Cement (3QFY20 Review): Pricing and cost tailwinds to continue - HDFC Securities

In a new report released, we deep dive into operating performance of 19 listed cement companies to compile industry trends. These companies comprise ~75% of the Indian cement industry and hence largely reflect the industry trend. Our analysis suggests that despite subdued demand in the past three qtrs, industry's operating margin has scaled up to decade high. This is driven by strong pricing in the north/central/Gujarat markets, steady fall in pet-coke prices and low diesel prices. Cement prices have increased QoQ in 4QFY20, aided by demand recovery. Further, as fuel prices continue to fall and diesel price remains stable, margin tailwinds appear sustainable for the industry. In our view, cement companies with large sales exposure to north / central / Gujarat markets should gain the most.

Subdued demand across India moderated NSR gains: During 3QFY20, cement demand remained flat YoY (for the 3rd consecutive qtr) owing to a high base and demand slow down. This also pulled down utilisations YoY. Amid weak demand, the YoY NSR growth intensity moderated in 3Q (from 10% in 1QFY20 to 3% in 3Q).

Divergent pricing trends: Strong utilisation in the north/central markets (NCG) has kept cement prices robust in these mkts vs those in the south/east/Maha markets (SEM). During 3Q, while cement prices in NCG markets were up 8% YoY, it declined 5% YoY in SEM markets! Even during 9MFY20, prices in the NCG region rose 10% YoY vs a modest 1% rise in SEM region. In our view, demand contraction in the southern region in FY20 and heightened competition in the eastern region has been driving this sharp divergence in realization trends.

Opex decline continued in 3Q on falling energy costs: The cement industry is also benefitting from continued fall in petcoke and diesel prices during 2019. This has reduced input and freight costs for the industry. Thus, despite slight rise in unitary fixed costs (on lower utilisation), unitary opex fell YoY, boosting margins.

Industry's margin at decade high; NCG outpaced SEM in 2019: As the industry continues to benefit from both higher realizations and opex moderation, industry's op margin has firmed up to its decade high (TTM basis) of ~Rs 1,000/MT. Interestingly, in 2019, NCG exposed companies' avg op margin surged ahead of SEM cos' margin by ~Rs 200/MT as compared to historical declining trend (During FY11-19, NCG's op margin lagged SEM's by ~Rs 160/MT on an avg).

Demand recovery to keep realization buoyant: Cement demand has been improving QoQ in 4QFY20, thereby supporting cement prices rise over the past two months. Again, the pricing gain remains stronger in the NCG region owing to high regional utilisation. In the SEM region, pricing recovery will remain volatile on account of low regional utilisation and aggressive competition. Hence, demand uptick is going to be a key driver for stable pricing in the region. As per our recent channel checks, we estimate avg cement prices in NCG to rise 3% YoY in 4QFY20. However, despite price recovery in the SEM region QoQ, we estimate cement prices to be 4% lower YoY.

Cost tailwinds also continue: Petcoke prices continue to decline in 2HFY20. Even imported thermal coal prices remain lower YoY, despite recovery in past two quarters. Thus, we expect industry's input costs will further cool of in FY21E, and keep industry's margin buoyant.

Source : Equity Bulls

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