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A subdued January thus far

Prices flat MoM, but expected to improve

Our channel checks indicate the demand momentum has slowed down in January on account of a) harsh winters, b) seasonal factors (such as harvest), and c) a rise in the cost of construction materials (such as steel, sand, and aggregates). Pan-India prices have thus been flat MoM (up 3% YoY), and a seasonal hike is yet to kick in. While we anticipate pricing to improve in the coming weeks as demand improves, we expect gains to be moderate over Jan–Mar this year at 1–2% QoQ (v/s 3-4% QoQ in earlier years). Cost inflation remains a concern in the near term as petcoke, coal, and diesel prices are up 57%, 10%, and 15% YoY, respectively. Given better fixed cost absorption in this quarter (on seasonally higher volumes), we expect industry EBITDA/t to remain strong at >INR1200/t (+15% YoY) in 4QFY21. We remain constructive on the sector and expect our Coverage Universe EBITDA to grow 37% YoY in 2HFY21. UltraTech is our top large-cap pick and Dalmia Bharat our top mid-cap pick.

Volumes growth slows in January, but expected to recover

* As per our checks, industry volume growth has slowed to the low single digits in January, from ~7% YoY in 3QFY21. While volumes are still growing at >10% YoY in East, they have slowed in North and Central and remain weak in South (down ~10% YoY).

* Demand in East has been particularly strong, supported by pre-election spending by the state governments in West Bengal and Assam. Odisha, on the other hand, has seen an uptick in industrial infra demand.

* Demand in West has been improving, led by recovery in urban real estate and construction workers returning to the sites.

* Demand in North and Central has been impacted by harsh winters and seasonal factors (such as harvest).

* Demand in South has been weak, but is expected to pick up on account of preelection spending in Kerala and Tamil Nadu. Demand from government projects has been stable in Andhra Pradesh, but is yet to pick up in Telangana.

South – price still up 17% YoY on strong production discipline

* The Cement industry in South has exhibited a strong production discipline in the past year in the face of weak volumes.

* Prices in South are up ~INR54/bag, or 17% YoY, to INR376/bag in Jan’21, led by hikes over Feb–May’20. Prices are up 36%/13%/13%/11% YoY in Andhra Pradesh / Tamil Nadu / Karnataka / Kerala.

* On a MoM basis, though, prices are down 2% due to decline seen toward the end of December. While price is down 3% MoM in Andhra Pradesh and Karnataka, it is flat in Tamil Nadu.

North and Central – softened demand and flattish price MoM

* In North and Central, an extreme winter and the harvest season have impacted demand, but it is expected to pick up from Feb’21. Rural demand has remained steady and should pick up further once the harvest season is over and workers return from the farms to construction sites.

* Prices in North are down 1% MoM (flat YoY) on 1% decline across regions – except for Rajasthan, which edged up 1% MoM.

* Prices in Central have also risen 1% MoM / 3% YoY to INR350/bag, led by marginal hikes in both Uttar Pradesh and Madhya Pradesh.

West – demand improving; prices flat MoM, but up 3% YoY

* Demand in West has been improving, led by recovery in urban real estate and construction workers returning to the sites. Maharashtra volumes are now nearly flat YoY v/s 10–15% YoY decline seen earlier. Demand in Gujarat has also been good, with volume growth of 5–10% YoY.

* In Jan’21, price is flat MoM / +4% YoY at INR340/bag in Mumbai, and it is up just 1% MoM / 1% YoY at INR350/bag in Ahmedabad. Price in West, on average, is flat MoM at INR345/bag (+3% YoY).

East – price recovering from December lows

* Demand in East has been the strongest among the regions – it has seen >10% YoY growth – supported by government spending (particularly in West Bengal, Assam, and Odisha) as well as strong rural demand.

* However, on account of aggressive expansions undertaken by various players, East has seen the weakest pricing among the regions in the past three years – current prices are the lowest in three years. The rest of the country, meanwhile, has seen an over 10% increase in prices in the past three years.

* Price in East has declined ~INR50/bag or 15% since May’20. However, it has recovered, coming in flat MoM (-9% YoY), on average, at INR275/bag in Jan, from the lows reported at end-December. Price in Bihar / Jharkhand / Odisha / West Bengal stands at -3%/-3%/+4%/+2% MoM.

Costs – higher energy cost to be offset by improved operating leverage

* Lower petcoke price has been a tailwind for the Cement sector. It aided decline (18% YoY) in power and fuel cost for five consecutive quarters up to 2QFY21. However, this is now set to reverse as petcoke price has risen substantially.

* Petcoke price is up 57% YoY to USD107/t in Jan’21. To mitigate the impact of higher petcoke price, cement producers increased the use of imported coal, but even this is now up 10% YoY in Jan’21 (and up 36% v/s Nov’20). We estimate power and fuel cost to increase by INR50–60/t QoQ (or 6–7%) in 3QFY21 and by another INR80–100/t QoQ (9–11%) in 4QFY21 – as low-cost inventory is exhausted.

* Diesel price is up 15% YoY in Jan’21 due to an increase in duties levied by the government, which would also cause marginal inflation in freight cost in 4QFY21.

* We thereby expect a total variable cost increase of INR100–120/t QoQ in 4QFY21; this should be neutralized by better fixed cost absorption in this quarter (owing to seasonally higher volumes). We thus expect industry EBITDA/t to remain strong at >INR1200/t (+15% YoY) in 4QFY21.

Top picks – UltraTech and Dalmia Bharat

* While we are structurally positive on the industry outlook, we prefer North and Central as these markets have a higher clinker utilization of over 80%.

* We adopt a bottom-up stock-picking approach and prefer companies that: a) are moving down the cost curve, b) have the potential to gain market share, and c) provide valuation comfort.

* UltraTech is our top large-cap pick, while Dalmia Bharat is our top mid-cap pick. We also like ACC as a value pick, but do not see much upside in Shree, Ramco, and Ambuja, whose potential market share gains are already priced in.

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