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Earnings woes continue; stock correction factors in concerns

Higher costs will impact earnings in 1HFY23

* Earnings for UTCEM as well as the Cement sector is expected to remain under pressure in 1HFY23 and lower than our earlier estimate due to: 1) sustained cost pressures (we expect a INR300-350/t increase in energy costs in 1HFY23), 2) recent decline in Cement prices, which came under pressure in Jun’22, 3) lower than our estimated growth in Cement demand in 1QFY23, and 4) tendency to increase capacities by different players (UTCEM and SRCM recently announced capacity expansions).

* Earnings recovery for UTCEM in FY21 and 1HY22 was driven by fixed cost controls as well as a better pricing scenario. Improvement in the pricing scenario in FY20/FY21 was led by lower industry clinker capacity additions over FY16-22 (a CAGR of 2.9% v/s 7.7% CAGR over FY10-16). Going forward, clinker capacity addition is estimated to be at 5% CAGR till FY25E, with higher capacities expected in Central and East India. This may put pressure on pricing power and profitability for the industry.

* Apart from the announced capacity additions, few other players may tend to announce new capacities. We understand through media articles that the Adani group, the new entrant (after the acquisition of Holcim’s stake in ACC/ACEM gets completed) in the industry, aims at achieving a capacity of 140mtpa over the next five years (v/s its current capacity of 68mtpa).

UTCEM is expanding capacities by 38.9mtpa by FY25E

* UTCEM recently announced a capacity addition of 22.6mtpa at a capex of INR128.9b. Capex/t for this expansion works out to USD76. Though the company has not specified any locations for these expansions, we expect the clinker plants to be set up across regions, except the western region. ? This expansion excludes the ongoing grinding capacity expansion of 16.3mtpa spread across regions, except South India. Completion of these expansion plans will help UTCEM to achieve domestic Gray Cement production capacity of 153.5mtpa (overseas capacity of 5.4mtpa).

* UTCEM in its Nov’19 corporate presentation had mentioned it had proven capabilities for organic growth of 51mtpa (it had capacities of 117.4mtpa at that time, including 4mtpa under commissioning in Central India) and inorganic growth of 66mtpa. Between FY16 and FY22, it added 84% of its capacities through the inorganic route.

* We believe that the Adani group’s intention to achieve 140mtpa capacities over the next five years is banking on inorganic growth opportunities, indicating increased competition for any possible acquisition opportunity in the industry.

* We have factored in volume growth of 8%/9% for UTCEM in FY23/FY24 v/s our industry volume growth expectation of ~8%. We have trimmed our industry volume growth estimate for FY23 to ~8% from ~9%.

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