Sops only a sentimental boost; rally in cement stocks will soon fizzle
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Things took a U-turn for cement firms at the most unfortunate time. Volumes have been hit by the cash crunch and fuel costs will soon begin to pinch. In such a situation, a key risk would be the inability of cement makers to pass on the surge in input costs through price hikes as decline in dispatches will restrict improvement in realizations.
The bloodshed that one was seeing in cement stocks since demonetization mirrors the pessimism among market participants in the sector.
In the backdrop of all that pain, announcements made by Prime Minister Narendra Modi on 31 December 2016, aimed at boosting rural and urban housing, perked up cement stocks and they ended the first trading day of 2017 in the green.
But some analysts do not expect this upmove to sustain. Though they agree that the cement sector would be an indirect beneficiary of these steps and interest rate cut by banks would act as a catalyst for housing, all of that would take at least two quarters to translate into higher cement demand on the ground.
The third quarter (Q3) earnings season of fiscal year 2017 is just around the corner and the second half of the fiscal year is seasonally strong for cement companies, but this time around, the scenario is unlikely to be very bright.
“In an otherwise normal quarter, a company like UltraTech should have done 11.2 million tonnes (volumes). Now, we know: 45% is exposed to non-critical areas. Let’s assume there is no growth here. Coming to core, which is 55%, say, falls by 20%. Even in that scenario, core plus non-core volumes should be 10 mt in Q3FY17. Also, let’s build in 5% sequential drop in realizations. Put them all together, impact on EBITDA, in our initial assessment, will be prominent,” said Rohit Natarajan, an analyst with IDBI Capital Market Services Ltd. Ebitda is short for earnings before interest, taxes, depreciation and amortization.
Brokerage firms like HDFC Securities Ltd expect Q3FY17 to be one of the worst quarters for cement companies in recent times. Forthcoming elections in five states including Uttar Pradesh and Punjab, will further dampen demand given that election code of conduct weighs on government spending.
Though the impact on demand is now known to a certain extent, there is still no clarity on how long it will take for volumes to recover and whether or not petroleum coke and coal prices will rise much higher from here on.
When cement stocks would go back to pre-demonetization levels will largely depend on management commentary post-Q3FY17 earnings, and further announcements, if any, in the forthcoming budget. Analysts are cautious and market participants looking to invest in this sector are recommended to wait and watch.