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Cement: Q1FY20 Review - Strong quarter; all eyes on demand revival

Cement demand weakens as Q1FY20 sees muted 1.2% yoy growth: As per DIPP, all-India production at ~29m tons grew at mere 1% yoy in Q1FY20. Weak execution of government housing & infrastructure projects (due to elections) and lacklustre construction activity (due to liquidity issues) resulted in the flat growth. In East India, demand was sluggish across segments, due to weak execution – a result of cyclone Fani, floods in Bihar, labour scarcity, unavailability of sand and shortage of funds. North & Central India too saw tepid demand, inhibited by lingering government funding, labour scarcity, etc. West India however recorded mixed demand, with weakness in Gujarat arising from labour and water scarcity and buoyancy in Maharashtra, driven by infrastructure and affordable housing. South India saw demand momentum sustain in Kerala, impelled by post-flood rehabilitation work and low-cost housing and commercial construction in Karnataka. However, demand was weak in Andhra Pradesh (AP), primarily suppressed by sand unavailability and cancellation of old orders by the new state government. Similarly, sluggishness in Telangana and Tamil Nadu too was a result of severe heat wave and water scarcity.

Long-term demand drivers intact: Near-term volume trajectory has been slow due to delays in project execution arising from lack of funds, labour shortage and general elections across India. The sluggishness is expected to continue into Q2FY20 due to persisting monsoons and liquidity issues. However, political stability and government spend towards infrastructure development and low-cost housing, rural economy, etc., should provide impetus to cement demand over the medium to long term.

Cement prices have begun correcting: Price hikes of Rs35-40/bag by cement companies, particularly in North and West India sustained for most of Q1FY20. This was visible from the sharp improvement in realisations for companies having exposure to the Northern and Western regions. However, prices began correcting by Rs15-20/bag across regions since June end, due to the lean season. Southern India, particularly AP/Telangana, saw the sharpest decline (Rs30-50/bag) with the onset of monsoons and slow construction activity. We believe cement prices will remain muted over the next few months led by lean season and weak demand. However, prices should stabilise with a positive bias in 2H20 once demand sees gradual uptick.

Costs to moderate: Most companies continued to see pressure on P&F costs in Q1FY20 due to high-cost petcoke inventory. Freight costs declined yoy across companies, supported by lower diesel prices and benefits from higher axle load norms. As domestic petcoke prices have fallen by 28% yoy/10% qoq in Q2FY20, with diesel prices largely stable, we expect costs to moderate going forward and partially offset the decline in prices.

UTCEM our top pick: UTCEM demonstrated strong performance, with sharp improvement in UNCL and JPA assets (PBT breakeven in Q1FY20). We expect the trend to reflect in Century assets as well, once the acquisition is complete. Even though demand is weak, we expect the uptick in infra spend and affordable housing to drive a gradual pickup in demand, thereby boosting UTCEM’s volumes and realisations. Concurrently, UTCEM’s sustained focus on costs as also deleveraging (limited capex plans) should drive strong 43% earnings CAGR over FY19-21E. At 11x FY21E EV/EBITDA and US$173 on EV/t, valuations look attractive, considering the earnings momentum, scale and efficient operations.