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India's 460-million-tonne cement industry, world's second largest, is likely to continue facing tough times in 2018-19, too. Hit by a mismatch between demand and supply for nearly a decade now, leading to poor capacity utilisation of less than 70 per cent, the sector’s volume has grown in low single digit.
Now, despite government's impetus on infrastructure, the sector might face pressure on its profitability, given the rising costs of input materials and muted capacity utilisation levels, which are seen hovering around 65 per cent.
According to a report by ICRA Ratings, cement makers have witnessed rising energy and freight costs on the back of higher prices of pet-coke, coal and diesel during the first half (H1) of 2017-18.
“The pet-coke prices have risen around 32 per cent in H1 of FY18 on a year-on-year (y-o-y) basis, while coal prices have increased 44 per cent, which has resulted in higher power and fuel expenses,” says Sabyasachi Majumdar, senior vice-president & group head of ICRA Ratings. He added that with a seven per cent rise in diesel prices, majority of cement makers faced higher freight costs, as well.
Cement is a highly energy-consuming sector and any rise in fuel prices tends to have an adverse impact on the profit margins of cement players. Further, pricing discipline has not been possible every time or it hasn’t lasted for long, given the supply overhang, leading to cement makers taking a hit on their profits in recent years. With expectations that scenario of supply overhang and cost pressures might not ease in near future, the coming quarters of 2018 look challenging.
“While the operating profitability of the cement companies has been under pressure on account of the rising costs in H1, higher realisations supported the margins to a large extent, except for south-based players. However, with expectations of higher power, fuel and freight costs in FY18 likely to continue, the same will put pressure on the profitability margins and debt metrics of the cement companies in the coming quarters, says Majumdar.
The Supreme Court had banned usage of pet-coke in a few northern states to curb rising pollution levels in November. Though it was relaxed later, future ban on pet-coke and its consequent adverse impact on the cost structure of cement makers can't be ruled out, says the report. The government had also increased import duty on pet-coke from 2.5 per cent to 10 per cent last month.
Analysts also have a cautious view on the sector. In a report late last month, Edelweiss analysts, led by Navin R Sahadeo, said, “Weakness in cement prices (down 2.5 per cent sequentially) and demand in Q3FY18, overhang of sand shortage on demand recovery and further escalation in fuel cost in the near term pose potential risk to our FY18/19E earnings.” As we revisit our numbers, we remain cautious on the sector in the near term in the absence of positive triggers, they added.
Whether, companies will be able to increase prices to sustain profitability remains critical.
But, almost all have been keeping high hopes from the current government as far as infrastructure spending is concerned. However, these factors are yet to reflect substantially in their sales numbers. The sector is likely to end FY18 with a growth rate of one-two per cent. According to sector executives, they do not see any surge in growth till FY20 and expect it remain in mid-single digit.
ICRA projects demand growth for 2018-19 to marginally increase to four-five per cent. This is primarily on the back of pick up in the affordable and rural housing segments.
As Majumdar puts it, "We expect the capacity overhang and the moderate demand growth to continue to keep the industry's capacity utilisation level between 60 and 65 per cent over the medium term."