by Khushbu Lakhotia, Associate Director, India Ratings and Research
After a surprise FY21, wherein the quick recovery restricted the decline in cement demand to low single digit, cement demand is likely to witness a high single-digit growth to around 350 million tonnes in FY22. After a strong start in 1QFY22, growth slowed down subsequently with factors like extended monsoons, sand availability issues and transporter strike affecting demand particularly in 3QFY22 which witnessed a marginal decline in volumes. As a result, volumes grew 12% yoy in 9MFY22 and notwithstanding a sequential improvement, demand pick-up in 4QFY22 seems to have fallen short of the expectations of a typical seasonally strong fourth quarter.
Going forward, Ind-Ra expects cement demand to grow 8-9% yoy in FY23 with cement demand to GDP multiplier likely to be over 1x, compared to trailing 15-year average of 0.9x. Ind-Ra believes the 36% increase in the budgeted capex (over the revised spending estimate for FY22) to INR7.5 trillion for FY23 is likely to drive infrastructure spending that accounts for around one-fourth of the cement demand. While the highway construction target of 12,000km in FY22 is likely to be missed (11MFY22: 8,045km down 25%yoy), road construction could be a key driver in FY23 with the target to add 25,000-km of highways as part of the PM Gati Shakti Plan that includes the expansion of roads, railways, ports, airports and logistics infrastructure.
The housing segment has been a key demand driver in the past few years, with the individual home builder segment displaying a remarkable resilience to the pandemic. Cement demand from the housing segment (which constitutes around 65% of the total demand) is likely to be supported by the government’s continued focus on affordable housing, with the allocation of INR480 billion for the completion of 8 million houses under the PMAY scheme, which is in line with the revised estimate of INR478 billion for FY22, up 70% from the budgeted estimate for the year. Further, upcoming general elections should support demand from 4QFY23.
Region wise, North has been most stable in FY22, led by the rural and infrastructure segments, with both demand and prices holding up more strongly than in other regions. Demand in the fastest growing Eastern region was affected in the past couple of quarters due to sand availability issues, transporter strike and unseasonal rains in FY22 while the urban focused West had been the worst impacted from Covid and witnessed a slower pace of recovery. The Southern region witnessed a pick up in the infrastructure and rural housing demand in Andhra and Karnataka and urban housing demand in Tamil Nadu and Kerala in 1HFY22 but heavy rains hit demand in most states in 3QFY22. Structurally, East, is however, likely to remain the fastest growing region, owing to its underpenetration as reflected in the low per capita consumption of cement and the high share of rural population which results in the region being a key beneficiary of affordable housing projects along with consolidated Central India.
On the supply side, the sector has witnessed a return of the capex cycle with expansions of around 120 million tonnes in the pipeline over FY22-FY24. While the actual capacity addition over this period could be to the tune of 90-100 million tonnes, the FY23-FY24 is likely to witness one of the highest additions since FY09-FY11. In addition to the quick recovery and the surge in profitability in FY21, the amendment in the MMDR Act in 2021 which requires leaseholders to commence production from the within a period of 3 years to prevent the lapse of the lease is a key driver of the capex plans of many companies. However, this capex cycle is preceded by 3 years of low capacity additions (FY19-FY21: 40 million tonnes) with FY21 witnessing one of the lowest additions due to capex deferrals in 1H and project execution challenges. As a result, utilizations are likely to remain at 65%-67% in FY22-FY23 (FY19: 70%, FY20: 67%, FY21: 64%) and unlikely to have an adverse impact on overall sector profits.
Bulk of the capex is concentrated in the fastest-growing Eastern region, largely in the form of grinding units, due to which the region is likely to witness subdued capacity utilisations in the near-term before demand growth catches up, resulting in subdued profitability in the region. While FY21 saw negligible announcements in the oversupplied Southern region, integrated projects have been announced in FY22, most of which would come on-stream in FY24-FY25. North is likely to remain the most balanced, with capacity additions likely to remain in line with the demand growth, ensuring robust utilisations and profits. The Western region could witness a fall in utilisations with a slow recovery and relatively large addition most of which was planned pre-Covid when capacity utilisations were strong.
After hitting a historical high of over INR1,350/mt in 1QFY22 (FY21: INR1,250/mt, FY20: INR1,150/mt) on strong realisations and low costs, EBITDA/mt of cement companies witnessed declines in 2Q and 3QFY22 owing to a rise in input costs as muted demand growth prevented affected the industry’s ability to sustain price hikes. As a result, the sector EBITDA/mt fell over 10% yoy in 9MFY22, limiting the rise in absolute EBITDA despite the growth in volumes. Ind-Ra expects the record high coal prices owing to the ongoing Russia-Ukraine conflict to hit profitability of cement companies in the near-term as price hikes are unlikely to match up to the cost headwinds. Power & fuel costs (~30% of the total cost), which was earlier expected to have peaked in 3Q/4QFY22, would now witness a sharp increase in the near-term as coal and pet coke hit new highs in March 2022. From an average of USD150-160/mt in 9MFY22, thermal coal prices currently stand at over USD300/mt currently, after witnessing all-time high of over USD400/mt in March 2022. Further, freight & forwarding costs that account for another 30% of the total costs are also likely to witness an increase with diesel prices starting to increase since the past of couple of days to given the massive rise in crude prices in March 2022. However, since most companies carry fuel inventory for 2-4 months, any meaningful impact would be visible only in 1QFY23.
Cement realizations have historically been resilient over full year periods, with only 3 instances of yoy decline in the past 15 years and single digit yoy movements in the past 13 years. After increasing 2% yoy in FY21, cement realizations averaged around 5% yoy higher in 9MFY22. With only a moderate demand pick up in 4QFY22, price hikes have remained restricted to low single digit in March. Given the surge in costs, prices hikes in April remain a key monitorable for the near-term profitability.
While profitability is likely to be strained in 1HFY23, a gradual moderation in coal and pet coke prices coupled with robust demand fundamentals would lead to a recovery in 2HFY23. A sustained increase of USD50/mt in coal prices would require price hikes of 5% to sustain EBITDA/mt at 9MFY22 levels of INR1,100, which will be contingent on the pick-up in demand. With most companies focusing on alternative energy sources, a higher share of green energy (WHRS/solar) in the power mix or availability of domestic linkage coal could somewhat soften the blow.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.
However, despite a likely fall in the profitability in FY23, Ind-Ra expects credit profiles of cement companies to remain comfortable, with moderate net debt levels and generally strong balance sheets after continued deleveraging in the past few years providing sufficient headroom. The sector’s liquidity is likely to remain adequate, supported by cash balances, robust cash flow generation resulting in robust interest and debt service coverage ratios, unused working capital linesand long maturity debt tie-up for capex. While the utilization of fund-based working capital limits remains limited in the sector, given the short working capital cycle, companies may need to increase non-fund based limits with coal and pet coke prices shooting through the roof.
