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Strong volumes improve clinker utilization

Sales volumes to jump 10% YoY in 3QFY23E; traction remains healthy

* After an initial hiccup in demand during early 3QFY23; we believe cement demand recovered strongly over the quarter. We estimate 10% YoY volume growth in 3QFY23 (three-year CAGR at 5.4%), aided by strong infrastructure and real estate demand as well as the low base effect of last year (sales volumes dipped 2.6% YoY in 3QFY22). We expect 12% YoY volume growth for our coverage universe in 9MFY23 and estimate 4% YoY volume growth in 4Q, thus translating into a volume growth of 10% YoY for FY23.

* We believe that clinker utilization for our coverage companies has improved to 81% in 3QFY23; up 4.5pp YoY and 5.0pp QoQ. Clinker utilization in 4Q is estimated to be at 89.4%; largely in line with the utilization trend of 4QFY19 (90.7%) when the industry began to exhibit pricing power. Demand trend in early-Jan’23 has remained strong and hence, we do not see any major risks for our 4QFY23 volume growth assumptions (4Q historically is the best quarter for cement demand).

Cement prices should remain strong in 4QFY23E

* Our analysis indicates that improvement in 4QFY19 clinker utilization led to strong pricing power for the industry (pan-India average cement prices rose 11.7% QoQ in 1QFY20). We note that clinker utilization remained/to remain strong during 4Q of FY21-22/FY23E, respectively, (4QFY20 was hit by Covid-19 as restrictions were imposed in Mar’20). Over the last few years, we have seen better pricing power in Mar-Apr leading to improved realization during the AprJun quarter (1Q of FY20-23).

* Average pan-India cement price has improved 7.5% QoQ during 1Q of FY20-23. Though cement price remains volatile on different factors (monsoons, festive seasons, regional issues, etc.), our assumptions do not factor in aggressive price improvements in 4QFY23/FY24E. In fact, we have considered that benefits of any reduction in fuel costs will be passed on to the consumers and therefore, we assume a decline in FY24 cement price. We consider 1% QoQ improvement in price for our assumptions in 4QFY23.

Cost pressures appear to be subsiding

* Cement companies’ OPM witnessed a sharp contraction over the past one year due to elevated fuel prices (both petcoke and imported coal). OPM for our coverage universe was at a record low of ~10% in 3QFY23 mainly fueled by ~42% YoY increase in variable cost/t. Average EBITDA/t of our coverage universe, at INR657, was at a 35-quarter low in 2QFY23.

* However, fuel prices have started to cool-off and petcoke/imported coal prices corrected ~21-41% from their peaks. Recently, South African coal (Richard Bay spot price) has corrected ~27% MoM to USD180/t and imported petcoke price declined ~6% MoM to USD170/t. We believe energy cost peaked out in 2QFY23 and expect reduction in energy costs from 3QFY23 onwards (reduction of INR200/t over 3QFY23-1QFY24E based on current coal/petcoke prices).

* Further, Baltic Dry Index declined 24% to USD1,146 in the last one week (overall ~80% correction from the peak of USD5,600 levels seen in Oct’21) that should help reduce freight costs for imported coal/petcoke.

* Diesel price has remained stable during the past seven months despite crude oil correction of ~35% over this period (with recent correction of ~7%). Hence, we do not expect any increase in diesel price over the near-term.

Profits likely to improve; we remain positive but selective in our stock picks

* Our estimates factor in an average EBITDA/t improvement of INR200 each in 3Q/4QFY23 and further INR200 in FY24. Our average EBITDA/t assumption for the industry is similar to the FY20 levels when the industry had started witnessing better pricing power propelled by improved clinker utilization. In the current scenario, we do not foresee any risk of earnings downgrades for FY24E.

* We remain positive on the cement industry dynamics for the next few years given: a) better demand prospects, led by infrastructure and housing sectors, b) heightened industry consolidation, and 3) regulatory changes in the allotment of limestone blocks.

* UTCEM is our top pick in the largecap space. We prefer DALBHARA and JKCE in the midcap space.

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