Want to bet on cement stocks? Here’s what to expect for the industry

The Indian cement industry, which posted a high single-digit growth in the twelve months ended March 31, 2022, is expected to post another year of solid demand boosted by government expenditure even though higher input costs could chip away some of the margins.

The cement industry saw demand growing to around 350 million tonnes in FY22. This is likely to climb another 7-8% in the current financial year, beating the five-year CAGR of around 5%, according to Fitch-affiliated India Ratings and Research (Ind-Ra).

“Growth is likely to be led by the government’s infrastructure spending (31% increase over the revised estimate for FY22) in capex spending to Rs 7.5 trillion), and a healthy rural and steadily reviving urban demand, which could cross pre-covid levels in FY23,” according to Ind-Ra.

“While the surge in commodity prices and disruptions in the global supply chain caused by the Russia-Ukraine can result in some deferral in private sector capex, government capex is unlikely to be dented,” it said.

The ratings agency said that by scaling up the capex to GDP ratio for FY22 to 2.6% as per the revised estimate from the budgeted 2.5% and budgeting the capex at 2.9% of GDP for FY23, the government has been showing its resolve to do the heavy lifting.

Meanwhile, the sector has seen a return of the capex cycle with expansion of around 120 million tonnes in the pipeline over FY22-FY24. Of this, the bulk is expected to be completed this year, a decadal high after three years of down cycle.

The capex would keep the capacity utilisation level around 65-67% this year, marginally higher than FY22 due to the higher demand, but at par with the pre-pandemic level.

Bottomline

While the demand picture is promising, things are not so great on the margin front. Given the rise in input costs, Ind-Ra expects cement companies to attempt price hikes in FY23 to prevent erosion of profits. The sector’s ability to sustain these hikes will be key to profitability in the year.

Profitability captured as EBITDA per tonne had hit an all-time high of Rs 1,350 a year ago, 10% higher than the average of FY21 and almost a third more than FY20 or the year right before the pandemic, due to strong realisations and low costs.

But this has changed significantly due to the surge in input costs with the Russia-Ukraine conflict. As the rise in price of coal is likely to be over what the cement producers can pass on to the consumers, margins will be under pressure in the near term.

If the situation improves in the second half of the current financial year, it may improve a tad but is still likely to be down by a third compared to the peak a year ago and around 10% lower than the estimated level of Rs 1,050 per tonne last year.

But these levels would still be much higher than the profitability in the five years preceding the pandemic.