Cement rally appears out of sync
Shares of major cement manufacturers ACC Ltd, Ambuja Cements Ltd and UltraTech Cement Ltd have gained 16-40% in the last six months. Does this suggest that all is hunky dory in the sector? Not really.
The muted trend in cement prices has become a niggling worry. Prices have fallen even in a seasonally strong March quarter (Q4) and remained weak for the fifth month in a row. As such, FY24 exit prices could be subdued as the year-end chase to meet volume targets intensifies. This would weigh on the near-term realization outlook.
It also means that the benefits of softening input costs and the recent cut in diesel prices would help the sector’s earnings performance only to a certain extent. “Given the sharp drop in pricing and continued weak demand, we expect Ebitda/mt for cement industry to contract by at least ~₹100 per tonne, in Q4FY24, despite correction in operating costs,” said Mangesh Bhadang, vice president, Centrum Broking.
Notwithstanding a significant drop in pricing in recent months, the cement index (market capitalization weighted index of 10 listed cement stocks) has risen 17% over the past six months. This suggests a growing disparity between stock prices and ground reality, cautions Bhadang.
Additionally, commentary from various dealers’ channel checks suggests that a meaningful improvement in demand and pricing is possible only post-monsoon in the second half of FY25. Then why are stock prices surging? The narrative in cement stocks seems to be driven by the pace of capacity additions amid elevated competition.
Robust cash flows have pushed cement companies to add capacities in the last decade, according to Tushar Chaudhari, Prabhudas Lilladher analyst. Now, further capex plans have been announced to maintain market share post-Adani group’s entry into the sector. “On a YTDFY24 basis, 26 mtpa capacity was added and another nearly 130mtpa is expected to be added till FY27 if everything goes smoothly, taking the sector’s total capacity to around 740 mtpa (million tonnes per annum),” he said. Region-wise, maximum capacities are being added in the east and south markets. With the government's sustained focus on infrastructure and allied activities, India’s long-term growth story is expected to remain intact. Given the cement sector’s high correlation with gross domestic product growth, government capex on railway and roadway projects (high-speed rail, dedicated freight corridor, PM Gati Shakti) should give an impetus to cement volumes.
Plus, the housing sector—the biggest demand driver for cement—is on a solid footing, at least in the urban areas going by the strong launch pipeline of listed realty companies in key cities.
But what should be noted here is that the benefits of capacity additions would accrue gradually. Also, to reap that benefit, demand growth has to be enough to absorb the incoming supply. For instance, in rural housing, the traction in home-building activities could be slower due to high inflation and stressed income levels.
Over-capacity, if not accompanied by robust demand, would put industry prices and capacity utilization under pressure. For now, demand is likely to be weak as we enter FY25. The first half will see general elections followed by monsoon, curbing significant volume growth uptick.
Meanwhile, the sector’s increasing investments in alternative fuels and green energy, mainly waste heat recovery systems, should help contain fuel costs ahead. But that is unlikely to aid earnings outlook in the medium term. Given this, the risk of earnings downgrades to FY25 estimates looms, especially if pricing continues to disappoint.