Cement sector likely to witness margin squeeze once inventories run out

Rising fuel costs amid geopolitical tensions may pressure cement sector margins, with the impact expected to intensify once existing inventories are exhausted

While analysts were positive on the cement sector going into March, the Iran conflict has led to fears of higher raw material costs and weaker demand due to sentiment being affected. March is usually a strong month for the sector, but there is caution due to the conflict.

 

Cement production is highly energy intensive and transportation is also a significant cost. Both are likely to be affected as coal and pet-coke prices are rising. Imported fuel costs are up, and given rising costs, producers may need to make price hikes, which can only be sustained if demand is strong. Cement spreads have declined in Q4 so far, compared to Q3FY26, as costs have compressed margins with average prices remaining flat. 

As of now, petcoke and coal are available (albeit at higher prices) and most companies have inventory, so price rise will translate into higher raw material costs only with a lag. Another potential concern is petrochemical, or petchem shortages, which may translate into shortages of packaging. Again, inventory with producers will probably mean this translates with a lag.

 

Spot fuel costs take 60-90 days to be fully reflected. Hence, if the conflict continues for an appreciable period, there could be rising costs through the next three months and beyond, as inventory is consumed. Moreover, Indonesia had indicated it could cut back on coal exports, which could push up coal and petcoke prices further.

 

Investors will have to take a call on whether this creates an opportunity if it leads to valuation downgrades across the industry. Timeframes would be uncertain, since it depends on conflict resolution and reintegration of supply chains after that.

 

On the demand side, as of now, analysts are witnessing strong rural demand and better pricing discipline from producers. Price hikes are likely soon, as producers seek to offset costs and maintain spreads, even as demand ramps up with the new fiscal.

 

Cement demand had improved in February, when prices were hiked by ₹5-10 per bag in the North, West and Central regions. In the East and South regions, non-trade prices rose by ₹15 per bag in early-February, but the hikes were later rolled back. March has been a washout in terms of hikes, even as geopolitics kicked in.

 

This is obviously a near-term risk. Crude, coal and freight rates are linked and may spike further. This has already impacted valuations in the cement sector. Value investors with deep pockets may find this situation attractive if they can hold for the long-term.

 

Crude oil prices have risen 39 per cent, global thermal coal by 14 per cent, and global pet coke by 18 per cent. The rupee has also depreciated, adding to inflation. Share prices of cement majors are down by 11-12 per cent as a result. H1FY27 is likely to continue being inflationary for cement, as inventories run out. The conditions may persist if the conflict lingers on. Demand during the monsoon season (usually Q2FY27) is always low, and that could be the bottom of the cycle with cement prices down, and raw material costs up.

 

At the onset of the Ukraine War in February 2022, there was sharp fuel inflation and cement suffered since it could not sustain price hikes to offset higher costs in Q2FY23. Valuation multiples also tend to be volatile in such situations, given uncertainty of timelines and fuel price spikes.

 

One way around for analysts may be to use enterprise value (EV) per tonne as an additional metric, along with price to earnings since EV/tonne gives an idea of long-term replacement costs. Sector dynamics like demand, cement price trends, among others, seem favourable with a long-term perspective.

 

But, the geopolitical tensions may take an indeterminate time to resolve, and costs will be elevated for that period and beyond, since a lot of infrastructure has been damaged. Demand, too, could be affected by sentiment. A value investor should probably wait for some clarity on these grounds. There could be a sharp rebound in valuations as and when the conflict ends, and fuel prices normalise.