New Delhi: Cement companies, so far defiant on cutting prices, could soon be trapped in their own net— their huge investment plans are set to result in oversupply by the next fiscal. That could hit profitability and force them to reduce prices, analysts said.
The supply of the construction raw material is expected to overtake demand in 2008-09 when the capacity addition projects are completed. This would bring down prices by 7-15% and weigh down heavily on the companies’ earnings, analysts at domestic brokerage firm SSKI said in a report.
While companies have announced significant capacity addition amid a dream run over the past two-three years with robust profitability driven by record high prices, the supply-demand scenario is now set to turn negative.
Cement firms could see their annual earnings plunge 19-34% during 2008-09 as the ongoing cement cycle is unlikely to extend beyond the current fiscal, they added.
The manufacturers have seen their share prices and profits significantly appreciate in the last one year, even as they remain firm on not cutting prices despite the government repeatedly asking them to reduce prices as part of the efforts to contain inflation.
On an average, cement prices have increased from Rs156 a 50kg bag in March 2004 to Rs225 in March 2007, driving revenues and profits.
The analysts wrote in a research note sent to their institutional clients that the rally seen in the sector is unlikely to extend beyond 2007-08 despite strong demand growth or maintenance of pricing discipline by companies.
A tight demand-supply situation has driven prices to record highs over the past two-three years and in anticipation of further demand growth, companies have announced capacity additions of close to 99 million tonnes (mt) by 2009-10.
Cement demand grew at a compounded annual growth rate of 12% in 2005-06 and 10.5% in 2006-07, but supply failed to keep pace in the absence of any significant capacity addition during the past three-four years.
However, due to large capacity additions being planned, supply would grow close to 13% over FY07-10, compared with 10% demand growth. This could lead to a surplus of about 8.6mt in 2008-09, analysts said.
Some industry experts also believe the cement industry has achieved a reasonable level of consolidation with five-six players controlling about half the total capacity. This could allow companies to hold prices firm even during an oversupply scenario, as has been demonstrated over the past one year when prices have shot up despite pressure from the government, they argue.
However, the industry might find it difficult to hold the prices firm, as smaller players are adding capacities at a faster pace than the top five players. When all expansion projects are commissioned, the market share of the top five would fall to 42.9% in 2009-10 from 49.3% currently, SSKI analysts said.
Besides, the government’s decision to scrap customs duty on imported cement would discourage a hike in domestic prices.
“With no tax incidence on imported cement, except VAT that is also exempt for direct imports by users, imported cement prices now work out to be cheaper than domestic cement prices,” SSKI analysts Shirish Rane and Salil Desai said.
However, prices are expected to hold firm in the current fiscal. This is because a significant proportion of the planned 99mt capacity addition would start coming on stream by the second half of the year and the full impact of supply from these capacities is expected to be felt only by early 2008-09.