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Cement: Q3FY18 Preview - Low base effect to drive earnings, realisations weak

Our channel checks suggest that cement demand picked up during the quarter, led by infra demand as also pick up in housing. On other hand, sand unavailability continued to restrict construction activities in certain states (Rajasthan, UP, Bihar, Tamil Nadu). However, most companies are likely to report robust volume growth due to low base of last year (demonetization-related weakness). Cement prices were subdued during the quarter with all India average prices having declined ~2% (Rs8-10/bag) owing to weak pricing discipline of players. In North, while there were attempts to raise prices in response to petcoke ban, prices failed to sustain due to year end volume push by companies. On the other hand, while prices fell sharply in South, hikes were undertaken towards the end of the quarter. On the cost front, petcoke prices continued to rise, with average prices having risen ~15% qoq/27% yoy in Q3FY18. Diesel prices too rose (+9% yoy; +2% qoq in Q3FY18), which we believe will result in higher freight costs. Accordingly, we downgrade earnings estimates for our coverage companies by 4-9% on back of weaker than estimated realisations for the quarter. Overall, a low base effect (demonetisation impact in Q3FY17) is likely to drive margin expansion and thereby earnings growth, led by robust volume uptick and better realisations. We remain positive on the sector, with Ultratech as our top pick, led by improved demand outlook (strong government impetus on infra and low-cost housing, improved rural economy) and waning capacity additions.

Demand pick up in Q3FY18: Our channel checks suggest cement demand improved in most regions post monsoons, backed by government spending and pick up in housing/real estate. In West, both Maharashtra (led by infra demand around Mumbai) and Gujarat (government spending, pick up in real estate) saw an uptick in demand. Demand in East remained robust across states (except Bihar, due to sand unavailability), led by government spending. In South, demand was robust in AP/Telengana (government spending on infra, low-cost housing) and steady in Karnataka, while Tamil Nadu continued to remain subdued. In North/Central, demand was steady in most regions except Rajasthan/UP (sand unavailability restricted construction activity). Companies under our coverage are likely to see strong volume growth, led by a low base (sharp decline in demand in Q3FY17 post demonetization) as also ramp up of expansions and acquired assets.

Prices subdued in Q3FY18: Cement prices were subdued across most regions in Q3FY18, as attempts to raise prices did not succeed due to weak pricing discipline among players. South saw the steepest price decline in the quarter of Rs15-20/bag (-5% qoq). However, we note prices have been hiked in Dec 2017 (+Rs10/bag; demand uptick). Cement prices in the West continued to decline (Rs10-12/bag on qoq basis) in Q3FY18, led by year-end volume push by companies. In the North, average prices fell ~1% qoq (~Rs5/bag) in Q3, as hikes post petcoke usage ban in Nov 2017 failed to sustain. Central was the only region that saw ~2% qoq (~Rs6-8/bag) price hike in Q3FY18. Our channel checks suggest that with likely demand uptick, led by seasonal construction activity, cement prices are likely to be increased across regions in Jan 2018.

Cost pressures in Q3FY18 due to higher petcoke as well diesel prices: Petcoke prices rose 15% qoq and 27% yoy. While the ban on petcoke usage by cement companies was revoked in North, we believe hike in import duty on petcoke will result in petcoke prices remaining elevated. This will keep energy costs high. Diesel prices too have risen (+9% yoy; +2% qoq in Q3FY18), which is likely to drive higher freight costs.

EBITDA/t to improve yoy on a low base: Most companies are likely to report yoy improvement in EBITDA/t due to a low base (demonetisation impact of weak realizations and low volumes in Q3FY17). Ultratech is expected to report a yoy decline in EBITDA/t due to consolidation of the less profitable Jaypee assets, while Ramco will be impacted by weaker realisations. However, EBITDA/t is likely to be weak qoq for most players, as weak realizations and higher costs offset benefits from positive operating leverage.