FREE

Cement: Q3FY20 preview - Easing costs to aid profitability

While demand was sluggish in 3QFY20, there were some green shoots of revival in Dec-19 in most states except Andhra Pradesh / Telangana. All India cement production saw a 2% yoy decline for Oct-Nov 2019. The muted demand and year end volume push by companies led to continued fall in prices across regions by Rs10-20/bag on qoq basis, with all-India average cement price falling by ~4% qoq. However, we expect cost pressures to ease, supported by lower power & fuel (P&F; petcoke prices fell 30% yoy and 8% qoq) and freight costs (diesel prices fell 6% yoy, flat qoq). For Q3FY20E, we expect profitability to be strong on yoy basis, for all companies under our coverage, led by higher realisations and lower P&F costs. We maintain our positive stance on the sector and expect demand to gradually improve in 1HCY20E (government impetus on infra, good monsoons and stimulus to boost rural demand). This would aid utilisations and drive pricing power for companies, providing a boost to earnings. Ultratech Cement (UTCEM) is our top pick in the sector.

Dec-19 sees green shoots in demand: The quarter saw weakness in demand across regions, largely led by slowdown in execution of infrastructure projects due to state elections in certain states, festive season and lack of funds. Demand was particularly weak in Oct-19 (-8% yoy in production) due to Diwali and prolonged monsoons. However, demand picked up in Nov-19 (+4% yoy in production), driving cement production decline of 2% yoy during Oct-Nov 2019. As per our channel checks, demand has picked up across most states in Dec-19, except AP/Telangana as project execution remains weak. We expect most companies within our coverage universe to report flat to marginal growth in volumes.

Prices decline in Q3FY20 on qoq basis: Cement prices dropped across regions during 3QFY20 due to weak demand and high competitive intensity. Price drop in South and East India were the sharpest at ~Rs18-20/bag on qoq basis (steep decline of Rs25-30/bag in AP), while West saw a drop of Rs10-12/bag (largely driven by Maharashtra). However, price drop was relatively moderate in North and Central at Rs7-8/bag (largely at the start of the quarter). Overall, All India cement prices are up 5% yoy due to the price hikes taken in 1QFY20 and a decline of ~4% on qoq basis.

Cost pressures easing: Domestic petcoke prices fell sharply by 30% yoy and 8% qoq in Q3FY20, with international petcoke prices too easing to US$70-75/t from US$95-100/t over last few months. We expect the price drop to provide relief in P&F costs on both yoy and qoq basis. However, effect of lower petcoke costs would reflect with some lag, as companies typically carry 3-4 months of inventory. Similarly, a 6% yoy fall in diesel price in Q3FY20 (flat qoq) with no busy season surcharge on rail movement should result in lower freights costs. Accordingly, we expect cost pressures to ease for all companies under our coverage.

EBITDA/t to improve on yoy basis: Sluggish demand would result in companies reporting muted volumes in Q2FY20, in our view. Moreover, price correction across regions and thereby a drop in realisations are likely to cause EBITDA/t to decline on qoq basis, albeit reporting growth on yoy basis. However, easing cost pressures would partially offset the muted volumes and weak realisations.