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COVID-19 to have significant near-term volume impact
March volumes to decline 35-40%, April to be a washout
We hosted a conference call with cement dealers from the east (Kolkata, WB), central (Kanpur, MP) and west (Mumbai, Maharashtra) regions to gauge the impact of shutdowns after the outbreak of COVID-19. Key highlights:
* Demand robust before lockdown: Demand was robust before the lockdown was implemented. Volumes had been growing at 10-12% YoY in east and 4-5% YoY in the west and central regions.
* Scenario post 21st Mar’20: Cement dispatches stopped completely post 21st Mar’20 and all major cement plants are shut now. Moreover, all construction sites have stopped work completely according to the Home Ministry guidelines.
* Volume loss from lockdown to be ~40% in March and >60% in April: The shutdown has come at a time of peak construction activity and would likely result in nearly 40% volume loss in March. Once the lockdown in over (currently 15th April), dealers expect it would take another 10-15 days before construction activity normalises as most of the migrant labor force has gone back to their hometowns. For companies as well, it would take 2-3 days to fully ramp up the plant post restart. Volumes in April would thus be minimal (down >60%). Normal volumes are thus likely only from May, assuming lockdown gets over as scheduled. Volumes lost during the lockdown period can’t be recouped.
* 4QFY20 volume may thus decline 8-10% YoY (as against ~2% decline in 9MFY20).
* Inventory in system: Dealers are holding only 3-4 days of inventory. Some stocktransfer inventories are stuck outside state borders as movement of goods has stopped suddenly. Companies would also be holding some inventories in plants and warehouses. Since cement has a shelf life of 2-3 months, there should not be any loss from the same for both dealers and companies. Impact on working capital:
* Non-trade/institutional: Except the Mumbai market, non-trade sales are billed in companies’ books but these are generally backed by secured letters of credit (LC) from the customers and hence should be settled in a timely manner.
* Trade: Dealers generally provide unsecured credit to customers in this segment which generally makes up for 60% of volumes. While 70% of the customers who buy on credit make payment within 3-5 days to avail cash discount, others avail full credit period of 30 days. Once the lockdown is lifted, dealers may have to extend additional credit of 10-15 days to customers for making payment, thereby increasing working capital.
* Dealer incentives: In order to give relief to dealers, companies have communicated that they would consider the sales made till 21st March on a pro-rata basis to calculate the monthly incentives.
* Pricing: Cement prices have been buoyant this quarter with all-India average price up by INR13/bag QoQ in 4QFY20 (+3.5% QoQ and +5% YoY) which bodes well for margins. Region-wise average QoQ price hikes in 4QFY20:
* East: INR20/bag, +6% QoQ, +5% YoY
* North: INR15/bag, +4% QoQ, +16% YoY
* South: INR3/bag, +1% QoQ, -4% YoY
* West: INR13/bag, +4% QoQ, +4% YoY
* Central: INR9/bag, +3% QoQ, +9% YoY
* Government measures necessary to boost demand post normalisation: (a) Release funds immediately to construction projects to revive liquidity. (b) Shorten payment cycles to contractors.
* Relief measures sought by dealers: Given increased working capital and no revenue currently, dealers have sought relief from bankers toward interest payment, credit limits etc. Moreover, while cash inflows have stopped, fixed costs shall continue to be incurred by dealers on account of rent and staff salaries, creating a further liquidity stress.
Valuation and view
* We expect cement sector utilization to improve structurally over the next three years given limited capacity addition at ~4% CAGR. As against that, we expect demand CAGR to sustain at 6% – in line with past five years.
* We believe that the north and central India markets are best placed structurally as they have achieved a high level of consolidation with utilization at ~85% already. Prices in these regions should continue to fare better.
* We prefer companies that (a) have an ability to gain market share, (b) are moving down the cost curve and (c) provide valuation comfort. Therefore, UltraTech is our top large-cap and JK Cement our top mid-cap pick. We also like ACC as a value pick.
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