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Cement: Q1FY19 review - Demand momentum continues, but margin pressures remain

Cement demand was robust in Q1FY19, led by continued momentum in construction activity in infrastructure, low-cost and rural housing. Demand remained strong in the East (infra and low-cost housing), West (infra projects in Maharashtra), North/Central (pick up in infra, low-cost and rural housing) as also South (irrigation, housing, infra notably in Andhra Pradesh (AP)/Telangana). Sand availability improved in UP, Bihar, Tamil Nadu due to resumption of sand mining, causing demand to improve in these regions. On the other hand, sand unavailability in Rajasthan continued to restrict construction activity. Robust demand, a low base and consolidation of new/acquired capacities (Jamul, ACC; JPA assets, UTCEM, etc) aided strong volume growth for most companies.

Long-term demand drivers intact: We expect muted volumes in Q2FY19, given the restricted construction activity across regions, due to monsoons. However, demand should pick up post monsoons, boosted by execution of key government schemes (infra, low-cost housing, etc), ahead of 2019 elections. We believe AP/Telangana (infra, irrigation, low-cost housing) will continue to lead the demand in the South. In the West, Maharashtra (infra projects in Mumbai, rural spending) and Gujarat (infra projects like dedicated freight corridor, roads, etc) should display robust demand. While momentum in the East is expected to continue (sustained government spending), Northern/Central regions (pick up in government projects and construction of low-cost housing) too reflect strong demand.

Cement prices improve: Cement prices improved in Jun/Jul 2018, particularly in the North and Central regions led by improved discipline among players. Compared to Q1FY19 average, prices in the North rose by Rs8-10/bag, while central region saw an increase of Rs10-12/bag. Prices in the East and South were largely stable while West saw a decline of Rs5-7/bag. Current all India prices are higher by Rs3-5/bag over Q1FY19. We expect prices to improve post monsoons, as robust demand coupled with high capacity utilizations for most companies would result in reduced competition for market share.

Costs to increase on higher petcoke, diesel prices: Petcoke prices continued to rise with prices 7-8% higher qoq (+40% yoy), which we believe will result in higher power and fuel (P&F) costs. Freight costs too are likely to rise on higher diesel prices (+20-22% yoy).

Ultratech Cement (UTCEM) remains our top pick: We expect recovery in demand to absorb capacity additions and help improve cement prices and profitability of companies. We reiterate UTCEM as our top pick, considering its strong growth profile and cost efficiencies. Reiterate Outperformer on the stock.

Key trends in Q1FY19

• Companies reported strong volume growth on demand pickup and consolidation of new capacities.
• Average realisations were steady qoq, as attempts to raise prices failed due to lack of discipline.

·      Costs, notably P&F and freight, continued to rise on higher fuel prices (petcoke, diesel). Continued rise in fuel prices are likely to drive yoy increase in costs.