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Cement- Headwinds Abound In FY12
The current price discipline prevalent in the cement industry will be
threatened in FY12 by fresh supply and sluggish demand growth. We
re-iterate our SELL stances on ACC and Ambuja Cements and HOLD
stance on UltraTech Cements. We maintain our BUY stance on Shree
Cement on account of diversification benefits from the Power business.
Cement demand fails to take off post the monsoons: Cement sales in
3QFY11 grew by a modest 3% YoY (similar to that in the subdued monsoon
quarter, 2QFY11). This was due to adverse weather conditions, the slowdown
in infrastructure project execution and to lower offtake in housing demand.
Cement demand growth to remain low until end of CY11: We expect the
low demand growth (~5% YoY) to persist until October 2011 on account of
the continuing slowdown in construction activity. The upcoming elections
during May-June 2011 in five states (accounting for 20% of total cement
consumption) would further impact demand growth as these State
Governments shift focus towards populist rural and social spending. Beyond
October 2011, we expect cement sales to firm up to 10% YoY as infrastructure
and housing construction activities pick up. We estimate demand to grow by
3-5% YoY in FY11 and by 7.5% YoY in FY12.
Impending capacity addition to keep utilisation subdued: We expect
overall addition of 50mn mt of cement capacity during FY11-12 with 30mn mt
being added over the next one year. This should keep utilisation levels
subdued at 74%, similar to FY11 levels.
Price discipline to be threatened from July 2011 onwards: While we
expect price discipline to be in vogue across India over the next three months,
muted demand growth in the rest of FY12 and lower utilisation will pose
challenges to this price discipline and then lead to price declines. This should
result in flattish realisation YoY for FY12 as the realisation growth YoY in
1HFY12 would be neutralized by YoY realisation decline in 2HFY12.
Cost pressure mounts: Coal prices have risen by 30% over the last three
months after the floods in Australia in December 2010 disrupted supplies.
Thereafter, the recent civil unrest in the Middle East has led to a surge in fuel
oil prices which in turn pushed coal prices upward as it is an alternative to fuel
oil in many cases. These cost increases should negatively impact operating
margins (by 150-300bps) of all cement companies during FY11-13.
Union Budget 2012 impacts excise duty hike of Rs2-4/bag: While
manufacturers may be able to pass on the hike in the near term due to the
price discipline in vogue, we expect manufacturers’ net realisation to be
lowered by Re1/bag (~0.5%) in FY12. This should result in a 2-3% reduction
in FY12 operating profits for cement companies under our coverage.
Implications for the stocks under coverage: We have a BUY stance on
Shree Cement as the estimated increase in earnings from Power sales in FY12
should help cushion the lower profits from the cement business. Additionally,
the negative impact of excise hike is expected to be neutralized by the
lowering of the customs levy on pet coke. Our SELL stances on ACC and
Ambuja Cements are driven by our concerns regarding softening PAT margins
and an absence of positive catalysts. We have a HOLD on UltraTech.
Headwinds abound in FY12
Cement demand growth fails to takeoff post monsoons
Cement sales in 3QFY11 grew by a modest 3% YoY, similar to the growth
experienced during the subdued monsoon quarter (2QFY11). Whilst cement
manufacturers claimed that demand growth was hampered by the extended
monsoon in many parts of southern India and severe cold conditions in the
northern half of India, our analysis (see below) points to some additional factors
which are adversely impacting demand.
Real estate demand has weakened during the last six months after a sharp
increase in prices across India. As a result, sales volume has suffered and builders
have missed their new launch guidance by 20-25%. Low operating cash flows
have worsened the debt:equity ratio of real estate developers who were impacted
further as interest rates continued to rise. This reduction in new launches is
partially responsible for lower cement demand growth even after the monsoon
season.
Additionally, infrastructure project loans offtake has slowed down QoQ since
October 2010 after strong disbursement growth in the preceding quarter – as
reflected in data disbursement from IDFC — one of the leading infrastructure
financers in India (exhibit 3). This slowdown in project loans reflects the slowdown
in capex growth in India in the wake of the scam-driven gridlock in the political
system. Obviously, such a widespread investment slowdown impacts cement
demand adversely.
Lower demand growth to persist over the next six months
In our previous cement thematic (Firming Up After The Rains, 1 December
2010), we had expected demand to pick up in 3QFY11. Now we are
postponing the demand recovery to 3QFY12.
While we expect long term cement demand to grow at 10% CAGR, some nearterm
headwinds are likely to impact demand growth. The upcoming elections in
1QFY12 in three major states – Tamil Nadu, West Bengal and Kerala (which
together comprise 20% of total cement demand) should keep demand growth
further muted as Governments in these states would be focused more on populist
measures such as rural and social spending. Then between June-September 2011
the monsoons are likely to impact demand growth. Therefore infrastructure project
execution is expected to pick up only from October 2011 onwards.
Expect demand growth to firm up from the end of CY11
Cement demand grew by 4% YoY in the first 10 months of FY11. With muted
demand expected to prevail until Oct 2011, we expect FY11 demand growth of 3-
5%. We expect demand growth to firm up to 10% YoY from 2HFY12 onwards as
project execution picks up and is aided by the low FY11 base effect. However, the
muted offtake of 5% YoY during 1HFY12 is likely to keep overall demand growth
in FY12 at 7.5% YoY. However, despite demand firming up, we expect realisation
to soften in 2HFY12 as price discipline is likely to wane from June 2011 onwards
due to the monsoons and higher supply pressures.
Capacity expansion during FY11-13 to remain broadly unchanged
Cement capacity of 15mn mt was added during 9mFY11 raising installed capacity
to 280mn mt. We expect another 30mn mt of new capacity to be added by FY12
followed by a further ~13mn mt of capacity in FY13. The recent headwinds should
lead to some deferment in the case of new project offtake (due to commissioning
late FY13 onwards) led by higher funding costs and delays in land and license
clearances.
Cost pressure mounts led by global issues
Fuel cost has surged by ~30% over the last three months after the floods in
Australia in December 2010 disrupted coal exports from the country. Power and
fuel cost together constitute ~30% of operating cost for cement manufacturers.
Indian cement manufacturers are highly dependent on imported coal due to the
relatively low availability of coal linkages within India and from the e-auction
markets. The larger manufacturers import 30-50% of their energy requirement.
The recent civil unrest in the Middle East has pushed oil prices upward; coal prices
too have risen as coal is a substitute for oil in many cases. Hence the sharp
increase in imported coal prices should negatively impact operating margins (by
150-300bps) of all cement manufacturers in India in FY11-13.
Manufacturers play the price discipline game
Price discipline started to take shape from October 2010 onwards in the southern
markets after manufacturers’ profits in the region were hit badly in 2QFY11
(operating margins contracted 800-1000bps QoQ). Hence, cement manufacturers
cut production, squeezed supplies and raised prices by ~40% during Sep-Oct
2010. Subsequently, price discipline has been maintained. This also helped prices
to recover in the adjoining western markets where cement realisations had
declined during 2QFY11due to the supply influx from the southern region.
Price discipline in the northern region started to take shape in December 2010
led by the larger manufacturers and this has now spread across the northern
half of India. Over the last two months, cement prices in the northern half of
India have increased by Rs50-70/bag (20-25% rise over December 2010 prices)
as manufacturers cut production and squeezed supply in line with the lower
demand offtake. Cement dealers expect companies to hike prices by Rs10-
15/bag over the next month, which would bring cement prices closer to
Rs300/bag.
Price discipline to be challenged from July 2011 onwards
All of this being said, we expect price discipline to come under pressure led by
lower demand growth over the next six to eight months coupled with impact of
30mn mt of new capacity additions over the next one year. We expect the 5-7%
YoY realisation gain during 1HFY12 (on account of price discipline) to be
neutralized by the subsequent decline in realisation over the next three to four
months. However, we expect realisation to increase by 5% YoY in FY13 on the
back of demand firming up.
Changes in the excise duty structure have led to an effective increase in the excise
levy by Rs2-4/bag for various cement companies. While manufacturers may be
able to pass on the hike in the near term due to the price discipline in vogue, we
expect manufacturers’ net realisation to be lowered by Re1/bag (Rs20/mt) in FY12.
This should result in a 2-3% reduction in FY12 operating profits for cement
companies under coverage.
While the reduction in customs duty on gypsum has a marginal positive impact,
reduction in customs duty on pet coke prices will have a positive impact of
~Re1/bag for cement companies like Shree Cement and other small companies
like J K Lakshmi and J K Cement which depend on pet coke for cement operations.
Implications for stocks under our coverage
We expect the EBITDA margins of stocks under our coverage to be negatively
impacted during FY12/CY11 on account of flat realisation growth and cost
pressure. Hence, we have SELL stances on ACC and Ambuja Cements and a HOLD
stance on UltraTech Cements. We have factored in the marginal impact of an
excise levy hike for these three companies.
We have a BUY stance on Shree Cement as the estimated increase in earnings
from Power sales in FY12 should help cushion the lower profits from the cement
business. Additionally, the negative impact of the excise hike is expected to be
neutralized by the lower customs duty on pet coke.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Cement- Headwinds Abound In FY12
The current price discipline prevalent in the cement industry will be
threatened in FY12 by fresh supply and sluggish demand growth. We
re-iterate our SELL stances on ACC and Ambuja Cements and HOLD
stance on UltraTech Cements. We maintain our BUY stance on Shree
Cement on account of diversification benefits from the Power business.
Cement demand fails to take off post the monsoons: Cement sales in
3QFY11 grew by a modest 3% YoY (similar to that in the subdued monsoon
quarter, 2QFY11). This was due to adverse weather conditions, the slowdown
in infrastructure project execution and to lower offtake in housing demand.
Cement demand growth to remain low until end of CY11: We expect the
low demand growth (~5% YoY) to persist until October 2011 on account of
the continuing slowdown in construction activity. The upcoming elections
during May-June 2011 in five states (accounting for 20% of total cement
consumption) would further impact demand growth as these State
Governments shift focus towards populist rural and social spending. Beyond
October 2011, we expect cement sales to firm up to 10% YoY as infrastructure
and housing construction activities pick up. We estimate demand to grow by
3-5% YoY in FY11 and by 7.5% YoY in FY12.
Impending capacity addition to keep utilisation subdued: We expect
overall addition of 50mn mt of cement capacity during FY11-12 with 30mn mt
being added over the next one year. This should keep utilisation levels
subdued at 74%, similar to FY11 levels.
Price discipline to be threatened from July 2011 onwards: While we
expect price discipline to be in vogue across India over the next three months,
muted demand growth in the rest of FY12 and lower utilisation will pose
challenges to this price discipline and then lead to price declines. This should
result in flattish realisation YoY for FY12 as the realisation growth YoY in
1HFY12 would be neutralized by YoY realisation decline in 2HFY12.
Cost pressure mounts: Coal prices have risen by 30% over the last three
months after the floods in Australia in December 2010 disrupted supplies.
Thereafter, the recent civil unrest in the Middle East has led to a surge in fuel
oil prices which in turn pushed coal prices upward as it is an alternative to fuel
oil in many cases. These cost increases should negatively impact operating
margins (by 150-300bps) of all cement companies during FY11-13.
Union Budget 2012 impacts excise duty hike of Rs2-4/bag: While
manufacturers may be able to pass on the hike in the near term due to the
price discipline in vogue, we expect manufacturers’ net realisation to be
lowered by Re1/bag (~0.5%) in FY12. This should result in a 2-3% reduction
in FY12 operating profits for cement companies under our coverage.
Implications for the stocks under coverage: We have a BUY stance on
Shree Cement as the estimated increase in earnings from Power sales in FY12
should help cushion the lower profits from the cement business. Additionally,
the negative impact of excise hike is expected to be neutralized by the
lowering of the customs levy on pet coke. Our SELL stances on ACC and
Ambuja Cements are driven by our concerns regarding softening PAT margins
and an absence of positive catalysts. We have a HOLD on UltraTech.
Headwinds abound in FY12
Cement demand growth fails to takeoff post monsoons
Cement sales in 3QFY11 grew by a modest 3% YoY, similar to the growth
experienced during the subdued monsoon quarter (2QFY11). Whilst cement
manufacturers claimed that demand growth was hampered by the extended
monsoon in many parts of southern India and severe cold conditions in the
northern half of India, our analysis (see below) points to some additional factors
which are adversely impacting demand.
Real estate demand has weakened during the last six months after a sharp
increase in prices across India. As a result, sales volume has suffered and builders
have missed their new launch guidance by 20-25%. Low operating cash flows
have worsened the debt:equity ratio of real estate developers who were impacted
further as interest rates continued to rise. This reduction in new launches is
partially responsible for lower cement demand growth even after the monsoon
season.
Additionally, infrastructure project loans offtake has slowed down QoQ since
October 2010 after strong disbursement growth in the preceding quarter – as
reflected in data disbursement from IDFC — one of the leading infrastructure
financers in India (exhibit 3). This slowdown in project loans reflects the slowdown
in capex growth in India in the wake of the scam-driven gridlock in the political
system. Obviously, such a widespread investment slowdown impacts cement
demand adversely.
Lower demand growth to persist over the next six months
In our previous cement thematic (Firming Up After The Rains, 1 December
2010), we had expected demand to pick up in 3QFY11. Now we are
postponing the demand recovery to 3QFY12.
While we expect long term cement demand to grow at 10% CAGR, some nearterm
headwinds are likely to impact demand growth. The upcoming elections in
1QFY12 in three major states – Tamil Nadu, West Bengal and Kerala (which
together comprise 20% of total cement demand) should keep demand growth
further muted as Governments in these states would be focused more on populist
measures such as rural and social spending. Then between June-September 2011
the monsoons are likely to impact demand growth. Therefore infrastructure project
execution is expected to pick up only from October 2011 onwards.
Expect demand growth to firm up from the end of CY11
Cement demand grew by 4% YoY in the first 10 months of FY11. With muted
demand expected to prevail until Oct 2011, we expect FY11 demand growth of 3-
5%. We expect demand growth to firm up to 10% YoY from 2HFY12 onwards as
project execution picks up and is aided by the low FY11 base effect. However, the
muted offtake of 5% YoY during 1HFY12 is likely to keep overall demand growth
in FY12 at 7.5% YoY. However, despite demand firming up, we expect realisation
to soften in 2HFY12 as price discipline is likely to wane from June 2011 onwards
due to the monsoons and higher supply pressures.
Capacity expansion during FY11-13 to remain broadly unchanged
Cement capacity of 15mn mt was added during 9mFY11 raising installed capacity
to 280mn mt. We expect another 30mn mt of new capacity to be added by FY12
followed by a further ~13mn mt of capacity in FY13. The recent headwinds should
lead to some deferment in the case of new project offtake (due to commissioning
late FY13 onwards) led by higher funding costs and delays in land and license
clearances.
Cost pressure mounts led by global issues
Fuel cost has surged by ~30% over the last three months after the floods in
Australia in December 2010 disrupted coal exports from the country. Power and
fuel cost together constitute ~30% of operating cost for cement manufacturers.
Indian cement manufacturers are highly dependent on imported coal due to the
relatively low availability of coal linkages within India and from the e-auction
markets. The larger manufacturers import 30-50% of their energy requirement.
The recent civil unrest in the Middle East has pushed oil prices upward; coal prices
too have risen as coal is a substitute for oil in many cases. Hence the sharp
increase in imported coal prices should negatively impact operating margins (by
150-300bps) of all cement manufacturers in India in FY11-13.
Manufacturers play the price discipline game
Price discipline started to take shape from October 2010 onwards in the southern
markets after manufacturers’ profits in the region were hit badly in 2QFY11
(operating margins contracted 800-1000bps QoQ). Hence, cement manufacturers
cut production, squeezed supplies and raised prices by ~40% during Sep-Oct
2010. Subsequently, price discipline has been maintained. This also helped prices
to recover in the adjoining western markets where cement realisations had
declined during 2QFY11due to the supply influx from the southern region.
Price discipline in the northern region started to take shape in December 2010
led by the larger manufacturers and this has now spread across the northern
half of India. Over the last two months, cement prices in the northern half of
India have increased by Rs50-70/bag (20-25% rise over December 2010 prices)
as manufacturers cut production and squeezed supply in line with the lower
demand offtake. Cement dealers expect companies to hike prices by Rs10-
15/bag over the next month, which would bring cement prices closer to
Rs300/bag.
Price discipline to be challenged from July 2011 onwards
All of this being said, we expect price discipline to come under pressure led by
lower demand growth over the next six to eight months coupled with impact of
30mn mt of new capacity additions over the next one year. We expect the 5-7%
YoY realisation gain during 1HFY12 (on account of price discipline) to be
neutralized by the subsequent decline in realisation over the next three to four
months. However, we expect realisation to increase by 5% YoY in FY13 on the
back of demand firming up.
Changes in the excise duty structure have led to an effective increase in the excise
levy by Rs2-4/bag for various cement companies. While manufacturers may be
able to pass on the hike in the near term due to the price discipline in vogue, we
expect manufacturers’ net realisation to be lowered by Re1/bag (Rs20/mt) in FY12.
This should result in a 2-3% reduction in FY12 operating profits for cement
companies under coverage.
While the reduction in customs duty on gypsum has a marginal positive impact,
reduction in customs duty on pet coke prices will have a positive impact of
~Re1/bag for cement companies like Shree Cement and other small companies
like J K Lakshmi and J K Cement which depend on pet coke for cement operations.
Implications for stocks under our coverage
We expect the EBITDA margins of stocks under our coverage to be negatively
impacted during FY12/CY11 on account of flat realisation growth and cost
pressure. Hence, we have SELL stances on ACC and Ambuja Cements and a HOLD
stance on UltraTech Cements. We have factored in the marginal impact of an
excise levy hike for these three companies.
We have a BUY stance on Shree Cement as the estimated increase in earnings
from Power sales in FY12 should help cushion the lower profits from the cement
business. Additionally, the negative impact of the excise hike is expected to be
neutralized by the lower customs duty on pet coke.
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