Prices remain subdued, may rise in third quarter

The all-India cement prices declined by Rs 2 per bag to Rs 326 per bag in October as per our channel checks. Prices declined in east, south and north by Rs 3-5 per bag during the month but increased marginally in central, western regions. We expect cost to rise yet again in the third quarter of FY19 due to weakening the rupee-dollar rate and firm pet-coke prices.

Efficiencies in logistics costs led by increase in the axle-load limit may aid costs in a few regions but will be partially offset by higher diesel costs. We maintain our cautious stance on the sector on expensive valuations. Cost pressures continue to rise for cement companies – spot rupee-dollar rate is down 5 per cent compared with the second quarter of FY19 rate of Rs 70.1 per dollar – this will hurt costs of cement companies (though with a lag) given close to 35 per cent of the costs are at parity to the dollar, as per our estimates.

Imported pet-coke prices have remained firm at $122 per tonne in October. We note that Indian refineries set their ex-works prices on import parity and these prices are set to rise soon if import prices remain firm. So far, in October domestic pet-coke prices increased by 3 per cent to Rs 9,450 per tonne and are lower than import parity.

As per the DIPP data, industry volumes increased by 14 per cent year-on-year in August to 25.7 million tonnes, but on a low base – we note that demand growth in August 2017 was merely 1 per cent. The two-year volume CAGR works out to 7 per cent for August 2018. We believe the low base will continue to aid demand growth for September-October as well – cumulative demand for these three months was down 1 per cent year-on-year last year.

We note that as per company narratives, the improvement in demand in the last few months is mostly led by pick up in infrastructure activity from increased government spending.

We maintain our cautious stance on the cement sector on expensive valuations and on expectations of moderate improvement in earnings over the next two years. Cost headwinds necessitate a sharp improvement in industry utilisations for meaningful earnings improvement.

However, we believe large capacity addition will keep industry utilisations low (below 70 per cent). Despite the recent correction in stock prices, valuation of largecap cement names is expensive at 11-16X FY2019E EV/Ebitda.