Despite low demand, Street waking up to cement sector's improving prospects

Investors may consider companies with industry-leading growth and profitability

Despite low seasonal demand and surplus capacity, the cement sector may see improving prospects through the second half of the year. For one, volume growth has happened in comparison to the last monsoon and better demand is expected as the monsoon retreats. More importantly, margins should expand considerably since there’s been a drop of 40 per cent in pet coke prices. At the same time, cement companies have been rolling out price hikes in southern and eastern India which seem to have been accepted by consumers since demand has been stable.

Pet coke accounts for roughly two-thirds of the fuel mix for most cement companies. The price drop will obviously lower costs. However, thermal coal -- which is another key raw material in this energy-intensive process -- continues to rule high. It’s estimated that the drop in coke prices will push up spreads by around 12-15 per cent. Diesel prices are also stabilising as the global economy adjusts to the fears of supply disruption due to the Ukraine war.

There is surplus capacity in the cement sector and capacity expansions are continuing and will add roughly 20-25 per cent to existing capacity in the next three years. Demand is not expected to grow much this financial year, but it has been better year-on-year (YoY) through the monsoon. A rebound in rural demand and private consumption overall could be a booster but that’s not expected to be very strong. In volume terms, the aggregated industry may see offtake growing at an average 10 per cent YoY in 2022-23 and another 10 per cent YoY in 2023-24 over 2022-23. The outperformers will beat that growth rate. Assuming an economic rebound, there should be enough demand to absorb much of the capacity currently under construction.  

Speculators are also now optimistic for a relatively quick end to the Ukraine war which shall probably lead to easing global coal and pet coke prices. On average, Ebitda per tonne may see a decline in Q2 (July-September) and turn flat in Q3, and move up from Q4, both on QoQ (quarter-on-quarter) and YoY bases. In the near term, share-price movements may depend on the spread between cement prices per tonne versus the variable costs per tonne. In the longer term, margins and spreads may have bottomed out.

A full recovery to pre-Covid margins may only occur in 2024-25. In terms of realisations per tonne, single-digit growth (averaging 5-7 per cent) in 2022-23 is expected, with a rebound only in Q4 (maybe Q3). In 2023-24, realisations are expected to be near flat. But Ebitda per tonne is expected to decline in the full year 2022-23 and improve by 20 per cent YoY or better in 2023-24.

It seems that the market is waking up to this situation. Most cement stocks have seen a surge in prices in the past three sessions. The one exception is Shree Cement, which is seeing some selling. Investors may need to be selective.