Firm outlook for cement despite a lean Sept quarter

If one were to factor in 2-3% reduction in tax rates post GST, the overall pricing trend is encouraging

Cement demand and pricing trends in the monsoon impacted September quarter have been a mixed bag. But, a closer look suggest that the recent past as well as future prospects of many cement companies is in good shape, and that investors can use any correction in share prices as a buying opportunity.

While cement prices in Eastern and Western India have surprised with year-on-year gains, it was not so in other regions. Hence, average all India cement prices are pegged to have been flat or up three per cent year-on-year at most in the quarter, based on various estimates. However, if one were to factor in the 2-3 per cent reduction in tax rates post implementation of GST (goods and services tax) which is also reflected in prices, the overall pricing trend is encouraging, say analysts.

On the demand front, although monsoon impacted construction activities, factors such as sand availability and active government projects too had a bearing on regional patterns. Among regions that gained, north and east as well as Andhra/Telangana saw sales volume growth of 10 per cent year-on-year during September quarter (Q2FY18), as per Centrum Broking channel checks, largely driven by increased execution of government projects. However, sales declined in the central and southern regions dragged by sand shortage in Uttar Pradesh and Tamil Nadu; Tamil Nadu and Kerala markets are also not seeing much activity in government projects, point out analysts. Not surprising then, central and southern India have seen major price impact.

Source: JM Financial, Data compiled by BS research Bureau

Nevertheless, the average all-India volume growth remains healthy. While analysts at HDFC Securities say that cement companies in their coverage universe are expected to post 13.4 per cent volume growth for September quarter, Kotak Institutional Equities say that their coverage universe will likely report six per cent year-on-year growth in cement volumes. The analysts also say that the first quarter under GST could yield surprises on realisations as well as benefits from input cost credit.

With healthy volume growth and realisation, all India players such as UltraTech and ACC, and those with higher exposure to East and West such as Ambuja Cements and Shree Cement are expected to report better September quarter performance. Rising cost of fuels such as pet coke and coal, however, may restrict any sharp increase in per tonne profitability, over the year ago period.

Beyond the September quarter, too, analysts remain positive on the prospects of the cement companies, anticipating turnaround in demand in second half of FY18 led by rural recovery even as the first six months may have seen impact of RERA. Analysts at JM Financials expect demand from the affordable housing and infrastructure segments to drive volume growth in second half of FY18, while Centrum Broking says dealers and marketing executives have indicated that cement demand should recover post monsoon and as the GST and Rera drag wanes off in coming months and sand availability improves. "Good monsoon across most parts should also drive recovery in retail demand going forward, and also lead to sequential prices rebounding," they add.

Experts also say that with overall capacity expansion pace slowing and demand outpacing, cement manufacturers should benefit. Binod Modi at Reliance Securities foresees incremental demand to outpace incremental supply and thus better utilisation in ensuing years. While he has factored in an average yearly incremental capacity addition of 8-10 million tonnes (MT), incremental demand is pegged at 15-20 MT over FY18-FY20.

In this backdrop, pan-India players such as UltraTech with expanded capacities remains the obvious choice. ACC, too, having seen some capacity expansions and with merger benefits (with Ambuja Cements) to flow to both companies, is also among top picks. Shree Cement remains an efficient cement producer adding capacities regularly. Besides, some mid-cap players, too, may get re-rated backed by improving return ratios. Kotak Institutional Equities highlights that on an average, large cap cement stocks are trading at 12-15x enterprise value -to-EBITDA multiple based on FY2019 earnings, while mid-caps are trading at 6-9x on this metric.

Amongst midcaps, analysts prefer JK Cement, Mangalam Cement, Ramco Cements, India Cements and Sagar Cements, with some also highlighting Dalmia Bharat, Orient Cement and JK Lakshmi as their picks.