By Aakash Athawasya

Economic activity is recovering fast, and one indicator of that is cement demand. Right at the center of this demand rush is India’s biggest cement maker, UltraTech Cement (UltraTech). The Aditya Birla Group company had a quiet first half of FY22 as construction activities were disrupted due to the second Covid-19 wave, labour shortages, and heavy monsoon showers. These demand deterrents will reduce in H2FY22 and construction activity will pick up.

Fuel prices are still high, affecting the production and transportation of cement. In order to reduce margin pressures, UltraTech hiked prices four times in FY22 so far. Will the price hikes and higher demand make up for the rising input costs?

Revenue improves due to higher volumes, margins decline

In Q1FY22, the cement maker’s revenues were Rs 12,156 crore, a 16% rise YoY on the back of an 8% growth in cement production volumes. However, revenues improved by just 1% compared to the second wave fraught Q1YF22. 

Revenues only marginally improved in Q2 due to heavy monsoon rains across much of the eastern and central states affecting construction activities. Net profits were Rs 1,310 crore, a 6% growth YoY, but lower by 23% sequentially due to rising fuel costs.

The main concern for UltraTech, and the cement industry, is falling EBITDA margins. Margins have been falling since Q3FY21 due to rising input costs mainly power fuel (coal and pet coke) and freight fuel (petrol and diesel). UltraTech’s Q2 margins were 23.5%, lower by 3.5 percentage points fall YoY.

Fuel costs moderation expected, and price hikes to continue

Over the past few quarters, cement companies switched production fuels to coal from petroleum coke (or petcoke) due to rising petcoke prices. But coal spot prices nearly doubled in Q2FY22 to $230 (Rs 17,900) per tonne which resulted in lower margins for cement makers.

UltraTech’s Q2FY22 power and fuel costs were Rs 5,193 crore, a 25% growth YoY. However, fuel costs rose by just 4% QoQ, despite a two fold increase in the price of its most used fuel source, coal. This was because the company had used coal inventory from earlier quarters which it procured at an average cost of $120-130.

For every $10 (Rs 750) increase in the price of coal per tonne, cement companies’ costs go up by Rs 50 per bag. In order to pass on rising fuel prices, the cement industry collectively hiked prices thrice in 2021 — March, May, and June. This was varied across regions as cement companies in the east, 17% of UltraTech’s domestic market, raised prices the most while companies in the north raised prices the least. During the Q2FY22 earnings call, UltraTech’s management said it hiked prices again in the first week of October. 

In total, UltraTech hiked prices by Rs 40-50 per bag across regions in 2021 to make up for a near $20-30 increase in coal prices. This is why its margins declined for the past two quarters.

While the company expects a $10-20 increase in coal prices in Q3FY22, margins will not be impacted. UltraTech may look to hike prices again in Q3 as demand has not waned following the earlier price hikes. In fact, the management said, buyers expected higher cement prices in Q2FY22.

After UltraTech’s Q2FY22 earnings call, China, the largest supplier of coal in the world, said it will increase coal supply. This is expected to reduce coal prices for domestic cement makers as a majority of companies have shifted to imported coal as the primary fuel source. As of Q1FY22, 60% of UltraTech’s primary fuel was imported coal, up from 10% of total fuel in Q1FY21.

With these two catalysts in place — price hikes and cheaper imported coal, brokerages expect the company’s margins to improve in H2FY22. The management guided for EBITDA margins of 26-28% in the next two quarters. This seems like a tall order considering margins were 23.5% in Q2FY22. However, with cement demand improving, this guidance could be achieved.

Higher cement demand from realty and infrastructure companies

In Q1FY22 and in Q2FY22, cement demand waned due to lower infrastructure and realty activities. This was because of raw material supply chain disruptions, labour shortages, and delayed government payments impacting project execution. Just when construction activity was picking up in September, unusually high monsoon rains in certain parts of the country delayed construction activity further. This impacted housing and infrastructure activities (90% of cement demand). 

As the monsoon rains will cease by mid-November, the cement maker’s management expects construction activities to pick up. This will coincide with a resumption in infrastructure activities as part of the center’s Rs 5.5 lakh crore allocation for capital expenditure for roads, highways, metro, and irrigation projects under Budget 2021. The Ministry of Road Transport and Highways (MORTH) expects to construct 40 kilometers of roads and highways per day, higher than the 37 kilometers per day mark set in Q4FY21.

Expecting demand to improve in H2FY22, UltraTech guided for an 8% YoY growth in volumes to 54 million tonnes (MT). Brokerages are more enthusiastic and expect the country’s largest cement maker’s volumes to grow by nearly 14% YoY if there is no disruption in demand due to a possible third wave.

An early sign that demand momentum is rising is UltraTech’s trade mix. A cement company’s trade mix is the division between cement sold in the trade (realty and infrastructure companies) and non-trade (individual home builders) segment. In Q2FY22, UltraTech’s trade mix was 67% to the trade sector and the rest to the non-trade sector. The management said this is on par with the Q4FY21 levels, indicating rising demand momentum from the real estate and infrastructure sectors.

Big capacity expansion planned

UltraTech has an annual cement capacity of 112.5 million tonnes per annum (mtpa). This is 22% of India’s total cement capacity, making UltraTech the largest cement producer in the country and the third largest in the world, excluding China. UltraTech is looking to increase its capacity by 17% to 132.4 mtpa by FY23.

In October 2021, the cement maker commissioned two plants in Bihar and West Bengal, respectively with an annual capacity of 1.2 mtpa. The company expects this added capacity will allow it to gain a stronghold in the eastern states, a market where it competes with listed companies like Birla Corporation, Shree Cements, and Dalmia Bharat. Another plant in Uttar Pradesh with a capacity of 2 mtpa will be operational by Q4FY22. 

The estimated capital expenditure that the company will take on for these projects is Rs 6,800 crore between FY 22-23. This is expected to lower the cement maker’s cash flows for the year according to brokerages.

The management expects its capacity target of 132.5 mtpa to be achieved by FY23. Cement makers expect FY23-24 to be a big year for construction activities due to the number of state elections in 2022-2023 and the general elections scheduled for May 2024.

UltraTech’s total debt at the end of Q2FY22 was Rs 11,100 crore. In FY22 so far, it paid back debt worth Rs 400 crore. With the cash it has on its books, the company’s net debt is Rs 6,400 crore. This is a 74% reduction from net debt levels of Rs 25,000 crore two years ago. Even with lower debt levels, the company will fund its current capex through internal accruals rather than debt. Brokerages expect the company to pay back debt worth Rs 4,000-5,000 crore by FY23.

The largest cement maker not only expects higher demand but with price hikes in place, improving margins as well. This will be key in ensuring its profits improve after two quarters of sequential decrease in profitability. 

UltraTech will also ensure it does not take on too much debt in the coming quarters as it has big capacity expansion plans. It’s clear cement makers are looking ahead to FY23 as the key year for cement demand, but UltraTech for one is expecting a good second half of FY22.