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Cement Recovery to Gain Pace in 3Q; Stable to Positive Future Outlook

Cement Recovery to Gain Pace in 3Q; Stable to Positive Future Outlook

by Khushbu Lakhotia, Associate Director, India Ratings and Research

Cement sector in India has witnessed a strong recovery starting from 2QFY21 after being hit hard by the pandemic induced disruption in 1QFY21 (volumes down 30% yoy). Volume growth returned in 2QFY21 itself with 5% growth yoy (albeit on a low base of last year) and the pace of recovery is expected to sustain in 2HFY21. In 3QFY21, the cement demand is expected to grow by 5-7%, and supportive base effect in 4QFY21 (15 days disruption in March 20) would mean that the cement demand degrowth for the full year could be limited to 5% in FY21 with risks to the upside. This is in contrast to Ind-Ra’s earlier estimate of demand degrowth expectations of 12-15%.

Cement volume growth has been largely led by rural demand in 1HFY21 with normal monsoons, robust government support, return of migrant labour and lower impact of Covid. Rural housing constitutes 35-40% of total demand and a large part of infrastructure spend of 25% is also spent in rural areas. In 3QFY21 the rural demand momentum was complimented by infrastructure growth – for instance, targeted national highway target of 11,000 km is likely to be met in FY21 despite 2 months of lost working days, and greenshoots in urban demand.  Region wise, East has seen highest demand growth (in double digit), with Central and North being other regions witnessing healthy demand upsurge. Urban focused West has been the worst impacted and is likely to see a slower pace of recovery.

Going forward, Ind-Ra expects India’s cement demand to grow at 13-15% yoy in FY22, after two consecutive years of flat to negative growth. Cement demand to GDP multiplier is likely to hit 1.5x, which is the third highest (FY19: 2x, FY09: 1.9x) and compared to trailing 15-year average of 0.9x. FY22 budget has demonstrated government’s focus on infrastructure growth with 26% increase in capex spending to INR 5.5 trillion. While government spending focused on rural area in FY21 (30% growth yoy on major schemes), in FY22 growth in urban spends is likely to outpace (12% yoy in FY22 against 7% in FY21 across schemes). Allocation towards national highway projects has increased by 15% and the number of projects under National Infrastructure Pipeline has increased to 7,400 from 6,835 projects. The real estate sector could receive support from the extension of tax incentives on affordable housing by a year to March 2022 and the extension of exemption to affordable rental housing projects. Encouragingly the government has offered announced measures to attract long-term infrastructure funding by creation of a development financial institutions; regulatory easing for attracting foreign funding in infrastructure; and capital recycling through asset monetization plans across road, power and gas transmission assets, warehouses, dedicated freight corridors, etc.

Sector profitability has recovered even faster than the volume growth, led by significant cost savings both on fixed costs and overheads as well as variable costs, with cement prices remaining broadly flat yoy. Despite a 13.5% yoy decline in volumes in 1HFY21, EBITDA of the sector was up 1% yoy. EBITDA/t hit record level of over INR1,300/t. While EBITDA/t increased for all listed entities in 2QFY21, the stronger realisations and a low base resulted in South-based players leading the pack. For 3QFY21, we expect sector EBITDA to grow at c. 40-45% yoy – broadly at a similar level of growth as in 2QFY21, with an increase of around INR300 in EBITDA/t amid a return of operating leverage with growth in utilization levels. This is despite an expected sequential moderation in EBITDA/t by around INR100-125due to partial normalization of discretionary spends with input price inflation mitigated by low cost inventory.  Going forward, Ind-Ra expects EBITDA/t to further moderate in 4QFY21 and 1QFY22, as full impact of input price inflations becomes visible. Yet unit profitability is likely to sustain at a higher than historical levels seen until FY20. With the faster return in profitability, the credit metrics have likewise improved for the sector, and Ind-Ra now expects the net leverage for its rated companies to largely remain flat in FY21, with steady deleveraging from FY22. 

Ind-Ra expects cement prices to stay firm in the seasonally strong 4QFY21, with likely modest impact from investigations related to alleged anti-competitive behavior by Competition Commission of India (CCI). Power and Fuel costs which constitute around 25% of the total cost is likely to see pressure for sharp increase in petcoke (up 65% from since June) and coal prices (up 45% since June). The companies have mitigants like switching between fuels and higher green power sourcing like WHRS, but they are likely to prove insufficient. Freight and Forwarding costs (30% of total cost) is likely to be impacted by higher diesel prices despite flexibility to switch to railways and some optimization on lead distances. Limestone costs in future are going to rise with adoption of auctions from 2015, although near-term impact is limited and would be offset by trend of rising blended cement. Discretionary spends related to marketing, travel, etc, are likely to return although some cost savings are likely to continue.

Return of volume growth in 2QFY21 has stoked capex appetite, with companies announcing over 20 million tonnes (mnt) of capacity additions since mid-October. While FY21 is likely to have one of the lowest capacity additions due to capex deferrals in 1H and project execution challenges, FY22-FY23 is likely to witness one of the higher capacity additions since FY09-FY11. Yet, utilisations are likely to remain at 66%-67% in FY22-FY23 (FY19: 70%, FY20: 67%, FY21: 63%), assuming cement demand growth of 14%/5.4% in FY22/FY23, which should be a supportive backdrop for industry profitability. Ind-Ra cement demand growth assumptions imply a 2.5% CAGR growth over FY19-FY22. Encouragingly, the bulk of the capex is concentrated in regions which are also witnessing a higher demand or capacity crunch such as East and Central than South or the slow-growing Western region. 

 

 




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