investment portfolio of the banks as well as result in sharp decline in treasury income. As the banks have deployed major chunk of excess liquidity from the demonetisation drive in government bonds, they have to report MTM loss from this portfolio. We expect our banking sector coverage universe to report a NII growth of 22% YoY and 4.6% QoQ led by PSBs (24.8% YoY and 3.7% QoQ) and private sector banks (18.9% YoY and 5.7% QoQ). However, other income of our banking universe is expected to decline by 13.3% YoY and 29.5% QoQ due to sharp decline in treasury income. Thus, on pre-provisioning profit front, we expect 15% QoQ decline. Overall, we expect our banking sector coverage universe to report 19.7% YoY and 5.8% QoQ decline in PAT led by PSBs with 68.5% YoY and 27.3% QoQ decline vs. 0.2% YoY and 2.1% QOQ decline for private banks.

Outlook & Valuation

Lower operating profit, subdued treasury income and higher credit cost on ageing of stressed assets will negatively impact the sequential performance of the banks in 3QFY18. As the recent steps by the RBI and the GoI clearly indicate that the banks will have to accelerate their efforts to resolve issues on asset quality front, we expect further surge in provisioning expenses in FY18E. We expect overall return to remain depressed over FY18E for the banking sector in general and corporate term loan focused banks in particular. Further, we believe that incremental deterioration in asset quality has been aptly addressed in last few quarters, however speedy resolution will continue to impact banks’ profitability. We expect improvement in banks’ core operating performance in coming quarters due to peaking out of NPA recognition cycle and improvement in non-corporate credit demand. As we expect the demand for retail loan to pick-up before any rise in demand for infrastructure/corporate loans, we prefer the banks having higher exposure to consumer and business banking portfolio. We expect asset quality stress to decline along with relatively moderation credit cost from FY19E onwards.

Our Top Picks: IndusInd Bank, DCB Bank, HDFC Bank and Federal Bank among private sector banks and SBI and Indian Bank among the PSBs.

Next Read :FMCG Sector-Q3FY18-Results Preview
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Q3FY18-Sector Review:
Pharmaceuticals Sector -Q3FY18-Results Preview
FMCG Sector-Q3FY18-Results Preview
IT Sector-Q3FY18-Results Preview
Banking Sector-Q3FY18-Results Preview
Cement Sector-Q3FY18-Results Preview

FMCG Sector-Q3FY18-Results Preview

FMCG Sector - 3QFY18 Results Preview - Lower Base Effect to Prop up Earnings; Medium-term Outlook Remains Robust

Our consumer sector coverage universe comprising of 18 companies is poised to report a stellar performance in 3QFY18 albeit due to favourable base effect (Demonetisation in the base quarter). We expect the sector to report 12.1% revenue and 13.3% earnings growth in the quarter. Excluding ITC, the growth is estimated to be even higher at 12.8% for revenues and 17.8% for earnings.

We expect the growth momentum to improve in the coming quarters on the back of trade channel stabilisation post GST roll-out, two consecutive good monsoons aiding rural growth, increasing premiumisation, strong pricing power and increasing share of the organised players in the GST regime. The sector currently trades at rich valuations of 35x FY19E earnings, while excluding ITC, the multiples are even richer at 40.7x earnings. We expect the current valuations to sustain, as medium-term growth momentum is on the cusp of taking off due to above mentioned factors and hence, we remain Positive on the sector. Our top picks are: ITC, Asian Paints, Colgate-Palmolive and Kajaria Ceramics.

Coming out of a Challenging Phase

The consumer sector has been through a challenging phase for past four quarters. When the growth was seemingly recovering in 3QFY17, it was hit by government’s decision to demonetise high value currencies, which substantially impacted the companies, consumers and the entire trade channel. While other channels have witnessed gradual recovery in demand led by modern retail, the wholesale trade segment continued to remain under pressure in parts of the country. All companies have rightly made investments in enhancing their direct distribution network in past couple of years. The second near-term disrupting factor was GST roll-out. While GST rates were largely positive for the sector sans ITC, the implementation with inherent complexities and confusion led to sharp correction in trade pipeline in the run-up to the roll-out in the month of June. While the growth has somewhat recovered in 3Q, we expect the full benefits of GST to flow in with effective implementation of E-Way bill system w.e.f. Feb’18.

Mixed Input Cost Scenario

Situation on the raw material cost front was largely mixed in the quarter. While the average prices of HDPE (down 3%), PFAD (down 6%), Milk (down 11%), Wheat (down 15%), Sugar (down 5%) and Refined Palm Oil (down 7%) declined on YoY basis, the prices of Copra (up 85%), Menthol (up 75%), Liquid Paraffin (up 25% YoY) and VAM (up 22% YoY) were substantially higher. The prices of TIo2 were moderately higher by 6% in the quarter. While most consumer companies enjoy strong pricing power, there is a lag effect between increase/volatility in raw material prices and the corresponding price hikes. This may impact the near-term gross margin profile of the sector.

Outlook & Valuation

We expect our consumer sector coverage universe to report 11.8% and 15.8% growth in revenue and earnings, respectively in FY18E, and the growth is estimated to improve to 14%/18% in FY19E. While valuations at 40.7x FY19E earnings ex-ITC are rich, we expect the sector to command high multiples on visible improvement in growth trajectory in coming years. Key risks for the sector are: delay in recovery in consumer demand, sharp increase in input costs and delay in implementation of E-Way bill system. In that case, the sector is likely to go through a prolonged time correction than price correction, in our view.

Our top picks are: ITC (muted expectations and attractive valuations), Kajaria Ceramics (strong brand and increasing market share post GST roll-out), Asian Paints (double-digit volume growth and reasonable time correction) and Colgate-Palmolive (renewed efforts to recover market share loss and benefits of lower GST rates).


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Q3FY18-Sector Review:
Pharmaceuticals Sector -Q3FY18-Results Preview
FMCG Sector-Q3FY18-Results Preview
IT Sector-Q3FY18-Results Preview
Banking Sector-Q3FY18-Results Preview
Cement Sector-Q3FY18-Results Preview

Pharmaceuticals Sector -Q3FY18-Results Preview

Pharmaceuticals Sector - Results Preview - Domestic Biz to Recover Further; US Biz Expected to Remain Weak

The companies under our pharma coverage universe are expected to report a flat sales performance both on YoY and QoQ basis in 3QFY18 due to multiple headwinds in the US (increasing pricing pressure, regulatory concerns and channel consolidation). Overall, we expect weak sales growth in the US business (-12.9% YoY in CC terms) and further recovery in domestic business post GST roll-out. We expect EBITDA and PAT of our coverage universe to decline by 13.3% YoY (-3.0% QoQ) and 15.4% YoY (-6.1% QoQ), respectively, while the EBITDA margin is expected to decline by 350bps YoY (-67bps QoQ) due to weak US sales. However, we continue to remain positive on long-term prospects of the pharmaceutical sector and recommend being stock-specific.

Pricing Pressure & High YoY Base to Impact US Biz
Most companies in our coverage universe are expected to report muted growth in US sales (YoY) due to high revenue base in 3QFY17 and steep price erosion (led by faster ANDA approvals and channel consolidation). We believe US business will continue to remain under pressure due to regulatory concerns (US FDA). On a positive note, the US FDA has approved higher number of ANDAs to Indian companies (246 ANDAs in 3QFY18 vs. 198 in 2QFY18 and 169 in 3QFY17). Notably, the US business remains mainstay for most companies under our coverage universe. Several measures i.e. aggressive R&D spend and scale-up in complex ANDA filings are considered sustainable for meaningful growth in their US business. We envisage improvement in US sales of the companies like ARBP (injectable portfolio) and Cadila HC (gLialda & gTamiflu), while we expect weak US sales for Sun Pharma (increased price erosion & gGleevec), Glenmark (end of gZetia exclusivity) and Lupin (steep price erosion to gGlumetza and gFortamet sales).

Further Recovery in Domestic Biz Post GST Roll-out
Domestic formulation business of our pharmaceutical coverage companies was adversely impacted in 1QFY18 on the back of challenges relating to GST (inventory de-stocking by trade channels in run-up to roll-out). We have seen significant recovery in 2QFY18 due to inventory re-stocking at retailers level. We expect the domestic business of the companies to stage a further recovery in 3QFY18. Notably, inventory re-stocking is yet to reach at pre-GST level. The Indian pharmaceutical market – which reported 6.5% YoY growth in Oct’17 (vs. +3.2% YoY in Jul’17) and +6.0% YoY growth in Oct’17 (MAT; AIOCD) – is expected to witness mid-teen growth over next few years led by new product launches and volume growth. We continue to remain bullish on Indian pharmaceutical sector from long-term perspectives.

Top Picks: Alkem Labs, Torrent Pharma and Cadila Healthcare

Key Developments to Watch Out For:
Ajanta Pharma: Outlook on India business and margin profile.
Alkem Labs: Outlook on India business and update on new launches in US.
Aurobindo Pharma: Update on debt front and outlook on injectable business.
Cadila HC: Outlook on India and US business.
Cipla: Update on combination inhaler launch in the UK.
Glenmark: Outlook on the US/India businesses and update on debt repayment.                               
Lupin: Outlook on US and India business.
Sun Pharma: Update on Halol plant inspection and the US business outlook.
Torrent Pharma: Outlook on India business post acquisition of Unichem’s India business.

Next Read: Cement Sector-Q3FY18-Results Preview

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Q3FY18-Sector Review:
Pharmaceuticals Sector -Q3FY18-Results Preview
FMCG Sector-Q3FY18-Results Preview
IT Sector-Q3FY18-Results Preview
Banking Sector-Q3FY18-Results Preview
Cement Sector-Q3FY18-Results Preview

Cement Sector-Q3FY18-Results Preview

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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Previous Read : Pharmaceuticals Sector -Q3FY18-Results Preview

Q3FY18-Sector Review:
Pharmaceuticals Sector -Q3FY18-Results Preview
FMCG Sector-Q3FY18-Results Preview
IT Sector-Q3FY18-Results Preview
Banking Sector-Q3FY18-Results Preview
Cement Sector-Q3FY18-Results Preview