Firm outlook for cement despite lean Q2

Energy costs may limit September quarter profitability, but rising demand and lower capacity additions bode well for future prospects

Cement demand and pricing trends in the monsoon-impacted September quarter (Q2 of FY18) have been a mixed bag. But, a closer look suggests the recent past as well as future prospects of many cement companies are in good shape, and investors can use any correction in the share price as a buying opportunity.
 
While cement prices in eastern and western India have surprised with year-on-year (y-o-y) gains, it was not so in other regions. Hence, average all-India cement prices are pegged to have been flat to up three per cent y-o-y in Q2, based on various estimates. But, if one were to factor in the two-three per cent reduction in tax rates after implementation of the goods and services tax (GST) which is also reflected in the prices, the overall pricing trend is encouraging, say analysts.

 
On the demand front, although monsoon was a factor impacting construction activities, sand availability, active government projects etc., too, had a bearing on regional patterns. Among regions that gained, north and east as well as Andhra Pradesh/Telangana saw sales volume growth of 10 per cent y-o-y in Q2, according to Centrum Broking channel checks, largely driven by increased execution of government projects. But, sales declined in the central and southern regions dragged by sand shortage in Uttar Pradesh and Tamil Nadu; the Tamil Nadu and Kerala markets are also not seeing much activity in government projects, point out analysts. Not surprising then, central and south India have seen major price impact.

 

Nevertheless, average all-India volume growth remains healthy. While analysts at HDFC Securities say cement companies in their coverage universe are expected to post 13.4 per cent volume growth for Q2, analysts at Kotak Institutional Equities say their coverage universe will likely report six per cent y-o-y growth in cement volumes. The analysts also say the first quarter under GST could yield surprises on realisations as well as benefits from input cost credit.
 
With healthy volume growth and realisations, all-India players such as UltraTech and ACC, and those with higher exposure to the eastern and western regions such as Ambuja Cements and Shree Cement are expected to report better Q2 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 Q2, too, analysts remain positive on the prospects of the cement companies, anticipating a turnaround in demand in the second half of FY18, led by rural recovery even as the first six months may have seen the impact of the Real Estate (Regulation and Development) Act (RERA). Analysts at JM Financial expect demand from the affordable housing and infrastructure segments to drive volume growth in the second half of FY18, while Centrum Broking says dealers and marketing executives have indicated that cement demand should recover after monsoon and as the GST and RERA drag wanes off in the 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 say.

 
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 the 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 remain 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 the 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 (earnings before interest, tax, depreciation and amortisation) multiple based on FY19 earnings, while mid-caps are trading at 6-9x on this metric.

 
Among mid-caps, analysts prefer J K Cement, Mangalam Cement, Ramco Cements, India Cements and Sagar Cements, with some also highlighting Dalmia Bharat, Orient Cement and JK Lakshmi as their picks.