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Cement Q1FY19 result preview - Strong demand momentum but margin pressures continue

Demand momentum remained strong across regions in Q1FY19, led by government spending towards infrastructure and housing. Execution of major infrastructure projects (metro, freight corridors, irrigation projects, roads, etc) continued at a brisk pace, while low-cost housing projects picked up gradually across regions, helped by government incentives. Sand availability normalized across regions (except Rajasthan) and further supported demand. Cement prices remained subdued during the quarter, with all India average prices flat qoq. However, prices improved towards the end of the quarter, especially across North, Central and parts of South India. Prices improved in West too, after a sharp decline in Q4FY18. On the cost front, average petcoke prices continued to rise at ~9% qoq/30% yoy in Q1FY19. Diesel prices too rose (+24% yoy; +6% qoq in Q1FY19), which we believe will drive an uptick in freight costs. Overall, we expect muted realisations and higher costs to hit profitability of most companies in Q1FY19E. We remain positive on the sector, given our improved demand outlook (on strong government impetus on infrastructure and low-cost housing, improving rural economy) and expect demand growth to outpace capacity additions. Ultratech is our top pick.

Demand momentum sustains in Q1FY19: Momentum in cement demand continued in Q1FY19 across most regions, backed by government spending on infrastructure and affordable housing and a low base (few states faced issues on sand mining last year). In the western region, Maharashtra saw robust demand from infrastructure while Gujarat remained steady. Demand in the eastern region remained robust across states fuelled by low-cost housing and government spending. The southern region saw demand momentum in AP/Telengana (government spending on infrastructure, low-cost housing), while Tamil Nadu demand was supported by improved sand availability. Most regions in northern/central India saw strong demand from infrastructure, rural and low-cost housing. However, continued sand unavailability in Rajasthan restricted construction activity. We expect most companies within our coverage universe to report strong volume growth on robust demand and new capacity additions/consolidation of acquired capacities.

Subdued prices in Q1FY19: Cement prices were subdued across regions despite the robust demand due to weak production discipline. Prices were weakest in the North with average prices down Rs6-8/bag qoq, which improved towards the end of Jun 2018 by Rs10-20/bag. In the West, prices improved in Apr 2018 and have largely been stable since, with average prices likely to be higher by ~Rs10/bag qoq (sharp decline in Mar 2018, especially in Maharashtra). In the South, multiple attempts to raise prices in Apr/May-18 failed due to weak discipline. However, sharp hikes in Jun-18 are likely to result in flattish prices on qoq basis. Both Eastern and Central India saw steady prices during the quarter on strong demand. Overall, prices have improved in Jun 2018, which we believe will strengthen further post monsoons, as demand momentum would result in enhanced pricing power.

Higher petcoke and diesel prices will drive higher costs: Petcoke prices rose 9% qoq and 30% yoy in Q1FY19, which we believe will continue to increase Power & Fuel (P&F) costs, though companies with higher petcoke inventory would see a delayed impact. Diesel prices too have risen (+24% yoy; +6% qoq in Q1FY19), which may result in higher freights costs.

EBITDA/t to decline: We expect companies to report decline in EBITDA/t due to weak realizations and higher costs. On a yoy basis, EBITDA/t is likely to witness sharp 25-30% fall, led by ~2-3% decline in realisation (peak realisation in 1Q18), while higher costs would offset the benefits from positive operating leverage. We expect a similar declining trend in EBITDA/t on qoq basis, led by higher costs and flattish realisations.