Cement companies have announced price hikes in some regions in anticipation of good demand after the end of the rainy season. While prices are increased around this time every year, this time around it also has to do with a steep surge in petroleum coke (petcoke) prices.
In any case, the price hikes are hardly anything to get excited about, especially keeping in mind where valuations of cement stocks are.
But first, it must be noted that the recent hikes are on expected lines, and may be enough to only cover increased costs. A recent ICICI Securities Ltd report said petcoke prices have risen by nearly 80% over the past six months, which is likely to impact margins in a seasonally weak period, and the brokerage firm expects it to be passed on to consumers in the medium term. “Companies have announced price hikes of Rs10-50/bag across most regions in September 2016 mainly on reversal of price fall during monsoon,” the report added.
Prices in western, eastern and southern parts of India have seen a rise while prices in central and northern India remain more or less stable, say some analysts. Some experts such as Amey Joshi, associate director at India Ratings and Research Pvt. Ltd, say that prices may increase further in October. “At that time, many companies would be looking at replenishing their petcoke stocks at an increased price, and hence would pass on the increase in costs to customers,” he says.
While a hike in prices to cover the increase in costs is welcome, it is clearly not enough to support the record valuations of cement companies. In a report titled, Testing the upper bands of optimism, analysts at Kotak Institutional Equities write, “Cement valuations continue to scale new peaks, meaningfully higher than historical bands and despite optimistic earnings assumptions that carry downside risks. Large cement companies have rarely breached the 15X EV/EBITDA on one-year forward estimates over the past decade, and accordingly, we see no scope for multiple re-rating from here.” EV is short for enterprise value while Ebitda stands for earnings before interest, taxes, depreciation, and amortization.
In the near term, the seasonally weak second quarter of fiscal year will end in a few days from now and some analysts have already cautioned about subdued performance from cement companies, especially on the operating margins front due to increase in fuel costs, which could lead to a short-term correction in these stocks.
Though some experts maintain that the second half of the year will be better for cement companies, the impact of the aforesaid price rise and whether or not the much-anticipated revival in demand has happened, remains to be seen.
The fact that the industry’s capacity utilization is currently low at less than 70%, it does leave ample room for volume growth, especially if a strong economic recovery is on the cards. But that can’t be taken as a given, especially if capacity additions are higher than expected. Again, current valuations assume strong growth and much more. Kotak’s analysts write, “The pitfalls of poor earnings predictability may make asset-based valuation a suitable alternative check on valuations. Our analysis of gross block addition for the large cement companies and their individual capex plans, suggest capex of Rs 5.5 bn/mtpa (US$84/ton at spot rate) and transaction multiples of US$115-140/ton, (which is) significantly lower than trading multiples of US$127-304/ton for pan-India companies.”