There’s upside potential in cement sector
Between September and November, cement prices have increased for three straight months across every region. In addition, energy prices -which are a key input -- have seen a decline in the last seven weeks. Apart from crude and gas, imported coal prices have declined by over 20 per cent month-on-month (MOM) in November. This will improve Ebitda (earnings before interest, tax, depreciation and amortisation) per tonne for cement companies in the third quarter of the 2022-23 financial year (Q3FY23) and in Q4.
That could mean strong gains over Q2FY23 results which were weak due to seasonal factors and high energy costs. There could also be a demand recovery through the second half (H2) of FY23, and through the next fiscal, when electionrelated considerations are likely to boost infra expenditures. However, the northern part of the country could see more bans on construction related to pollution if other states emulate Delhi.
The sector has many well-run companies but it also has a significant surplus capacity and it may be even more in the future since most companies have expansion plans. Many of the larger companies have strong balance sheets and have deleveraged, taking advantage of low interest costs for the last three years. Logistics in the form of cheaper transport costs, efficiencies and economies of scale, and captive sources of power -- will all be useful variables to track going forward.
The Adani Group’s entry into the sector through acquisition adds a new dimension. Will there be further consolidation or will there be a price war?
Maintaining price discipline would be good in the short-term perhaps but a price war to win market share may also be a long-term gamble that the group has the deep resources to take.
To be noted, the entire Adani stake in Ambuja and ACC was initially pledged to raise debt funding for the acquisitions from a consortium of 14 foreign banks via a Mauritius-based Special Purpose Vehicle. The debt burden of $4.5 billion equivalent may affect the strategic decisions made by the group since the debt would have to be serviced though there's talk of refinancing the loans with longer tenures.
The Q2 weakness in the sector was marked. A sample of 40 cement companies reported a 12 per cent year-on-year (YOY) increase in sales, but expenses rose by 28.5 per cent, with raw material costs up 18 per cent, and energy costs up 69 per cent. Pbidt or profit before interest, depreciation and taxes fell by 49 per cent and interest costs also rose by 8.6 per cent. Net profits fell by 86 per cent. Several large players -such as ACC and Nuvoco -registered losses.
The impact on share prices has not reflected the poor results. Most managements have positive advisories and most of the leading companies have seen share price gains in the last month.
Most investors are betting on a better H2 and on a Budget which strongly emphasises construction activity going into 2024 General Elections. If energy prices do stay down and demand does improve, the sector has an upside.