Profitability of cement firms to take a hit due to weak prices, high costs
The September quarter is seasonally weak for the cement industry and prices weaken due to lack of adequate demand, heavy rainfall in a few states and floods in Kerala
Cement prices across India remained weak in the past two months and declined further in September. A recent market assessment by domestic brokerage house Kotak Institutional Equities showed that average cement price at the all-India level corrected by ₹3 per bag so far in September. One cement bag weighs 50 kg.
The second quarter of the fiscal year is seasonally weak for the cement industry and prices weaken due to lack of adequate demand. This year, prices were also affected by heavy rainfall in a few states and floods in Kerala.
There’s a bigger problem for companies this time, however. Profitability of cement companies is likely to be under pressure due to relentless cost pressures. Prices of petroleum coke (petcoke), a key input for cement makers, is still elevated and so is the cost of coal. The recent rupee depreciation adds to procurement costs since these fuels are largely imported.
According to analysts’ estimates, around 30% of costs of cement firms are affected by fluctuations in foreign exchange rate. Further, higher crude oil price has resulted in sky-rocketing diesel prices, pushing transportation costs higher.
Region-wise, prices declined in the East by ₹9/bag to ₹336/bag so far in September. They declined in the West by ₹4/bag to ₹311/bag but were relatively steady in the South and Central regions. In the North, cement prices increased by ₹2/bag to ₹304/bag. The Kotak report added that prices in the North and Central regions are higher by 3-4%, quarter-on-quarter, in the September quarter, primarily due to price increases taken earlier in July 2018.
Further, it said that the monthly spread movement between cement prices (net of taxes) and energy costs (estimated assuming 70% pet-coke usage for the industry) continue to remain weak for pan-India names. It is expected to decline by around 1% on sequential basis. “We expect the spreads to improve for regional names in North and Central regions aided by higher cement prices while the spreads are to weaken in West and South,” added the report dated 12 September.
Meanwhile, the Department of Industrial Policy and Promotion (DIPP) data showed cement volumes increased by 11% on a year-on-year basis in July 2018 to 25.9 million tonnes, but this improvement is largely due a low base effect.
Analysts added that cement demand continues to be driven by government spending on infrastructure and allied activities. Demand from the housing sector, a key contributor to overall cement demand is still muted. Consequently, the industry’s capacity utilization remains low at around 60-65%.
Weak price trends and rising cost pressures raise concerns on whether earnings of cement firms are unlikely to revive anytime soon. Investors don’t seem perturbed by them, as shares of major cement companies continue to trade at rich valuations. That could get tested unless cement prices recover in the months ahead. Investors in cement stocks should tread with caution.