Higher infrastructure spending buoys cement manufacturing

Higher infrastructure spending buoys cement manufacturing

Cement dispatches have been robust in the second half of FY10 on account of higher government expenditure on infrastructure and steady rural consumption. We expect demand to hold firm, particularly in India’s northern market, with a growth of over 10% in the next two years. On the flip side, our analysis suggests that cement overcapacity is imminent in the medium term.

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This, together with rising coal and freight costs, signals a challenging road ahead in FY11. With the southern market at greatest risk of a supply glut, we maintain our preference for north-based firms such as Grasim Industries Ltd, Jaiprakash Associates Ltd and Shree Cement Ltd.

Mid-cap companies in the rapid-hardening hydraulic cement universe led the way in terms of dispatch growth for January. While India Cements Ltd’s volumes grew 30% year-on-year (y-o-y), JK Lakshmi Cement Ltd registered an increase of 27%. Orient Paper and Industries Ltd, Shree Cement and Birla Corp. Ltd also logged strong growth rates of 20%, 18%, and 16% y-o-y, respectively.

Mangalam Cement Ltd was the only firm in our universe to witness a decline with volumes slipping 16% y-o-y due to a five-day maintenance shutdown at its plant. Among large-caps, the Aditya Birla Group (Grasim and UltraTech Cement Ltd) continued to outpace Holcim (ACC Ltd and Ambuja Cements Ltd). Year-to-date, Shree Cement and Grasim were in the lead with volumes rising 24% and 20%, respectively.

With cement dispatches picking up over the last three months, we expect to close FY10 with demand growth of over 11%. Further, with the sustained government thrust on infrastructure spending and a revival in the real estate sector, demand for cement could exceed the traditional correlation range of 1.2–1.3 times gross domestic product to touch 1.4–1.45 times in FY11 and FY12.

After declining by Rs15–80 per bag in the third quarter of FY10, cement prices have partially recovered (in the range of Rs10–40 per bag) on account of buoyant demand and logistics-related supply shortages. The price hikes have been spread across regions, barring the south. However, with a large quantum of fresh capacities set to be commissioned in FY11 (30 million tonnes), we expect pricing power to deteriorate after May.

The Budget is likely to see a rollback of the excise duty cut from 8% to 10%. We believe cement firms will pass on the duty hike by raising prices in the near term. Over the long term, however, cost rationalization will be the key to preserving profitability.

We believe FY11 will be a difficult year for the industry as the risk of oversupply looms large. The southern market would be the hardest hit as a bulk of planned capacities will be commissioned there (53% and 23% of all-India fresh capacity in FY10 and FY11, respectively). This coupled with a demand slowdown due to political turmoil in Andhra Pradesh makes it the most vulnerable to pricing headwinds.

Graphics by Yogesh Kumar / Mint