New capacity, falling prices, higher input costs are the dampeners.
Cement makers are likely to face a tough second half due to excess capacity, which will lead to a drop in capacity utilisation, prices and profitability. As a result, most companies are likely to register a drop in net profit for the current financial year.
After recording a consistent 10 per cent growth year-on-year in cement despatches for the most part of 2009-10, the sector has for the past four months been registering single-digit, year-on-year, growth rates. Going ahead, while higher input costs and dip in prices will depress margins, excess supply and regional imbalances at a time of muted demand remains the key issue for the sector.
Over-supply
The sector added 40 million tonnes (mt) of fresh capacity in 2009-10, a fifth of 2008-09 capacity. Most of the new capacity came online in the March quarter of this year, compounding problems. With new capacities also expected to come online later this year and recently installed capacities coming online fully, the sector is saddled with capacities (supplies) way beyond demand. The problem is likely to be more acute over the next three months, traditionally a weak demand period due to the monsoons. Capacity utilisation levels are expected to touch seven-year lows of 79 per cent in 2010-11, states a Goldman Sachs report.
Demand, costs and prices
Over-capacity has led to a fall in cement prices by about Rs 5-10 per bag in most regions in the month of May, with the fall most severe in Andhra Pradesh. Analysts expect demand is likely to pick up after September and estimate it will grow by about 10 per cent annually, on the back of higher spending on infrastructure projects, as well as investments in the rural and urban housing segments. While this should provide comfort, higher input costs (in the form increased coal prices going forward) and transportation costs, and the lack of pricing power due to severe competition, is likely to impinge on their margins.
While Grasim will eventually become a holding company for the Aditya Birla group’s cement business, we review the medium-term prospects of the remaining largest players in the sector.
ACC
While the company is expanding South, nearly half of its capacities (30 mt) are in the North and East, which are seeing good demand. Cost rationalisation over the past two years and coal linkages (65 per cent) will help this pan-India player to control costs, even while it increases volumes. With major expansion out of the way, the company is expected to generate free cash flows from CY11. Buy on dips. Ambuja Cements
About 60 per cent of the company’s sales come from the lucrative markets of the North, Central and East regions, with no exposure to the South. Hitherto, the company was dependent on third parties for clinker, but the commissioning of its own capacity in the March quarter will lead to lower raw material costs. The stock, however, is one of the most expensive on all parameters in cement and is better avoided.
UltraTech
The consolidation of the cement business under one roof will make the company India’s largest producer, with a capacity of 49 million tonnes and a market share of 20 per cent. Though the company has a presence across the country, about 29 per cent of its exposure will be in the South, which could be a cause for concern over the short term. The company plans to add another 25 million tonnes over the next five years, at a cost of Rs 12,500 crore. Though the stock has corrected over the last quarter, there is room for further decline, believe analysts.
India Cements
An 85 per cent exposure to the southern market is the biggest risk for this stock. The company is expected to experience a margin contraction, both due to its South presence and higher input costs. It imports 65 per cent of its total coal requirements and with coal prices going up and higher costs of transportation, its margins are likely to drop to 20 per cent in 2010-11, as compared to the industry average of 25 per cent. Avoid for now.
