Cement Sector Preview – Q3FY15/Q4CY14 :: HDFC Securities

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Stocks of cement companies have gained sharply in the last one year on hopes of a demand recovery and are trading at premium valuation, leaving little room for
outperformance, unless economic recovery gathers steam at faster than expected pace.
All India cement production growth to moderate
After reporting strong volume growth in Q2FY15, we expect some moderation in demand during the quarter. All‐India cement production has declined by 1% in Oct‐14.
However, it reported strong growth of 11.3% y‐o‐y in Nov‐14. With the visible signs of late recovery, we expect this quarter to end with a growth of 4.9% y‐o‐y to 64.7MT
at pan India level. In terms of pricing, there could be some pressure on pricing (expect South) due to moderation in demand.
Weak pricing scenario
All‐India average cement prices have come off for the second consecutive month, down 2% month‐on‐month since October due to low demand and delay in recovery in
the capex cycle. The decline in prices during the peak demand months of October and November is worrying. This is after average revenue growth for top 10 cement
players by market capitalization improved to 14.4% for the first two quarters of this fiscal year after muted growth last year on the back of an 8‐10% price hike and
volume growth buoyed by pent‐up demand. This pricing downtrend in October and November was driven by demand weakness, followed by partial recovery in
December in select regions ‐ North and West. Prices in South India were relatively stable with an upward bias (Rs.10‐15/bag improvement).
Realisations to be mixed
On the realisation front, companies like ACC and Ultratech Cement enjoyed better realisation on account of south prices being firm (up 3.4% q‐o‐q basis) while the north
and central companies could report down tick in realisation. Operating margins for players like Ambuja Cement, ACC and Ultratech could improve marginally on recent
fall in energy prices. Pick‐up in construction activities is yet to be seen. However, a more infra and housing focused fiscal budget could translate into higher demand in
FY16.
Cost moderation could limit decline in profits
Decline in realisations could be partially offset by positive operating leverage from higher volume and moderation in variable cost, which could be led by a sharp decline
in imported coal cost and reduction in diesel price. While benefits of lower input cost would percolate gradually over the coming quarters due to existing inventories
(which are supposed to be low in a post monsoon quarter), there could be a partial cost savings in Q3FY15. Costs like freight cost are expected to see some moderation
due to fall in diesel prices. However, PAT is likely to be impacted y‐o‐y due to capex completion led high depreciation and interest cost in some companies.
Outlook
We expect demand to improve going forward which could lead to gradual improvement in utilization for the industry and would lend better pricing power to
manufacturers. Post a dismal Q3, we expect demand to pick‐up going forward and with recent increase in cement prices, we believe that Q4 numbers would see a sharp
up‐tick. Cement demand is expected to gradually improve to 9‐10% in 2015 from sluggish demand of around 3‐7% in the past couple of years due to excess capacity, but
valuations of stocks seem to have priced in the rebound in economic activity.
Delay in on‐ground pick‐up in construction activities could reinstate pricing volatility at intervals. While we remain positive on the medium‐term growth outlook, we
would monitor for a real pick‐up at the ground level. Commencement of investment cycle is essential for sustained demand growth. We are positive on players with
strong volume levers, efficient operations and healthy balance sheet (or deleveraging visibility).

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