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Cement: Q3FY18 review - Demand picks up but margin pressures remain

Cement demand picked up in Q3FY18, as construction activity improved post monsoon, led by infrastructure and housing. Demand continued to be driven by East (except Bihar; ~18% yoy, led by low-cost housing, infra demand) and AP/Telangana (~13% in 9MFY18; irrigation, housing, infra). The Western region (notably Maharashtra ~16% yoy) continued to see traction, led by execution of infra projects. Demand was lacklustre in UP, Bihar, Tamil Nadu, Rajasthan (sand unavailability) and Kerala (weak construction activity). However, companies reported strong volume growth on low base and consolidation of new/acquired capacities (Jamul, ACC; JPA assets, UTCEM, etc).

Long-term demand drivers intact: We expect demand momentum to continue in Q4FY18, led by continued execution of government-led infra projects, affordable housing projects as also rural demand. Our checks suggest sand availability is gradually improving in UP/Bihar, which would further support demand. For FY19E, we expect further pick up in demand, as execution of key government schemes (infra, low cost housing, etc) pick up, ahead of elections in 2019. We believe AP/Telangana (infra, irrigation, low-cost housing) will continue to lead the demand in South. In West, demand is likely to be robust in Maharashtra (infra projects in Mumbai, rural spending) and Gujarat (infra projects like dedicated freight corridor, roads, etc). The momentum in East is likely to continue (sustained government spending), while we expect demand to be strong in the Northern/Central regions (pick up in govt projects & construction of low-cost housing).

Mixed trends in cement prices: Cement prices showed signs of improvement in Jan 2018 across markets. In East, rake unavailability impacted supplies, causing higher prices to sustain. However, price hikes in North failed to sustain in Feb 2018 due to weak discipline among players. Compared to Q3FY18, prices are largely flat currently across most regions except in East and West (+Rs5-7/bag). We expect muted prices in the near term, as year-end volume push could restrict price hikes.

Costs to increase on higher petcoke, diesel prices: Even though petcoke prices have stabilized since Q3FY18, we expect exhaustion in low-cost inventory and higher duty on imported petcoke to result in higher power and fuel (P&F) costs. Freight costs too are likely to rise on higher diesel prices.

Ultratech Cement (UTCEM) remains our top pick: We expect gradual recovery in demand with waning capacity additions to drive improvement in cement prices and thereby profitability of companies. We reiterate Ultratech Cement as our top pick, considering its strong growth profile and cost efficiencies.

Key Q3FY18 trends  

• Companies reported strong volume growth on the back of pickup in demand as also consolidation of new capacities and a low base.
• Average realisations declined qoq due to weak prices across regions on weak discipline. Prices continued remain muted as attempts raise prices have failed to sustain.

·         Costs, notably P&F and freight, continued to rise on higher fuel prices. Prices continue to remain elevated and are likely to drive yoy increase in costs.