After returning an average of only 6% between Q2FY17 and Q2FY20 to the investors, the top seven listed cement companies in India generated an average price return of 23% for the two years ending September 30, 2021. A basic sketch for these listed companies is given below:

Reasonable valuations in the sector

The PEG ratio of the top seven players based on one year trailing twelve months’ (TTM) earnings growth and market cap as on the respective result dates is 0.85, signifying attractiveness of current valuations. The relevant PE ratio is 29.65X and TTM growth is 35%.  Dalmia Bharat is particularly trading at reasonable valuations considering its aggressive expansion plan. However, the key concern here is the sustenance of growth given cost concerns.

On the road to recovery post Covid-19

The announcement of a 34.5% increase in government capital expenditure to Rs 5.54 lakh crore in the 2021 budget session renewed investors' interest in this sector. Further, schemes such as National Infrastructure Pipeline (FY19-25) and Pradhan Mantri Awas Yojana (PMAY) gave a boost to the cement demand from Q2FY21 and onwards.

The re-rating of the sector also occurred on the back of a swift recovery in earnings reported for Q3FY21 and Q4FY21. Earnings rebound occurred due to a strong revival in construction activities boosting the cement players’ volumes, and price hikes taken by the companies. Around the same time, top cement players made serious attempts to reduce their debt load and now have leaner balance sheets. Industry leader UltraTech Cement reduced its net debt by 45% to Rs 6,717 crore between September 2020 and March 2021. Another key player, Dalmia Bharat reduced its leverage by 37% to Rs 2,710 crore in FY21. However, Shree Cements raised additional debt of Rs 473 crores between H1FY21 and H1FY22.

The going was good in Q1FY22 as well with the top 7 players reporting 97% YoY growth in aggregate net profits on the back of robust sales volume growth and low base effect. However, these cement companies reported a sharp spike in power, fuel and freight costs on a YoY basis on the back of rise in coal, pet coke and diesel prices. The impact of commodity price inflation globally was more visible than ever in the financial results for Q2FY22.

Profitability in Q2FY22 takes a beating despite volume rise

Second quarter of the financial year is traditionally a weak one for the cement industry owing to the monsoons. However, the cement players still managed to report a decent volume growth in the quarter with UltraTech Cement, JK Cement and The Ramco Cements reporting YoY growth of 13%, 18% and 23%, respectively. Infrastructure segment particularly propelled the sector’s sales growth in Q2 even as the housing segment was lackluster due to heavy rains in northern and eastern regions of India.

The major dampener for cement players in this quarter was high energy costs. The rating agency ICRA said coal prices rose by over 100% YoY, pet coke prices rose by over 80% YoY and diesel prices rose by 20% YoY in H1FY22 as against H1FY21. Shree Cements and Dalmia Bharat saw the highest jump in their power and fuel costs, while JK Cement witnessed only a 5% rise. For JK Cement, the share of green (based on renewable sources of energy) power in its overall power mix stands at 27% which it intends to scale up to 75% by 2030. 

Cement prices softened pan-India with the onset of monsoons in July 2021 and fell by nearly 6% to Rs 354 per 50kg bag between June 21 and September 21 according to a report by Kotak Securities. As a result, four out of seven companies in consideration reported a YoY fall in their realisations/tonne metric with the average growth being a dismal 2.4% for the top seven players.

Cost pressures and subdued realisations ultimately led to erosion of EBITDA margins for six out of seven companies with each of them seeing margins dip by 200 bps. The fall in margins was particularly pronounced for JK Cement and Ramco Cements. JK Cement witnessed an 8%+ fall in margins owing to 10% rise in freight cost, 12% rise in raw material cost and 23% rise in other expenses despite a slight spike in power cost. In this scenario, ACC still managed to grow its margins by 30 bps, and EBITDA/tonne by 1.2% on the back of its cost optimisation project ‘Parvat’ launched back in 2019.

Amid the gloom of Q2 results, there are positive signals from the industry on expected demand revival in H2FY22 and rebound in average cement prices. 

Favourable demand outlook in H2FY22 

Analysts estimate that the all-India average cement prices rose by 7-8% in October 2021 MoM and YoY to Rs 384-386 per 50 kg. This bodes well for the realisations of the cement players reeling under cost pressures. 

However, there is one negative piece of news on this front. As per brokerages, cement companies rolled back price hikes to the tune of Rs 10-20 per bag of the announced price hikes of Rs 35-50 per bag in November 2021. It remains to be seen how cement bag prices evolve post November given the demand outlook.

On the sales front, players like Dalmia Bharat and JK Cement expect demand to grow over 10% in H2FY22 on the back of a ramp up in infrastructure spending by the government. It is crucial for cement companies to achieve high sales volume growth in H2 to avoid significant margin erosion. 

Robust demand outlook beyond FY22

The rating agency CRISIL expects housing and infrastructure segments to create an incremental cement demand of 70 million tonnes (MT) over the next 3 years. Accordingly, cement players will be adding production capacity of 80 MT by 2024. In this context, the capex plans of top seven cement players make for an interesting read.

UltraTech Cement and Dalmia Bharat announced major capacity additions by the end of H1FY22. UltraTech and Dalmia plan to invest Rs 5,477 crore and Rs 9,000 crore on their capex plans, respectively. Brokerages expect their net debt to be at reasonable levels despite the planned expansions. 

Although Q2FY22 results disappointed the street in general, the medium-term outlook for the sector remains intact. Morgan Stanley believes that the industry is beginning a new cycle, and has recommended playing the longer-term cycle rather than focusing on near-term cement price movements.