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Cement: Q2FY20 Review - Dull quarter but all eyes on demand revival

Overall cement demand was weak in Q2: At ~78m tons, all-India cement production grew mere 0.3% yoy during Q2FY20, as per DIPP. We attribute the sluggish demand to weak execution of government housing & infrastructure projects due to heavy monsoons and lacklustre construction activity, caused by liquidity constraints. East India saw muted demand across segments, given the floods in Bihar, labour scarcity, unavailability of sand and shortage of funds. South India too faced sharp slowdown in demand momentum across states, led by construction halt in Amravati, Andhra Pradesh, in addition to lack of government funding and heavy rains in Telangana and Karnataka. This slowdown was visible in muted volumes for companies with higher South exposure (India & Orient saw the steepest decline, Ramco saw market share gains). West and Central India too saw tepid demand, inhibited by lingering government funding, heavy monsoons, etc. However, North saw moderate uptick in demand trends, driven by pre-election spending in Haryana, government spending on low-cost housing in Delhi-NCR and infra spend in Punjab and Himachal Pradesh. Accordingly, players in North saw relatively improved volume trajectory vs peers.  

Long-term demand drivers intact: While near-term volume trajectory has been slow, we expect a gradual uptick in demand over the long to medium term. Government spend towards infrastructure development and low-cost housing, along with improvement in the rural economy and re-construction activity post heavy monsoons, etc, would boost demand, in our view. We believe North will continue to see improvement in demand as seen in 2QFY20, while South will likely see muted demand in near term on continued decline in Andhra Pradesh.

Cement prices correcting: In Q2FY20, companies rolled back the price hikes taken in H1CY20 across regions, as demand slowed down. Correction was particularly sharp in the South and East, with prices buoyant in the North, West and Central regions. This was particularly visible from the reduction in realisations of companies having exposure to South and East. Southern India, in particular AP/Telangana saw the sharpest decline (Rs30-50/bag) on weak demand. Our channel checks suggest that while players in South India are attempting price hikes, they are being rolled back due to poor demand. We expect prices to gradually rebound in H2FY20 on demand recovery across regions.

Costs to moderate: While most companies felt the relief in P&F costs through declining petcoke prices, they are yet to realise the full benefit of this correction, as they have high-cost inventories. Freight costs declined yoy across companies, supported by stable diesel prices and benefits from higher axle-load norms. We expect costs to moderate and partially offset the decline in prices, as domestic petcoke prices have already seen 27% yoy/10% qoq slide in Q2FY20, with diesel prices largely stable.

UTCEM our top pick: UTCEM demonstrated strong operational performance during Q2, evident from the strong realisations and cost efficiencies in UTCEM and UNCL assets. While Century showed weak performance during the quarter, we expect the asset’s profitability to improve post rebranding, power cost efficiencies, etc. Concurrently, we expect UTCEM’s sustained focus on costs (freight initiatives, higher usage of WHRS, etc) and deleveraging (limited capex plans) to drive strong 40% earnings CAGR over FY19-21E. The stock looks attractive at 11x FY21E EV/EBITDA and US$167 EV/t, considering its earnings momentum, scale and efficient operations. We reiterate our Outperformer rating on UTCEM.