Demand on shaky ground but lower crude softens blow for cement firms2 min read . Updated: 06 Apr 2020, 11:44 PM IST
- Labour issues and lower spending on infrastructure by government may dash hopes of better capacity utilization rates
- Meanwhile, lower input costs owing to a decline in crude oil prices would bring some cushion to operating profits
After subdued volumes between April and October 2019, the cement industry had started witnessing a demand pickup from November. But the good times did not last long due to the covid-19 outbreak, and the resultant demand slump.
In keeping with the changes, analysts at Emkay Global Financial Services Ltd now expect an industry volume decline of 2.4% in FY20, compared to 13.3% growth in FY19.
True, shares of cement firms reflect the change in business conditions, declining sharply along with the broader market. No doubt, valuations are undemanding.
Emkay analysts said: “Many cement companies under our coverage are trading at lower one year forward EV/Ebitda multiples compared with their historical averages. The multiple for nine companies under Emkay’s coverage universe stands at 10.3 times currently compared to an average of 10.4 times between CY07-CY20.." EV is enterprise value and Ebitda is earnings before interest, tax, depreciation and amortization.
Analysts now anticipate demand recovery from the second half of FY21. Even after the lockdown is lifted, demand is likely to be muted in the near term, as economic activity would take time to pick up. There could also be issues related to labour availability. Some also worry about the risk of lower government spending on infrastructure due to the strain caused by the shutdown. All this would also mean that hopes of better capacity utilization rates for the cement sector would get delayed until demand improves meaningfully.
In this scenario, it helps that many cement producers have relatively stronger balance sheets. Besides, fixed costs account for a relatively lower 15-20% of overall costs.
“We do not foresee any major liquidity stress for larger companies under our coverage," write analysts at ICICI Securities Ltd in a report on 2 April, adding ACC Ltd, Ambuja Cements Ltd, Star Cement Ltd are net cash firms.
“While for UltraTech Cement Ltd, Ramco Cements Ltd, Dalmia Bharat Ltd, JK Cement Ltd and JK Lakshmi Cement Ltd, net debt to Ebitda (FY20) remains about 2 times. Net debt to Ebitda would stretch to 3-3.5 times for Orient Cement Ltd, Prism Johnson Ltd and time about 5 times for India Cements Ltd," they added.
Meanwhile, lower input costs owing to a decline in crude oil prices would bring some cushion to operating profits. Emkay said operating costs of cement companies to reduce in FY21 led by lower petcoke/coal, diesel and crude oil prices. Given the muted demand conditions, softer costs could offer some comfort to investors in these uncertain times.