Cement: After demonetisation, rising costs, unfavourable volume base to hurt
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Cement demand in the December quarter was impacted by demonetisation in most parts of the country, with southern India being an exception.
Pan-India firms ACC Ltd and Ambuja Cements Ltd saw a 9% year-on-year (y-o-y) decline in volumes; and for UltraTech Cement Ltd, it was a 2% y-o-y fall. South-based firms Dalmia Bharat Ltd (36% y-o-y), India Cements Ltd (22% y-o-y) and Orient Cement Ltd (19% y-o-y) saw strong volume growth, benefiting from improved institutional demand in Andhra Pradesh/Telangana and a low-base effect on account of floods in Chennai during the same period a year ago. As a result, on an overall basis, cement companies reported a flat volume growth at 37 million tonnes (mt) in the third quarter.
Not only demand, profitability also took a hit as production costs increased. Fuel prices, especially those of petroleum coke (petcoke), surged Rs400-500/tonne in the past quarter. According to a Kotak Institutional Equities (KIE) report, on a sequential basis, profitability of cement companies declined 11% to Rs753/tonne, though y-o-y it is up 10%.
Meanwhile, low demand kept realizations subdued.
In the past two months, the impact of demonetisation has subsided and the demand scenario has improved, but it remains below normal levels, especially retail demand. A pick-up in government spending on infrastructure and affordable housing projects may lead to a sequential demand uptick, but y-o-y demand would decline mainly due to a high base since demand growth in the fourth quarter of fiscal year 2016 was strong. Cement prices in the country, except the south, have begun to rise, but if this improvement in cement prices doesn’t sustain, then realizations would decline sequentially in the March quarter.
That apart, another worry is surging input costs. In the December quarter, a slew of cement manufacturers opted for alternative fuels to minimize the adverse impact on margins, while some others made use of the low-cost petcoke stock they were left with. As per analysts, the full impact of the rise in petcoke prices will be felt in the March quarter as most cement companies are likely to have exhausted that inventory. Diesel price, too, is trending upwards which will result in higher road freight costs, raising the production cost per tonne.
Though the shares of large-cap cement companies have recovered from where they were when demonetisation was announced and are currently trading at rich valuations, given these concerns, March quarter earnings would be lacklustre, indicating that valuations need to correct.