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Cement: Q1FY20 preview - Strong quarter; H2 to see bounce back in demand momentum

Several government and private projects faced execution delays due to general elections. Our channel checks cited reasons such as lack of funds, clearance delays, issues pertaining to labour availability, adverse summer in select regions, sand unavailability, etc. for the delayed execution. Accordingly, most regions except central saw muted demand as reflected in All India cement production growth of 2.5% for Apr-May 2019. Nonetheless, high utilisation at the end of FY19 led to sharp rise in cement prices across regions in Apr 2019 (partial roll back in Jun 2019). As such, all-India average cement price increased by ~8% qoq. We expect cost pressures to ease, supported by lower power & fuel (P&F) and freight costs (petcoke prices fell 15% yoy and 12% qoq; diesel prices fell 2% yoy but were flat qoq). For Q1FY20E, we expect profitability to improve for all companies under our coverage, driven by higher realisations and lower costs (partially offset by negative operating leverage due to weak volumes). We reiterate our positive view on the sector and expect demand growth to bounce back in H2FY20E (sustained government impetus on infra and likely measures to boost the rural economy) and utilisation to improve. Accordingly, pricing power would augment, providing a boost to earnings. Ultratech Cement (UTCEM) is our top pick in the sector.

Demand momentum weakens in Q1FY20: The quarter saw weak demand momentum in most regions except Central India, largely led by slowdown in execution due to general elections and lack of funds. The North saw strong project execution at the start of the quarter, which eventually slowed in the run up to the elections, given poor availability of labour, sand mining issues, etc. In South, multiple projects were stalled in Q1 due to lack of proper labour across the southern states, water shortage in Chennai/TN, high temperature in Kerala and construction ban of high rises in Karnataka. In the West, Maharashtra saw modest demand, with the pace in execution of infra projects ongoing but slow, while demand was weak in Gujarat. Demand in the East decelerated across states due to lack of funding, except in Bihar. Overall, cement production was muted at 2.5% yoy during Apr-May 2019. We expect most companies within our coverage universe to report muted to negative volume growth on weak demand trends.

Prices improve in Q1FY20: Cement prices increased sharply across regions during Apr-May 2019 by Rs30-50/bag on high utilisation at the end of FY19 and strong pricing discipline. Price hikes in North and East India were the sharpest at ~Rs35-45/bag. Similarly, West and Central saw price hikes of Rs25-35/bag in April. However, South saw relatively muted price hike of 10-20/bag, after sharp hikes of Rs40-60/bag in Feb 2019. However, prices were partially rolled back (Rs10-20/bag) in June 2019 on weak demand momentum across regions. The steep price hikes should drive 8% qoq increase in All-India cement prices.

Cost pressures easing: Domestic petcoke prices fell sharply by 15% yoy and 12% qoq in Q1FY20, with international petcoke prices too easing to US$85-90/t from US$95-100/t over last few months. We expect the price drop to provide relief in P&F costs on yoy and qoq basis. However, lower petcoke costs would entirely reflect in Q2FY20E, as companies typically carry 2-4 months of inventory. Similarly, a 2% yoy fall in diesel price in Q1FY20 (flat qoq) and the entire benefit of higher axle load norms should result in lower freights costs. We expect cost pressures to ease yoy and qoq for all companies under our coverage.

EBITDA/t to improve: Sluggish demand would result in companies reporting muted volumes in Q1FY20, in our view. However, steep price hikes and thereby a sharp jump in realisations are likely to more than offset the negative operating leverage and cause yoy and qoq EBITDA/t to improve strongly. Easing cost pressures would in turn boost earnings of companies within our coverage.