Cement companies to benefit from macro build-up
The foremost cause for cheer is the 11% volume growth achieved in the five months till August compared with a meagre 3% growth in 2013-14
Cement firms are likely to do better in the coming quarters, as factors holding up growth in the past three years are turning around. The foremost cause for cheer is the 11% volume growth achieved in the five months till August compared with a meagre 3% growth in 2013-14. And, demand could get even better from here on, as the seasonal effect of the monsoon on cement sales is getting over.
July’s index of industrial production (IIP) showed a significant rise in cement despatches after a subdued performance for almost three years. Further, the installation of a pro-growth government has also raised expectations of growth exceeding the sub-5% levels seen between 2009-10 and 2013-14.
Cement prices, too, have been firm in the last few quarters. A report from Kotak Research explains that improved demand helps strengthen pricing discipline, and marginal firms adopt a less destructive approach by undercutting prices, as they can garner a share in an expanding market.
But strong prices alone cannot help cement firms. Skyrocketing commodity prices and the depreciation of the rupee had worked against cement companies. Rising transport costs and expensive imported coal eroded profit margins, but these are now set to ease.
Softening crude and coal prices should lower transport and fuel costs which form a substantial portion of cement manufacture. A report by Karvy Stock Broking Ltd analysing 17 cement companies says, “Industry operating profit declined by ₹ 265 per tonne to ₹ 675 in fiscal 2014 (year ended March). Demand increase and cost moderation should lead to a ₹ 200 per tonne rise year-on-year in each of the next three years."
The only glitch to strong earnings growth is the continuous capacity addition even through the years of slowdown, which keeps up the pressure from higher supplies. Even if one were to assume that demand grows by 12% compounded annual growth rate till 2015-16—assuming twice the gross domestic product multiplier—pan-India utilization rates will still remain at 72% in that year. Upsides in profitability could be higher if utilization levels improve, though regional disparities could continue to be visible.
Since large and some mid-sized cement firms had maintained profitability through price discipline in the last few quarters, cement stock prices have outperformed the S&P BSE 500 index since January, when cement prices started firming up. Yet analysts believe there would be scope for a re-rating in earning per share as the economy gets better. After all, some shares are still trading at a discount to the peak enterprise value per tonne scaled by these companies in the previous bull cycle of four years that ended in 2010.
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