– Industry volumes contracted in Q2 FY20
– Cement prices softening amid weak demand
– Input costs continue to trend downwards
– Prefer cos with strong market position and healthy financials
Strong demand from the infrastructure and housing industries drove cement volume growth in financial year 2018-19. However, FY20 started on a sombre note. Demand was subdued during the first quarter because of the general elections and water shortage. The July-September quarter is a seasonally weak quarter anyway. Not only did sluggish demand continue, prices also fell in some regions because of weather conditions and floods, which delayed various projects. The liquidity crunch too dampened demand. Thus, cement volumes fell for the second straight quarter contracting by about 4 percent during July- September. The saving grace: input costs were lower.
Top line improves, margins improved across the board
JK Cement’s revenue growth of 12 percent was aided by higher realisations and strong offtake in white cement & wall putty volumes (up 12 percent YoY). Overall volumes rose only 4 percent due to a marginal decline in grey cement volumes in Q2 FY20. JK’s high-cost inventory hurt its gross margins, but operating margins jumped substantially on the back of lower operating costs.
Birla Corp’s revenue growth was driven by a combination of higher realisations (up 6 percent) and volumes (up 4 percent YoY). The commencement of a Waste Heat Recovery System and railway siding plant along with a decline in power and fuel costs boosted its operating margins.
Sagar Cement’s Q2 performance was in stark contrast to earlier quarters. Volumes were hit on account of liquidity constraints and non-availability of sand, but margins expanded from a low base last year.
Lower demand in the Gujarat market had a significant impact on Sanghi’s volumes. The quarterly performance was dismal and the company has scaled back its expansion plants in light of the current economic environment. The company now intends to add 2 million tonnes cement capacity vs 4 million tonnes planned earlier.
Heidelberg’s top line was driven entirely by realisation as volumes were almost flat YoY. Operational performance was subdued owing to higher energy costs. The company is operating at a capacity utilisation of around 90 percent and is expanding capacity by 0.4-0.5 million tonnes through de-bottlenecking.
Star Cement’s top line growth was steady, but the operating performance was disappointing due to change in fuel mix and plant shutdown. Margins suffered as the disruption in the local coal supply market forced the company to use imported coal for its power and fuel requirements. The company also undertook a plant shutdown to complete a capacity de-bottlenecking exercise (0.2 million tonnes) in a seasonally weak quarter.
Prices moderate across most regions
Cement industry realisations have been strong in Q1FY20 and Q2FY20 owing to pan-India price hikes during January-February 2019. However, these hikes have been rolled back amidst weak offtake. Dealers are finding it tough to push volumes at higher prices. Barring the northern market, all other regions have seen steep price correction in recent months. The southern region is the hardest hit owing to stalled projects, high competitive intensity and low utilisation levels. Here, prices are down 2-3 percent YoY. Other regions, such as central and east have also seen consecutive monthly declines, but the current prices are at the same levels as last year. The northern region stands out as realisations continue to remain firm and are higher by 12-13 percent YoY.
Government spending to drive demand
Weak demand continues to persist amidst slowing economic activity, but the cement industry is hopeful of a demand recovery owing to the government’s five-year commitment of spending Rs 100 lakh crore for infrastructure. Other initiatives such as Housing for All also augurs well for the sector.
Given the near term demand challenges, we believe that companies with strong market positioning and low leverage on their balance sheets remain well-positioned to navigate the current economic downturn.
Birla Corp, which operates in the central market, has delivered strong results in the first half of this calendar year. However, we do not like the high debt levels on its balance sheet (Net Debt to EBITDA of 3x).
In comparison, Heidelberg Cement also operates in the same market and has a much stronger balance sheet, healthy margin profile and superior return ratios. The company has a stable earnings profile and its near-term valuations (FY20 estimated EV/EBITDA of 7.8x) are capped due to capacity constraints. Long-term investors should look to accumulate this stock in times of correction.
Among the regional players, we also prefer Star Cements (trading at 9 times FY20 estimated EV/EBITDA) as the business enjoys a competitive advantage owing to its strategic location in the North-East. Despite operating in a capital intensive industry, the company has a strong balance sheet with cash position of nearly Rs 360 crore. Investors should keep this stock on radar as the quarterly results have been below par owing to one-offs and profitability remains well positioned for recovery in an upcycle.