Cement: Grey skies

Demand may not rise fast enough to match the supply coming into the market.

Cement stocks have had a decent run over the past month or so – UltraTech and Shree Cement have outperformed the Sensex and even others like India Cements and ACC have given positive returns.

That’s possibly because cement prices have remained more or less stable across the country in the June 2008 quarter. Moreover, July and August have seen prices rise in some parts of the country, especially the south and west.

In July though, producers appear to have despatched less—-14.5 million tonnes than they produced—-14.7 million tonnes. According to industry watchers, demand is coming off slowly and could lag supply which is expected to increase by 20-22 per cent compounded annually over FY08-11.

Demand is believed to have been somewhat weak in June, growing in high single digits across most parts of the country except for the south where it was in double digits. One reason for this was that the monsoon set in early. Over the next few years, demand is expected to grow by just 10-12 per cent. That, say analysts, could impact prices which could decline by 8-12 per cent over the next 12-15 months.

Interestingly, the capacity utilisation for the industry is believed to have fallen for the first time in five years, to 89 per cent in the June 2008 quarter, from 100 per cent last year. That’s because around 30 million tonnes of capacity is understood to have been added in FY08.

Utilisation is expected to ease from the optimum levels of 95 per cent to around 87 per cent in the current year and further decline in FY10 should the anticipated addition of 120 million tonnes, over the next 2-3 years, take place.

Cement producers will also have to live with high coal prices. Even though international coal prices came off by 14 per cent in July, at $152 per tonne, they remain higher by 166 per cent y-o-y. Domestic prices of coal have, however, remained unchanged in the June quarter.

That together with the high cost of power could continue to pressure operating margins. Cement stocks are currently trading at multiples of 5-10 times estimated FY09 earnings and are not expensive. However, they remain vulnerable in a deteriorating economic environment.