We expect the financials of companies in the cement sector to take a hit in 2010-11 due to a fall in capacity utilisation and the resultant fall in price realisations. Additionally, the rise in costs of power, fuel and freight will also weigh on the sector’s profitability in the current financial year. The capacity utilisation in the sector is likely to fall to around 78 per cent in 2010-11 from the high of about 95 per cent seen in 2007-08.
While installed capacity addition in the last fiscal stood at 48 million tonnes (mt), effective addition was only 29 mt, implying that the full impact of the recently added capacities is yet to come. Also, for the June quarter, the industry is likely to add about 19 mt, of which, 13.5 mt per annum (mtpa) will be added by major players. The southern markets would lead the fall in cement prices with a decline of around Rs 15-20 a bag over the average price seen during the previous year. While the fall in prices in other regions could be about Rs 10 a bag.
This significant capacity addition, expected over the period FY09-12, could be tracked down to the capital expenditure plans announced by the companies during the uptrend seen over the last three-four years. The uptrend buoyed the balance sheets of the companies in the sector, resulting in an optimism to add capacities.
The demand for cement is dependent on some of the key sectors in the economy: Housing/real estate (contributes about 59 per cent to the total demand), infrastructure (20 per cent), commercial construction (12 per cent), industrial (four per cent) and others (five per cent). While the demand for cement is expected to be strong, the fall in utilisation rate is attributable to significant increase in capacity addition. The impact of deteriorating operating matrix on individual companies in the sector would depend on each company’s region of operation and other competitive strengths.
Cement, being a freight-intensive commodity, puts a producer in one region at a competitive disadvantage vis-à-vis a producer in another region. In this current down cycle, not all the regions would be impacted by the same degree. While, at an all India level, cement prices and utilisation rates in 2010-11 are expected to fall, the southern region would lead the fall. The southern region would account for around 42 per cent of the capacity addition expected over 2009-2014. The deteriorating operating metric in the south will also weigh on the west, because of its physical proximity to the south.
Our house view on the sector is underweight and we have a ‘reduce’ rating on ACC, Ambuja Cement, India Cements and UltraTech Cement.
The author is Business Head, Client Advisory Services, Edelweiss Securities