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Cement: Q2FY18 review - Demand outlook robust but margin pressures remain

Weak construction activity due to monsoon and sand shortages in different parts the country resulted in muted cement demand in Q2FY18. Demand continued to be driven by East (except Bihar; +9-10% yoy, led by low-cost housing, infra demand) and AP/Telangana (~18% yoy; irrigation, housing, infra). The Western region (notably Maharashtra) too saw some pick up, led by execution of infra projects. However, demand was lacklustre in UP, Bihar, Tamil Nadu (sand unavailability), Kerala (weak construction activity) and Gujarat (floods). Infra continued to drive demand across regions, with weakness in real estate/housing persisting. However, companies reported strong growth in volumes due to: a) low base b) consolidation of new/acquired capacities and c) slowdown in supplies from Binani, given their weak financial position.

Long-term demand drivers intact: We expect demand to improve in H2FY18, once execution of government-led infra and affordable housing projects pick up pace. Our checks suggest sand availability is gradually improving in UP/Bihar, which would further support demand. For FY18, we expect demand in the Southern region to be led by AP/Telangana (+12-15% yoy; infra, irrigation, low-cost housing), partly offset by weak demand in TN/Kerala (political instability, sand unavailability, weak housing demand). We believe demand will pick up in the western region, both in Maharashtra (infra projects in Mumbai, pick up in rural spending) and in Gujarat (pick in government spending ahead of elections in Dec 2017). The momentum in East is likely to continue (sustained government spending), while we expect to see recovery in demand in the Northern/Central regions (pick up in government projects and construction of low-cost housing).

Cement prices soften in Oct 2017: Cement prices remained weak in Oct 2017 with all-India average prices down by Rs3-5/bag, led price decline in the South. While prices were largely stable in North/Central and West, East and South saw a sequential decline in prices. Our channel checks indicate that weakness continues in Nov 2017 with prices currently lower by Rs8-10/bag vs Q2FY18 average. We estimate price hikes in North, as players look to pass on the rise in P&F costs on the back of recent petcoke ban.

Higher petcoke prices to result in higher costs: Freight costs too are likely to rise due to higher diesel prices on both yoy and qoq basis. In addition, the recent ban on petcoke usage in some Northern states is likely to significantly increase P&F costs due to high usage of petcoke in these regions.

UTCEM remains our top pick: Our expectation of a gradual recovery in demand makes us positive on the sector with Ultratech Cement as our top pick, considering its strong growth profile and cost efficiency.

Key Q2FY18 trends  

• Companies reported strong volume growth despite weak demand, led by consolidation of new capacities, low base and exit of weak players like Binani Cement.
• Average realisations were flattish qoq despite a decline in cement prices owing to change in sales mix towards FOR (free on road) basis than ex-factory and lower tax incidence under GST
• Costs, notably P&F and freight continued to rise due to higher fuel prices. Recent ban on usage of petcoke in Northern states is likely to put further pressure on costs