Ind-Ra: Infrastructure and Construction Likely to Pull Down Cement Demand

India Ratings & Research (Ind-Ra) has maintained a stable to negative outlook for the cement sector for FY15. The agency expects limited downside risks for integrated players who are also among the top two to three players in their respective regions. They are likely to maintain a Stable Outlook on their Long-Term Issuer Rating for FY15. The median EBITDA margin of this group is unlikely to fall more than 50bp-100bp yoy in FY15. However, non-integrated players placed on the cost curve may continue to face pressure on their credit profile and thus a Negative Outlook.

The resilience of top five integrated players in the industry to adverse macroeconomic factors is displayed in the form of a similar credit profile for the past two to three years. Ind-Ra expects the top five integrated players to see some margin pressure; however, it would not impact on their credit profile. Non-integrated players are likely to continue to witness a deteriorated credit profile till FY15, due to lack of control on cost, regional concentration and limited pricing power.

The agency expects cement demand growth to remain sluggish at around 5%-6% for FY15, given the slowdown in the construction and infrastructure sectors. The growth will be supported by an expected increase in demand from the rural sector and Tier II and Tier III cities. There could also be some uptick in demand from 2HFY15 due to a provision in the Union Budget of 2013-2014 for an investment allowance for infrastructure projects of INR1,000m and above between 1 April 2014 to 31 March 2015. Also, election results will impact overall growth in construction activities.

Ind-Ra expects the credit profile of non-integrated players to further deteriorate due to limited pricing power and rising costs. The EBITDA margins of non-integrated players fell to 11% in 1HFY14 from 18% in FY13 and the margins of integrated players fell to 18.5% from 22.7%. The difference of EBITDA margins between top five players and non-integrated players was 750bp. The agency expects EBITDA margins for top five integrated players to be around 19%-22% for FY15, while non-integrated it would be around 11%-13%.

Cement companies do not have the pricing power to pass on cost increases to customers due to the sluggish demand. There was a substantial increase in the overall cost structure in FY13. Median freight costs increased 17% yoy in FY13 due to an increase in rail freight rates and higher diesel prices.

Ind-Ra expects overall capacity addition will be moderate as incremental demand will be lower than incremental supply. Capacity additions will grow at a CAGR of 6% from FY13 to FY16, more than a 4% CAGR increase in demand in the same period.

What Can Change The Outlook

Improvement in Infrastructure Spending: A Stable Outlook could result from formation of a stable government post general elections, which may enable higher investment in infrastructure leading to an improvement in cement demand.

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