No cheer for cement makers in FY19, rising costs to hit profitability: Icra

Cement makers face another tough year; demand growth likely to be 4-5% in FY19

India's 460-million tonne cement industry, the world's second-largest, is likely to continue facing tough times in 2018-19 too. Hit by a gross mismatch in supply and demand for nearly a decade now, leading to poor capacity utilisation of less than 70 per cent, the sector's growth has remained stunted with a lower digit growth trajectory. 

Now, despite the government's push for infrastructure development, the sector may face pressure on its profitability given the rising costs of input materials, and capacity utilisation will hover around 65 per cent, says a report from ratings agency Icra. 

According to the report, 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 of 2017-18.

"Pet coke prices have risen by around 32 per cent in first half of FY18 on a year-on-year basis while coal prices have increased by 44 per cent, which has resulted in higher power and fuel expenses during the period," said Sabyasachi Majumdar, senior vice-president and group head of Icra Ratings. He added that due to a seven per cent rise in diesel prices, the majority of cement makers faced higher freight costs as well. 

It is worth noting that cement is an extensively energy-consuming sector and any rise in fuel prices tends to have an adverse impact on the profit margins of the cement players. The sector is dominated by players like UltraTech, Ambuja Cement, Shree Cement, Dalmia Cement, and India Cements. Further, with the ability to discipline prices every time either not being possible or not lasting for long, given the supply overhang in the Indian market, cement makers have been taking a hit on their profits in recent years. With expectations that the scenario may not ease in the near future, the upcoming quarters of 2018 look challenging.

"While the operating profitability of cement companies has been under pressure on account of the rising costs in H1FY18, 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 cement companies in the coming quarters," said Majumdar.

It's worth mentioning that the Supreme Court had banned the usage of pet coke in a few northern states in order to curb rising pollution levels in November last year. Though it was relaxed later, a future ban on pet coke and its consequent adverse impact on the cost structure of cement makers can't be ruled out, said the report. 

Whether cement makers will be able to increase cement prices to sustain profitability remains critical. In recent quarters, cement makers have largely attributed reasons like a judicious mix of fuels, efficiencies, branding of products and launching newer products as being the cause of their quarterly profitability.   

Almost all the players have been keeping high hopes from the current government as far as infrastructure spending is concerned — be it in irrigation, affordable housing, roads, highways or smart cities, among others. However, these factors could not reflect substantially in their sales numbers. The sector is likely to end the current financial year with a growth rate of one-two per cent. According to sector executives, they do not see any sharp surge in growth till FY20 and expect it to remain in the mid-single digit range.  

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. However, it may not have any meaningful impact on capacity utilisation.

As Majumdar put 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."