Infra Push to Support Cement Volume, Top line and Margin Poised for Growth:
Sector in a Nutshell
- Cement stocks have corrected about 10-15% from their recent peaks in May over concerns around pricing roll-back in June and demand moderation following election.
- Cement volume rose 13% in FY19. FY20 started in a subdued note following the general election and the monsoon but is expected to improve in H2.
- Capacity utilization reached 78% in Q4, the highest level in the last 28 quarters. Utilization level is expected to grow further, given the fact the industry is going to grow at around 8-10%.
- Indonesian coal prices, a key raw material, have fallen 14% in the first two months of the fiscal year. International thermal coal prices are down 21% sequentially.
- With international coal/petcoke price declining, it has been an added positive as costs reduced. Margins started to improve in Q4 FY19 and it is expected the trend will be maintained.
- Increase in petrol/diesel prices by Rs 2.5/litre (proposed in annual budget) may push up logistics cost (which accounts for 34% of total operating cost) by 50-60bps.
- The sector is comprised of many good quality stocks, but based on the O’Neil Methodology, we shortlisted Ultratech Cement (watchlist stock) and Heidelberg Cement India (Ex-Portfolio) as our top picks.
Demand Expected to Pick Up in H2 FY20
Despite a higher base, most Indian companies reported higher volume growth in the last one year on the back of continued government spending on infrastructure (accounts for 22-24% of volume) and housing segments (53-55% of volume). It was mostly South (flood restoration in Kerala, Amravati development and irrigation & low cost housing related work in Andhra Pradesh and Telangana) and East India (West Bengal, Bihar, Jharkhand, and Odisha) that witnessed strong volume growth. In the Union Budget 2019, the government emphasised more on infrastructure which includes railways, road, highways, and irrigation projects. This is expected to increase investment across several sectors and will stimulate cement demand.
Continuing the momentum gained in the previous year, the cement production rose 13% in FY19 (first time since FY10), thanks to 16% production growth in March led by strong industry utilization (improved 600bps y/y to 71% in FY19). In Q4 FY19, the capacity utilization reached 78%, the highest over the last 28 quarters. Growth was mainly led by lower base (GST in H1 FY18) and strong demand from East and South India. Taking demand in to account, capacity utilization in the industry has been soaring and is currently at 80-81% compared with 71% at the end of FY19. The utilization level is expected to grow further (~80-90%) given the fact that the industry is going to grow at around 8-10%. However, cement demand in H1 FY19 was adversely affected due to the general election and the onset of monsoon (production grew 2% and 3% in April and May, respectively), but is expected to recover in H2, driven by pick up in infrastructure and housing growth.
Demand Driver for the Industry: Housing and Infrastructure to Drive Volume Growth
The demand for the cement industry is mainly derived from the housing & real estate sector (54%) followed by infrastructure (23%), low-cost housing (12%), and Industrial (11%).
Housing Segment - Government Initiatives on Housing and Tax Reduction to Support Growth
Among the categories mentioned above, the housing segment carries the highest weightage, especially after some of changes brought in by the government.
- The GST committee has lowered the GST rate for the property under construction to 5% from 12%, which favours the end-consumer demand. The reduced rate should create increased demand for cement manufacturers.
- The affordable housing scheme launched by the government, aimed at the rural population, also helped in improving cement prices. This, in turn, improves profitability in the highly competitive low-margin business. In FY19, 15.3M homes were built under this scheme with an expenditure of Rs 258,530M.
Infrastructure Segment - Contributing 25% of Industry Demand
The government is equally focused on developing other infrastructure such as roads, ports, and dedicated freight corridors to enable smooth functioning of trades/operations. Some initiatives introduced by the government include Bharatmala (completion by 2022), Sagarmala for ports, dedicated freight corridor which consists of six corridors spanning the country (completion by 2020), and the smart city project (Rs 240B allocated in FY19). Moreover, in its election manifesto, the ruling BJP party mentioned they will build 60K kilometres of national highways in the next five years.
Easing Input Cost and Strong Realisation to Improve Margin
Cement companies are battling cost increases on multiple fronts. The companies have been grappling with the repercussions of rising crude oil prices and raw material costs. Crude oil price which were benign during the period FY16 ($38/Bbl), started to rise in FY17 and increased 72% to reach $71/Bbl in Q2 FY19.
Logistics make up the majority (30-35%) in total operating cost because it is positively correlated to the oil price which rose 72% from April 2016 to October 2018. With the government increasing fuel price by Rs 2.5 (proposed in annual budget), it will increase the logistics costs.
The prices of petcoke and diesel rallied strongly in the past. While the petcoke prices more than doubled to $116/ton in Q3 FY19 compared with $56/ton in Q1 FY17, diesel increased 37% during the same period. However, prices eased in Q4 FY19 and fell 16% and 8%, respectively. Domestic petcoke prices are down 13% q/q to Rs 7,600/ton in Q4 FY19.
The price of coal, a key raw material which tends to be in high demand among cement manufacturers, has increased, adding to energy costs. Since most of the requirement is met through imports, a weakening rupee is adding to the expenses.
However, Indonesian coal has come to the rescue as average coal prices have fallen 14% y/y in the first two months of the fiscal year. It is to be noted that India imports more than 50% of its coal requirement from Indonesia. Rising production and lower Chinese demand have pulled down Indonesian coal prices. Further, domestic thermal coal availability has improved after restocking at power plants while international thermal coal prices are down 21% sequentially.
Strong Price Realization - South and Central Lead Price Hike
After a strong show in April and May (price increased 30-50/bag according to the Cement Manufacturing Association), June witnessed a price correction of about Rs 5-10 per 50KG bag following increased competition due to higher volume push by selected firms. The onset of monsoon indicates further price moderation in the next few months. However, price correction was restricted to a few markets - it was not a broad-based reversal. In Q4, cement price increased 3% q/q on average, mostly driven by reconstruction activity seen in Andhra Pradesh and Kerala. In the eastern region, prices were moderated (-1% y/y). Despite the correction in June, the overall cement price in Q1 increased ~9% y/y on average, mostly driven by the northern and central part of India.
Region Wise Cement Price
Q4 Results - Strong Volume Growth Drives Revenue
Q4 results for cement manufacturers were encouraging. While the top line grew 10% on average, on the back of strong volume growth, EBITDA increased 29%, driven by disciplined cost management and price hikes. Both Ultratech and Shree Cement reported double-digit volume growth while other major players were in the mid-to-high single-digit bracket. Managements of different cement companies mentioned that higher government spending in infrastructural projects and effective execution of affordable housing has led to strong volume growth over the last one year.
Stock of Interest
Ultratech Cement: Ultratech Cement, part of Aditya Birla Group, is India’s largest manufacturer of grey cement, Ready Mix Concrete (RMC), and white cement in India. It has 20 integrated plants, one clinkerisation plant, and 26 grinding units with an installed capacity of 113 MTPA. In Q4 FY19, the company beat estimates on account of strong domestic sales volume. The operating efficiency helps the company to post strong EBITDA growth of 30% and margin expansion of 300bps.
O’Neil Methodology: The stock is trending higher along with rising 50-DMA and is 9% below its pivot price of Rs 4,904. Growth in earnings has been steadily improving from -33% in Q1 FY19 to 109% in Q4 FY19. It has a modest EPS rank of 65, but set to improve given the turnaround in earnings. It has an SMR Rating of B and a Composite Rating of 94, indicating strong fundamentals. The RS line is inching higher (A-) with a strong RS Rating of 86. Investors can initiate positions in the stock once it breaks out of the pivot level and registers strong numbers in Q1 FY20 (expected to be released on July 16).
ACC Cement: ACC is one of India's leading manufacturers of cement and RMC with 17 cement factories, 75 ready mix concrete plants, and a strong distribution network of over 50,000 dealers & retailers. The company is planning to add 6 MT capacity at a total outlay of Rs 30B, funded by internal accruals. Improving sales mix and cost efficiency helps the company improve profitability. In Q4, sales, EBITDA, and PAT grew 11%, 15%, and 13%, respectively.
O’Neil Methodology: The company reported strong earnings (>15%) in the last three quarters along with double-digit revenue growth. The stock broke out of an eight-week flat base recently but closed lower amid high selling pressure. It is currently trading in a flat base and is 11% below its pivot. Technical ratings are good, with an RS Rating of 75 and an A/D Rating of B-. The shares held by funds increased 1.5% y/y with a marginal increase in the number of funds. Investors can initiate positions in the stock, given the strong Q1 results and the stock breaking out of the recently formed base on higher volume.
Heidelberg Cement: Heidelberg Cement India is a subsidiary of Heidelberg Cement Group, Germany. The company manufactures and sells cement in India under its brand “mycem cement”. It has a total capacity of 5.4 MT. In FY19, the company hit utilization rate of 90%, with premium product volume increasing 19% y/y. The company’s EBITDA and PAT grew 33% and 66%, respectively. Its gross realization improved 7.7% y/y to Rs 4,897/ton.
O’Neil Methodology: The stock's three- and five-year EPS growth recorded at 72% and 83%, respectively. The stock has had significant accumulation recently, as was evident from its strong Up/Down Volume ratio of 2.3 and a 6% increase in the number of funds holding the stock in Q2 compared with the year-ago period. It has a good EPS Rank of 97. The stock displays high technical O’Neil Ratings and Rankings, with an RS Rating of 91, Group Rank of10, and Up/Down Volume ratio of 2.3. Its Composite and SMR Ratings stand at 96 and A, respectively. It has good support at its 50-DMA and can be a good buy if it continues trading above its support and breaks above its pivot on high volume.
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