Investors should remain upbeat on cement sector; price hike is a positive

Consider companies that can grow their market share and lower cost per tonne

The cement sector may be looking at better realisations and higher volume offtake going by the trends of the October-December quarter of the 2022-23 financial year (Q3FY23), a recent price hike, and the promise of a continued infrastructure thrust in FY24.

In Q3, revenues rose by an aggregate of 17 per cent year-on-year (YoY), but Ebitda (earnings before interest, tax, depreciation and amortisation) per tonne, fell by 14 per cent YoY while profit after tax (PAT) rose by 23 per cent YoY.

Expenses were up 30 per cent per tonne YoY -- power and fuel costs in particular -- and that’s no surprise given the rise in fossil fuel prices. However, quarter-on-quarter (QoQ) trends were good since fuel costs dropped by 6 per cent and Ebitda per tonne rose QoQ. Other raw material costs were up 4 per cent QoQ, and 7 per cent YoY. 

Most cement companies hiked prices in February, which is a healthy sign. It implies higher demand and that should continue through the next financial year. Energy costs should stabilise since domestic coal and pet coke prices have reduced, if only marginally, and this should lead to sequential improvement in Q4FY23 as far as expenses are concerned.  

Cement companies have announced price hikes of Rs 10-15 per bag (of 50 kg) in the second half of February 2023. The finance ministry has recommended a reduction of GST on cement from the current 28 per cent. If the GST Committee agrees to cut the tax on cement, it could improve realisations if it is not completely passed on by the cement producers. 

Cement companies are optimistic about future demand, since all the major ones have expansion plans. UltraTech is slated to increase its domestic capacity to 154 million tonnes per annum (mtpa) by FY26 and 200 mtpa by FY30. Shree Cement is expected to add 9.5 mtpa by December 2024, and is committed to reaching 80 mtpa by 2030. Dalmia Bharat is looking to hit 75 MT capacity by FY27, and 110-130 MT by 2031, with a short-term target of 49 MT by March 2024. Overall, capacity could expand at 6 per cent compound annual growth rate for the next two or three years. 

In Q4FY23, aggregated industry Ebitda per tonne could rise by around Rs 200 QoQ from around Rs 770 per tonne in Q3FY23, and it may even cross the Rs 1,000 per tonne mark, recovering from a low of Rs 620 per tonne in Q2FY23. Volume growth should be in the range of 8-10 per cent in Q4FY23 and sequential demand gains may sustain in FY24. 

Risks remain due to the capex plans creating a potential supply overhang, especially if there’s a macro-economic slowdown. This is a sector which is capital-intensive and power-intensive, with reasonably high working capital needs and its downstream sectors -- such as infrastructure and housing -- are also rate-sensitive. Hence, a scenario of rising interest rates is not ideal.

The sector is somewhat highly valued, given that cement is a commodity. On an average, cement companies have an enterprise value/Ebitda ratio of 19-20 or higher, and current price-to-earnings ratio higher than 40x.

The high valuations are partly a sign of being close to the bottom of a cycle. The industry Ebitda margin was down to 13 per cent in Q2FY23, and it improved to 13.8 per cent in Q3FY23. Investors should remain positive on the sector but they need to look for companies that can retain or grow market share, and ideally reduce cost per tonne.