Market may be pricing in negatives for cement sector as demand stays flat

Investors are divided on the future of the cement sector. The budgeted infrastructure building programme ensures some offtake, but private sector demand is muted. The entry of Adani Group in the Ambuja Cements-ACC takeover implies higher competitive pressure.

Given the planned capacity additions by many companies, there could be a price war and lower utilisation. At the same time, raw material and fuel prices are stabilising and may have peaked. This means easing margin pressures.

There will be an estimated 90 million tonnes (mt) of capacity added by 2024-25. This is a three-year compound annual growth rate (CAGR) of 5.5 per cent. For satisfactory utilisation levels, demand CAGR through this period needs to be 7 per cent or better. If that is achieved, there should not be a pricing disruption.

Consolidation is likely since the top four players will be adding around 60 per cent of the incremental capacity, implying market share will be concentrated, with these four holding 51 per cent.

Utilisation is around 69 per cent of effective capacity (525-550 mt in 2021-22, or FY22) and by 2024-25, it will be around 625-650 mt. The Southern region’s capacity utilisation is lowest at 55 per cent.

In the near term, margin pressure could continue for at least another quarter or more. There is usually seasonal weakness in demand through the monsoon period, leading to lower realisations.

Despite fuel prices showing signs of stabilising, coal, gas, and crude oil are high and other raw material costs even higher. The first half of 2022-23 (FY23) could see earnings before interest, tax, depreciation, and amortisation (Ebitda) per tonne decline by Rs 150-200 for various companies, compared to the fourth quarter of FY22.

Aggregated Ebitda could drop in FY23 and prices will be forced down if Adani Group, in particular, fights an aggressive war to win market share. If Adani looks for more acquisitions to gain market share, that could lead to fewer greenfield capacity expansions.  

Given the industry’s capital expenditure plans and the scenario of low private demand, free cash flows will be weaker, along with lower Ebitda. Conservative analysts have cut target prices and valuations for FY23 across the entire sector.

One key question is, has the market already discounted the negatives and is there too much pessimism about the sector?

Ignoring ACC and Ambuja, which have seen stock prices affected by the merger and acquisition dynamics, there have been stock-price corrections across all the other major listed cement companies.

Using enterprise value/Ebitda as a valuation metric, multiples across the sector have dipped below the three-year average. The sector has underperformed the broad market in the past six months.

Since the Ukraine war, coal and petcoke prices are up over 50 per cent. Domestic diesel prices have corrected after an excise duty cut in May. Cement prices peaked in March and corrected somewhat as the first quarter of FY23 kicked in. Although revenues should be marginally ahead of FY22 in FY23, profitability will be lower.

Stocks of UltraTech, Shree Cement, Ramco, Birla Corporation, and Dalmia Bharat have seen corrections of over 20 per cent in the past six months.

UltraTech has a target valuation of Rs 6,650, according to one analyst (current market price, or CMP: Rs 5,615). Shree has a target valuation of Rs 22,400 (CMP: Rs 19,400). Birla Corporation has a target valuation of Rs 1,070 (CMP: Rs 873). There could be a moderate upside with positive rerating if fuel prices fall.