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Cement: Q4FY18 preview - Margins under pressure on weak prices and higher costs

Our channel checks suggest robust cement demand in Q4FY18, led by increased government spending towards infrastructure and housing. Sand availability issues, which restricted construction activity in the past, receded in most regions (except Rajasthan), further supporting demand. Additionally, low base of last year (demonetization-related weakness in Jan/Feb) is likely to result in robust volume growth for companies. Cement prices remained subdued during the quarter, with all India average prices flat qoq; attempts to raise prices did not sustain. Cement prices in the eastern region improved marginally (+Rs5-7/bag qoq), as unavailability of railway rakes restricted supplies in some regions. In South, price hikes effected towards end of Q3FY18 failed to sustain with average prices falling Rs3-5/bag qoq. On the cost front, average petcoke prices continued to increase with a ~5% qoq/24% yoy in Q4FY18. Diesel prices too rose (+11% yoy; +8% qoq in Q4FY18) which is likely to drive an uptick in freight costs. Higher costs and weaker-than-estimated realisations during the quarter have led us to downgrade our earnings estimates for companies within our coverage universe by 7-12%. While we expect most companies to post strong volume growth, margin trends will be weak on back of higher costs. Overall, we remain positive on the sector on improved demand outlook (strong government impetus on infra and low-cost housing) and waning capacity additions. Ultratech is our top pick. 

Demand momentum sustains in Q4FY18: Cement demand improved in Q4FY18 across most regions, backed by government spending on infrastructure and affordable housing. Maharashtra led the demand in the West (infra demand) while Gujarat remained steady. Demand in the East remained robust across states fuelled by low-cost housing and government spending; resolution of sand mining issues led to a pick-up in demand in Bihar. The Southern region saw continued demand momentum in AP/Telengana (government spending on infrastructure, low-cost housing). But, lacklustre demand in Tamil Nadu persisted despite improved sand availability. Demand was steady in most regions in North/Central except in Rajasthan (due to continued sand unavailability). Overall, we believe a low base and year-end volume push will result in strong volume growth for most companies.

Subdued prices in Q4FY18: Cement saw muted prices across most regions, as year-end volume push resulted in weak discipline among players. In South, price hikes in Q3FY18 end failed to sustain, with prices deteriorating further in Q4FY18 (-Rs3-5/bag versus Q3FY18 average). Prices in East improved marginally by Rs5-7/bag, as rake unavailability in some regions restricted supplies. Average prices were largely flat qoq in the Western, Northern and Central regions. Our channel checks suggest a price hike in Apr 2018 in some regions – notably South and West. However, lack of discipline among players over last few quarters puts sustainability of these hikes in question.

Higher petcoke and diesel prices will continue to pressure costs: Petcoke prices rose 5% qoq and 24% yoy. Further, hike in import duty on petcoke from 2.5% to 10% will put further pressure on energy costs in Q4FY18. Diesel prices too have risen (+11% yoy; +8% qoq in Q4FY18), which will likely have a bearing on freight costs, in our view.

EBITDA/t to decline qoq: We expect companies to report qoq decline in EBITDA/t due to weak realizations and higher costs. On a yoy basis, EBITDA/t trends are likely to be mixed as higher cost would offset the benefits of positive operating leverage. Consolidation of less profitable Jaypee (JPA) assets will cause Ultratech’s EBITDA/t to decline yoy, while Ramco would see impact of higher costs. We expect Ambuja and Shree Cement to report yoy increase in EBITDA/t, as higher realizations (low base last year) offset the increase in costs.