The cement cycle has peaked. The results for the quarter ended September have signalled this already. Massive capacity additions, lower cement prices and higher costs will translate into lower price realizations and operating profit margins in the next 12-18 months.
Cement prices, which started softening in August in pockets, are expected to fall by at least 10% from present levels in the next six months. The reason: a demand-supply mismatch. Triggered by the growth story in infrastructure and housing, most companies planned huge expansions. However, delay in some expansion plans has led to bunching up of capacities. Hence, cement capacity will increase from 216 million tonnes per annum (mtpa) in 2009-10 to 267 mtpa by 2011.
However, growth in demand may be lower in the second half. Assuming an 8-10% growth rate in cement offtake, there would still be a demand-supply gap until FY11 (see table). The demand-supply mismatch would lead to a fall in capacity utilization, which could drop to around 80% from 88-90% in the first six months of the year.
The situation for southern companies would be worse as most of the capacity build up is happening in this region. Demand, too, in the second half is relatively lower in the southern markets. According to a cement company official, “In the next four-six months, if the demand grows by 10-12% in the west and north, it will grow by around 6% in the south.”
Logically, therefore, cement prices will soften and sales realizations will drop. Sales volume and value of ACC Ltd, the country’s largest cement manufacturer, fell by 7% and 5%, respectively, on a sequential basis. Likewise Ultratech Cement Ltdsales fell by around 20%. Analysts project an 8-10% drop in the revenue of most firms in the second half?of the?year.
Adding to the woes are the rising costs. Lower sales volumes will lead to lower fixed cost absorption. Besides, raw material, freight and fuel costs which are already
moving north, are expected to rise by at around 2-3% in the next six months. Hence, operating profit margins will come under pressure.
Cement stocks have underperformed the Sensex in the last three months due to these concerns. Front runners such as ACC,
Gujarat Ambuja Cements Ltd, Ultratech Cement Ltd and India Cements Ltd have lost ground by 20-30% since August. Given a three-five year investment horizon, a two-year oversupply can depress valuations considerably, until demand catches up with supply by the second half of FY11.