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Demand weak, but prices and margins strong

Cement spreads highest since June’20

Demand has been impacted severely by the lockdowns, and our checks indicate a 40–60% decline in demand across regions in May (v/s 20–30% decline in April). Unlike last year, trade demand this time around has been more adversely impacted and is down 60–70% (vis-à-vis 30–40% for non-trade). While we expect demand to improve in June as the lockdowns ease gradually, 1QFY22 should still see 30–35% QoQ decline in volumes (still up 10–15% YoY on a low base due to the lockdowns implemented last year).

Pricing, however, has held up well across regions and the industry average price is flat MoM in May and up 6% QoQ in 1QFY22 – led by sharp hikes in East, South, and Maharashtra. Therefore, we do not expect margins to be impacted despite the sharp commodity cost inflation – petcoke, coal, and diesel prices are up 106%, 82%, and 37% YoY, respectively. In spite of cost inflation, cement spreads (as per our model) are the highest since June’20. This should drive healthy EBITDA in 1QFY22 despite lower volumes.

While we maintain our expectation of 10% volume growth in FY22 (on the low base of FY21), any extended lockdown is a key monitorable risk. We remain structurally positive on the sector and expect demand to recover strongly once the lockdowns ease up. We expect a 10% volume CAGR over FY21–23E, which should improve industry clinker utilization to >80% (and >85% in North and Central). UltraTech remains our top pick among the large-caps, and Dalmia Bharat and JK Cement among the mid-caps.

Volumes down 40–60% across regions in May

* The second wave of COVID-19 infections in India has dampened the demand momentum. The strong uptick seen in 4QFY21 in urban real estate and infrastructure activity, coupled with strong rural demand, has been impacted by a fresh set of restrictions and the reverse migration of labor.

* Demand has declined 40–60% across regions in May (v/s 20–30% decline in April). Unlike last year, trade demand this time around has been more adversely impacted and is down 60–70% (against 30–40% for non-trade).

* Demand has been most impacted in North (due to the reverse migration of labor) and is down ~60% v/s 40–50% decline in other regions.

* Moreover, cyclones Tauktae and Yaas in West and East India, respectively, have led to the loss of 2–3 working days and further impacted volumes in May.

* While we expect demand to improve in June (as lockdowns ease gradually), 1QFY22 should still see 30–35% QoQ decline in volumes (still up 10–15% YoY on a low base due to the lockdowns implemented last year).

East – prices see sharp recovery, up 15% QoQ

* Demand in East was strong up to April and has only weakened in May due to the lockdowns and impact of cyclone Yaas. Demand is down ~40% in East.

* Price in East has recovered sharply from the four-year lows of Jan’21 and is up 15% QoQ (INR45/bag), on average, in 1QFY22. An INR40–45/bag QoQ hike was seen across the eastern states.

* After rising sharply in March and April, prices have been stable in May at INR328/bag (down just 1% MoM). Even Chhattisgarh has breached INR300/bag in May – the highest ever price in the state.

* However, prices in East have been volatile for the last three years; therefore, the sustainability of current prices holds the key. Expansions from various players are expected to continue in East for the next two years. This could lead to some rollback in prices due to the higher competitive intensity.

South – production discipline keeps prices strong, up 9% QoQ

* Demand in South had picked up well in 4QFY21, led by a strong uptick in Andhra Pradesh and Telangana. However, with the lockdowns and restrictions, all of the states in South are seeing 40–50% demand decline.

* The Cement industry in South has exhibited a strong production discipline in the face of weak volumes, and prices are up 9% QoQ (INR35/bag), on average, in 1QFY22.

* Price has continued to rise in May and is up 4% MoM to INR420/bag. It is up 6%/6%/2%/2% MoM in Andhra Pradesh / Karnataka / Tamil Nadu / Kerala.

West – prices rise in Maharashtra, remain stable in Gujarat

* Demand in West (an urbanized market) improved substantially in 4QFY21. However, the second wave of COVID-19 infections has triggered the reverse migration of labor, thereby slowing construction activity.

* In line with strong pricing in South, price in Maharashtra (which is largely supplied from South-based capacities) also improved substantially in March and April and is up 9% QoQ in 1QFY22. Price in May is flat MoM at INR385/bag.

* Gujarat, on the other hand, has a strong inter-regional flow of material with North; hence, price has been stable (in line with that of North), with average price up just 1% QoQ to INR360/bag in 1QFY22.

* Price in West, on average, is up 5% QoQ / flat MoM to INR373/bag.

North/Central – weak demand, but stable prices

* Demand has been most impacted in North (due to the reverse migration of labor) and is down ~60%, v/s 40–50% decline in other regions

* Central is also seeing sharp demand decline due to high positivity rates and widespread lockdowns.

* Trade prices have been stable in North/Central (flat QoQ /+1.5% QoQ). However, prices in May have risen 3% MoM in North to INR377/bag, while they are flat MoM in Central at INR345/bag.

* Non-trade prices have, however, declined by INR20–30/bag across North and Central. This has once again increased the gap with trade prices to INR60– 70/bag (v/s INR40–50/bag in 4QFY21)

Costs – remains elevated, but passed onto consumers

* Energy prices (petcoke, coal, and diesel) have risen substantially in the last six months. On a QoQ basis, we estimate INR100–150/t of variable cost inflation in 1QFY22, largely from power and fuel and freight costs.

* Petcoke price is up 106% YoY to USD128/t on both lower refinery runs and higher sea freight. Thermal coal price is also up 82% YoY to ~USD100/t. While low-cost inventory and the shift to coal (from petcoke) helped the industry curb power and fuel cost inflation in 4QFY21, we estimate this to rise by INR100– 120/t QoQ (10-12%) in 1QFY22.

* Diesel price is also up 37% YoY in May’21, driven by higher crude price and an increase in government duties post the pandemic. We estimate freight cost to rise by ~INR30/t QoQ (3%) in 1QFY22.

* However, with the strong price hikes seen in March and April, we estimate that the industry has fully passed on the cost inflation to customers.

* We estimate cement spreads (price – power & fuel cost – freight cost) for trade sales to be the highest currently at INR3,596/t since Jun’20 (flat YoY).

Top picks – UltraTech, Dalmia Bharat, and JK Cement

* While we are structurally positive on the industry outlook, we prefer North and Central as these markets have a stronger utilization outlook (>85% by Mar’23).

* 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, and Dalmia Bharat and JK Cement our top mid-cap picks. 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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