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Cement: Q3FY19 Review - Volume growth sustains, eyes on price hikes

Cement demand sustained 12.9% yoy in Q3FY19, led by continued momentum in construction activity in infrastructure (infra), low-cost and rural housing. IHB, PMAY, low-cost and rural housing and infra segments helped protract strong demand in the east, except in Chhattisgarh, where elections impacted demand. The west saw strong demand from MaharashtraI, with demand sliding in Gujarat, on weak traction from rural housing. Demand trends in north/central India were weak in Haryana and Delhi-NCR due to ban on NGT construction, Himachal Pradesh (early onset of winter) and Madhya Pradesh (state elections and the festive season). The weakness was offset by strong demand in Rajasthan (infrastructure development and PMAY) and Uttar Pradesh (strong traction from rural). In south, demand momentum sustained in AP/Telangana, upheld by government spending on irrigation, infrastructure and Amravati development; Tamil Nadu saw a strong pick up demand, boosted by infra and rural housing. While demand in Kerala recovered on reconstruction commencing post floods, Karnataka saw moderate demand from commercial segment.

Long-term demand drivers intact: While near term (Q4FY19) volume trajectory may slow due to delays in execution of projects caused by lack of funds and intense winter in the north, part of this could be offset by execution of key government schemes (infra, low-cost housing, etc), ahead of 2019 elections. We believe AP/Telangana (infra, irrigation, low-cost housing) will continue to lead long-term demand in the south. In the west, Maharashtra (infra projects in Mumbai, rural spending) and Gujarat (infra projects like dedicated freight corridor, roads, etc) too should display robust demand. While momentum in the east should continue (sustained government spending), the northern/central regions (pick up in government projects and construction of low-cost housing) too reflect solid demand trends.

Cement prices to improve: Attempted price hikes by cement companies in the start of 3QFY19 were unsustainable, as demand weakened towards the end of 3QFY19 in select states. Compared to Q2FY19 average, prices in south fell sharply by Rs10-12/bag, with the west seeing a decline of Rs3-5/bag. Prices in central and east prices were flat in Q3FY19 (qoq), with North seeing a rise of Rs3-5/bag. In Q4FY19, average all India cement prices were higher by Rs2-3/bag qoq with most regions witnessing a price hike in Feb 2019 - Rs60-75/bag in south and Rs10-15/bag in west, with Rs5-10/bag hike in other regions.

Costs to decline as fuel prices stabilize: Despite 4% qoq fall, petcoke prices are still up 14% yoy, which we expect will translate into lower power and fuel (P&F) costs qoq, as most companies have utilised their high-cost inventory in 3QFY19. Freight costs are expected to reduce yoy, as diesel prices have stabilized and the benefit of higher axle load is likely to be reflected in 4QFY19.

ACC our top pick: We expect recovery in demand to absorb capacity additions and aid in higher cement prices and profitability of companies. ACC remains our top pick on improved focus on volume growth and cost efficiencies with better consumption norms and strong growth in premium products. At 10x CY19E EV/EBITDA and US$93 EV/tonne, the stock looks attractive (21% earnings CAGR over CY18-20E).