Valuations don’t provide strength to cement stocks

The cement industry demand grew at around 5-6% year-on-year (y-o-y) during Q3FY24, sharply slowing from H1FY24 run-rate of 12-13%.
The cement industry demand grew at around 5-6% year-on-year (y-o-y) during Q3FY24, sharply slowing from H1FY24 run-rate of 12-13%.

Summary

State elections, unseasonal rains in some regions and labour unviability weighed on cement demand during Q3FY24.

For cement companies, the December quarter (Q3FY24) was a mixed bag. Price increases had to be partially rolled back on weaker absorption during the latter part of the quarter. In effect, aggregate realizations growth was tepid. The growth in demand eased.

According to Jefferies India, the cement industry demand grew at around 5-6% year-on-year (y-o-y) during Q3FY24, sharply slowing from H1FY24 run-rate of 12-13%. State elections, unseasonal rains in some regions and labour unviability weighed on cement demand during Q3FY24.

Easing input costs brought relief last quarter. Prices of key fuels required to manufacture cement, petroleum coke and imported coal, have fallen from the recent peaks. “Fuel consumption costs for cement players declined 5-15% quarter-on-quarter (except for ACC and Ambuja Cements which reported 1-2% quarter-on-quarter increase) to 1.50- R2.05/Kcal in Q3FY24," said a Motilal Oswal Financial Services report.

In Q4FY24, companies expect fuel cost to either remain flat or decline 4-5%, it added.

In a bid to save operating costs and reduce their carbon footprint, cement companies are increasingly adopting green energy and alternative fuels in their overall fuel mix. But the benefits would reflect on the sector’s earnings performance gradually.

In the near-term, from a demand perspective, the quarter ending March is usually seasonally strong, but things could be different this time. Demand is expected to be tepid in Q4 in a run-up to the national elections. The model code of conduct which is implemented ahead of general elections tends to impact government spending on infrastructure and construction activities. So, Jefferies anticipates FY24 likely ending at around 9% y-o-y growth a tad lower than the earlier estimate of 10%.

While demand prospects aren’t robust in the foreseeable future, pricing trends seen so far in the quarter too, have been muted. Reports collected from dealers by brokerages show that cement prices at an all-India level failed to sustain at higher levels so far in Q4FY24.

“Given that industry has missed taking price hikes in Feb’24 (so far) and March-end typically is seen as a ‘volume-push’ month (to meet year-end targets), price recovery can now be expected only in Q1FY25," said an ICICI Securities report dated 14 February.

In the backdrop of moderating demand, the industry’s aggressive capacity additions could weigh on the sector’s medium-term pricing outlook. Cement companies in regions such as in the eastern part of India are likely to face higher brunt of this demand-supply mismatch than the others in terms of pricing improvements.

It is worth noting that industry bellwether UltraTech Cement Ltd has revised its growth capital expenditure guidance to 9,000 crore per annum each in FY24/FY25 versus earlier guidance of 6,000-7,000 crore.

For now, as the fight between market share gains and realizations continue, improvement in margin may not be enough to trigger a meaningful re-rating. The volatility in cement prices could keep margin improvement in check.

To sum up, the threat of cuts to earnings estimates is lurking, at least for this quarter. “While earnings downgrades for Q4FY24E appear evident, the street may not tweak FY25E/FY26E earnings yet in the hope of a revival in Q1FY25 (mainly April 2024 – a key monitorable)," added the ICICI Securities report.

Meanwhile, the stock performance of key cement companies has been mixed so far in this calendar year. The shares of UltraTech, Shree Cement and Dalmia Bharat have declined by 5-10%. On the other hand, ACC Ltd and Ambuja Cements Ltd have rallied nearly 20% and 10%, respectively. Valuations on an EV/Ebitda basis for FY25, ranging between 11 and 18 times, showed Bloomberg data. Valuations don’t provide comfort given the near-term concerns on demand and pricing outlook.

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