Some headwinds emerge for India's cement sector amidst high valuations

There are confusing reports and advisories about the cement sector. While the space has seen speculative support on the basis of the Budget’s infrastructure thrust, there are several negative factors surfacing as well. The sector may be overcrowded with a fair number of large players and the entry of the Adani Group through its two key acquisitions, followed by the takeover of majority stake in Sanghi Industries via Ambuja Cements. Since every major player is in expansion mode, there could be a capacity surplus and hence, price wars.

All this is known and largely discounted. But the latest channel checks and updates throw up some interesting data. The deficient and unseasonal rains this year could lead to lack of private rural demand. The upcoming general and multiple state elections could result in a diversion of policy attention, resulting in slowdown in clearances and code of conduct barriers may kick in, resulting in projects being postponed. But on the other hand, pre-election and campaign spending may give a boost.

The capex of the past year or two will probably result in over-supply. By some calculations, while demand will rise by 80-90 million tonnes per annum (MTPA) over the 2022-23 financial year (FY23)-FY26, the supply will increase by 130 MTPA.

However, in the near to medium term, major players also have inventory of fuel and raw material at lower costs, and recent price hikes in the eastern and southern regions, suggest that pockets of demand are resilient.

Operating costs -- such as imported coal prices and petroleum coke (petcoke) prices -- have increased by double digits in the last 3-4 months, though, both coal and petcoke prices are still lower on a year-on-year (Y-o-Y) basis. Costs will probably be higher by the fourth quarter (Q4) of FY24 if the current trends continue. It remains to be seen if the price hikes can be sustained since the industry may be betting on a festive pickup that may or may not meet expectations. Cement volume offtake is estimated to be up 7 per cent Y-o-Y in July, 23 and is likely to be higher by 10-12 per cent Y-o-Y in August, 23.

Most industry observers remain positive on the sector dynamics due to the likelihood of sustaining demand, given the government push towards infrastructure development and hopes of increasing demand in housing. Further industry consolidation is likely, which will favour the majors.

The industry has been looking at options like building green power capacity via waste heat recovery systems, and solar, raising the share and quantum of alternative fuels and raw materials and focusing on branding and premiumisation.

Nevertheless, valuations are high because there’s been so much optimism about the growth prospects. Investors are likely to turn more selective going forward. Size will matter. Pan-Indian footprints will too. Low leverage and healthy balance sheets may be a key factor since capex across the industry may push up debt-to-equity ratio and that may be a differentiator when it comes to consolidation. Most analysts continue to like UltraTech since it ticks all the above boxes.

Nuvoco Vistas also receives some recommendations on the basis of its large eastern presence since it should be the beneficiary of the recent price hikes there.

ACC also has some ‘buy’ calls on valuations being below the averaged EV/Ebitda (Enterprise Value/Earnings before interest, taxes, depreciation, and amortization) discount it has sustained in the last five years.