Most counter-intuitive sector in India?
Most counter-intuitive sector in India?

Most counter-intuitive sector in India?

Over the past decade, the cement industry has witnessed a decline in utilisation rates, despite which, cement prices have held up fairly well. FY19 is likely to end with near double-digit demand growth, which will also take up utilisation. This much-anticipated event, however, has been a big disappointer as prices did not see any benefit and in fact, unit Ebitda margins contracted in FY19. Lower energy prices are a relief but cement prices are the key, and uncertainty prevails here, which is quite counter-intuitive in the context of rising utilisation rates.

Government focus drove demand in FY19

  • Over the past several years, a weak macro weighed on cement demand which reported growth of -5 per cent over FY11-18 (FY18 growth of 8.5 per cent is off a very low base).
  • FY19 saw a trend reversal as demand is expected to be 9 per cent to 10 per cent, the fastest growth in almost a decade.
  • Industry feedback indicates FY19 growth has primarily come from government led infrastructure and a boost from pre-election spending (states as well as centre).
  • Across regions, the south and east have witnessed strong growth while the west faces challenges.
  • Momentum should continue and we build-in 7 per cent growth for FY20, despite a tough base.

Utilisation rates to move up:

  • Supply additions continued and rose 0.5 per cent YoY but trailed incremental demand in FY19 which drove up industry utilisation by around 0.3 YoY to 69 per cent in FY19.
  • Despite relatively lower utilisation than average, several players continue to add capacity; we forecast a 4.5 per cent CAGR for capacity over FY18-21CL.
  • However, with demand growth ahead of supply, industry utilisation rates should see an up-trend, which we forecast to average 73 per cent by FY21.
  • There would however be regional disparity with the south witnessing the lowest absolute utilisation while the north and central should see the strongest absolute level.

Energy cost advantage but cement pricing holds the key:

  • Energy prices exerted severe pressure during most of 2018 but have started to ease. For example, petcoke prices are down 25 per cent + and diesel prices are down +20 per cent from peak.
  • The benefit of these along with higher axle load should be visible during 2019.
  • The concern however is on cement pricing which remained weak for most of 2018. For FY19 we estimate a 1 per cent rise on a blended basis, well below cost inflation.
  • This is because of a market share fight among the large and the mid-sized players, which resulted in a 0.12 per cent YoY decline in the FY19 unit Ebitda despite a better utilisation rate.
  • With UltraTech likely to ramp-up its acquired capacity, Shree's foray into the south and west, Ramco's expansion in the east and Dalmia's foray into the west, concern remains.
  • For FY20, we still forecast a sector unit Ebitda of 890x/t, +14 per cent as energy prices cool off, and we also build-in around a 4 per cent YoY rise in cement pricing.

We turn more cautious on the sector

  • While an energy price correction should help, 'margin accretive' cement price hikes are a must for sector performance.
  • We lower our cement price assumptions to account for lower realisation in 3QFY19 and also for slightly moderate hikes thereafter.
  • We cut the EPS estimates for our coverage by 3 per cent to 15 per cent for large firms and also build-in the Binani acquisition for UltraTech.

Pricing continues to disappoint, despite robust demand and cost pressure 

  • Pricing has disappointed so far in FY19 in the context of strong demand, rising industry utilisation rates and energy price pressures.
  • While cement prices increased slightly, these trailed unit costs exerting margin pressures.
  • The key issue has been fight for market share as demand growth has been strong along with a slight mix change as the share of institutional sale rose.
  • Strong double digit demand growth and cost pressures were expected to justify an industry-wide price increase, which was also reflected across the earnings conference calls post the 3QFY19 results.
  • However, as per our channel checks, prices did rise in some markets during 3QFY19 but most of the gains reversed as hikes did not sustain - channel attributed this also to price-led competition.
  • The cement prices have largely remained flat in the CY18, with South and North seeing a decline and other regions witnessing marginal price hikes.
  • As we enter 4QFY19, the strongest quarter seasonally for cement due to peak construction activity, pricing should pick-up but rationality is a must.

About the authors:
Vivek Maheshwari, Bhavesh Pravin Shah and Jithin John of CLSA.
We would like to thank Evalueserve for its help in preparing the research reports. Bhavik Mehta (IT); Kamal Verma (Banking & Financial Services); Kushal Shah (Midcaps), Mihir Manohar (Capital Goods, Utilities, Power); and Suraj Yadav (Cement, Oil & Gas) provide research support services to CLSA.

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