Few months are left for the financial year 2020-21 to end. How will the demand offtake in the remaining months for the cement sector?
Cement demand recovered quickly to 79% of last year in May 2020 and 93% in June 2020, led by a strong rural demand aided by three consecutive good monsoons, adequate availability of local labour and lower spread of COVID-19 than in urban areas, leading to a decline of 35% yoy in 1QFY21. However, recurrent state lockdowns and fading pent up demand slowed down the recovery pace in July and August, with the months registering declines of 13.5% yoy and 14.6% yoy respectively (against 6.8% in June).
Rural demand would continue to outperform urban demand and companies having higher individual home builder exposure remain better placed. However, an increase in the incidence of COVID-19 in eastern and central regions and state lockdowns can impact the demand recovery. Demand from infrastructure would remain contingent on government spending though road construction remains a bright spot with highway construction in July only marginally lower at 27-km/day (July 2019: 28-km/day). Overall, we expect the pace of normalisation to be gradual with the third quarter likely to witness a decline of nearly 10% yoy. With normalcy likely to be restored only by March, FY21 could see a demand decline of 10-15% yoy.
What is your assessment for the next financial year 2021-22 for the cement sector?
The Indian cement sector has not only demonstrated demand resilience historically but also an ability to rebound quickly after an external shock. While the industry witnessed negative growth in the immediate months after demonetization, double digit growth occurred for the next 12 months (with monthly growth exceeding 20% on a few occasions) to offset the decline. Similarly, after the unprecedented decline in FY21, we expect recovery to be rather smooth in FY22, with demand likely to grow around 20% yoy. However, while the number appears high on a low FY21 base, sales would be only around 3% higher than the normalized FY20 volumes. The growth will be aided by a pick-up in the affordable housing space (after a subdued in FY21 given the stretched government finances) and some rebound in infrastructure, urban housing and industrial capex even though full recovery in these three segments is likely only by FY23.
Major cement manufacturers have reported a decline in net profit compared to the last quarter but not loss. How did the cement manufacturers manage to stay afloat during the lockdown and register profits in Q12020-21?
Despite a record lockdown-induced volume decline, the aggregate EBITDA/mt of listed cement companies hit a historical high of INR1,325/mt in 1QFY21 (1QFY20: INR1,252/mt, 4QFY20: INR1,064/mt) on the back of reduced costs. Power and fuel costs that form around one-fourth of the total cost of cement producers were lower by almost 20% yoy, led by a decline in coal and pet coke prices as well as better availability of domestic coal. The reduction in variable costs offset the increase in fixed costs due to an adverse operating leverage. Besides, with hikes in April and May 2020, all-India cement prices averaged around 1% yoy higher on a high 1QFY20 base, contributing to the profits. However, price elasticity of demand was visible, with entities that saw lower volumes declines witnessing lower realisations. Further, most large companies had adequate liquidity due to comfortable cash flows, unused working capital lines and financing access.
What are the challenges facing the industry?
With the sharp decline in cement demand, cement capacity utilisations are likely to fall by around 1,000bp to atleast a 25-yr low of around 56% in FY21 (FY20: 68%), widening the oversupply in the industry. While most of the ongoing capex is witnessing delays of three to six months due to labour shortage, Ind-Ra expects around 65% of the announced capex for FY21 (ie, 20 mnt) to come onstream during the year, given that much of this is in advanced stages. Capacity utilisations are likely to remain well below 70% in FY22 too. The fall in capacity utilisations could undermine the price resilience witnessed so far, particularly if demand recovery disappoints. Besides, even as volumes improve, the record EBITDA/mt witnessed in 1QFY21 may not be sustained. Pet coke and coal prices that had fallen by as much as 25%-30% yoy in 1QFY21, inched up in August and September 2020. Besides, an increase in ocean freight has increased the landed cost of imported coal and pet coke, in addition to higher diesel prices. While most companies had sufficient low-cost stocks for 2QFY21, the benefits are likely to reduce in 2HFY21. Cost saving initiatives (including waste heat recovery systems) undertaken by companies would, however, provide benefits. Further, government spending on infrastructure and affordable housing schemes remains a key monitorable.
The cement industry depends on government policies and projects to boost revenue. The pandemic has dented the revenue. How can the government step-in and hand-hold the industry in this difficult period?
With a constrained private sector capex, the role of government in the cement consumption has increased over the years. Nearly half of the cement demand is today linked to government spending, with infrastructure and affordable housing being key elements. Rural affordable housing, had been quite a success, until FY20 when it slowed down due to floods and funding issues. PMAY G was off to a tepid start in FY21 due to inactivity during the lockdown and funding constraints. A pick up in the segment can aid cement demand significantly. The Ministry of Road Transport and Highways (MoRTH) has set an ambitious target of 15,000-km for FY21, 46% higher than the length constructed in FY20. Further, highway awards increased significantly to 3,330-km over April-August 2020 (from 1,367-km in the previous year) and MoRTH has set a target of 20,000-km of award in FY21 (FY20: 8,912km). With demand from power projects and urban infrastructure likely to remain subdued, road construction hold key to cement consumption in infrastructure. Besides, measures taken to address employment generation for migrant labours could also be a stimulant to cement demand.
Lastly, where will the maximum demand for the industry come from in the next financial year?
Housing is the biggest driver of cement demand accounting for 60-65% of the total demand, followed by infrastructure (~25%) and the balance by commercial and industrial consumption. Rural housing, that forms around 60% of the housing demand, will continue to be a key growth driver, led by the expectation of a good crop this year and some benefit from the government stimulus package for the agriculture sector. With over 5 million houses sanctioned under PMAY G, pending execution, the construction is likely to recover in FY22, particularly benefitting the Eastern and Central regions. Of the PMAY Urban's total target of 11.25 million houses, 10.7 million houses have already been sanctioned and the Southern region is likely to see some traction from the segment. With a gradual recovery and expectation of a GDP growth of 9.9% in FY22, demand from infrastructure and industrial capex is also likely to improve.
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