India Ratings and Research (Ind-Ra) has maintained a "stable" outlook on Indian cement manufacturers for FY18. Ind-Ra expects the operating profitability of cement manufacturers in FY18 to be around the FY16 and estimated FY17 levels, due to stable demand growth, despite an increase in input cost. Demand will be backed by an increase in government expenditure. Ind-Ra also expects the credit profile of cement manufacturers to remain stable on stable operating profitability and in the absence of debt-led capex.
Stable Demand Growth
Ind-Ra has revised down its FY17 growth estimates to 3 per cent-3.5 per cent from 4 per cent-6 per cent, earlier. This revision is largely attributed to a blip in demand due to demonetisation. The rating agency, however, expects the cement industry to grow 4 per cent-5 per cent year-on-year (y-o-y) in FY18, driven largely by the demand stemming from infrastructure activities and a revival in housing demand in rural areas, both led by government spending.
Rising Cost Curve
The price of pet coke and coal has almost doubled since September 2016. The current increase in crude oil prices is also likely to lead to an increase in diesel prices. Ind-Ra expects stable cement demand to enable cement manufacturers to pass on increases in cost during FY18.
The rating agency believes that a 38 per cent and 23 per cent increase in the allocation of funds towards the housing sector under the Pradhan Mantri Awas Yojana and spending of the ministry of road transport and highways to Rs 290 billion and Rs 649 billion, respectively, would increase cement demand in FY18.
Limited Capacity Utilisation
According to Ind-Ra's expectation, from FY16-18, there will be an additional capacity of around 50 mtpa capacity at a CAGR of 6 per cent, compared to the CAGR of 4.9 per cent during FY13-FY16 (additional 40 mtpa). The country's eastern region will continue to lead supply growth and is likely to add 17 mtpa through FY16-18, followed by the north (14 mtpa). The CAGR capacity additions in the eastern (10 per cent) and northern regions (7 per cent) may outpace cement demand in these regions.
Pan-India capacity utilisation remained stable in FY16 at around 70 per cent. However, the rating agency has revised pan-India capacity utilisation for FY17 to 65 per cent from 69 per cent-70 per cent, due to the weak demand outlook in 2HFY17 on account of demonetisation. Importantly, the rating agency does not expect capacity utilisation to improve significantly in FY18 and expects it to remain around 70 per cent.
The credit profile of cement manufacturers is likely to remain stable in FY17. The negative impact of a possible decline in operating profitability during 2HFY17 due to an increase in fuel cost and lower volumes will be compensated by the higher operating profitability reported by the companies during 1HFY17 due to lower fuel prices and higher demand. Median EBITDA margins for a sample of 17 cement companies improved to 15.37 per cent in 1HFY17 (FY16: 14.38 per cent, FY15: 15.07 per cent).
Positive Impact of GST
The current excise duty is 12.5 per cent and VAT is 12 per cent-15 per cent. Thus, the total tax paid or payable on cement by end-customers can range anywhere between 24.5 per cent-27.5 per cent. At a GST rate of 18 per cent, even if cement companies pass on 50 per cent of their savings by lowering cement prices, the agency believes that their margins would increase by 300-500 basis points. However, a change in cement prices would not be large enough to affect product demand.
Slow Demand Pick-up
Cement demand grew 2.8 per cent y-o-y during April-December 2016 (April-December 2015: 2.64 per cent, FY16: 4.8 per cent). It tanked 8.7 per cent y-o-y in December 2016; however, it increased 7.2 per cent month-on-month in December 2016. The rating agency expects the demand would be sluggish for the remaining part of FY17 due to demonetisation.
In the current fiscal year, urban housing demand has been affected by continued affordability issues and weak consumer sentiments. Urban housing in Tier-1 cities may improve with a reduction in interest rates. Rural demand was expected to improve during FY17; however, demonetisation has impacted the demand due to a cash crunch. Historically, the drivers of cement volume have been infrastructure, construction and real estate activities. Cement volume growth shows a varying correlation with each of these segments.
Bank credit growth has been used as an indicator of activities in these three segments. The moderately high correlation of close to 0.6 between cement volume growth and bank credit growth for the construction and commercial real estate sectors indicates that activities in these sectors are possibly the key drivers of cement volume growth. Ind-Ra expects construction gross value addition growth to improve to 4.1 per cent in FY18 from a likely 2.9 per cent in FY17 (FY16: 3.9 per cent). Historically, cement growth has been in line with the growth in construction gross value addition.