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Not many cement mixing trucks are plying on the highways these days. The rotating drums that mix cement, sand, gravel and water to make concrete are lying idle — post the announcement of demonetisation by the Modi government. “Without sand and gravel, what’s the use of cement,” asks a Chennai-based cement dealer.

 

Demonetisation effect

The procurement of sand and gravel — where transactions are largely done on a cash basis — took a big hit last week on account of demonetisation. This, in turn, had repercussions for off-take of cement – which requires sand and gravel to produce concrete. Moreover, given the liquidity crunch faced by individual house builders — a large demand driver for cement — cement sales were down 40-80 per cent in the last 10 days.

 

While the fall in demand due to liquidity crunch is expected to recover from next January, there are concerns as to the long-term impact on cement demand from a crackdown on black money.

 

According to Ambit estimates, demonetisation could affect 15 per cent of the cement market — with volume growth reducing to 0-4 per cent between December 2016 and March 2017 and 5 per cent in FY ‘18. North and Central markets are expected to bear the maximum brunt, given the higher extent of cash-based transactions as compared to the South.

 

Market break-up

About 60-65 per cent of cement demand comes from individual housing — which is equally split between rural and urban markets. Rural demand, dependent on agriculture and allied activities, is expected to be unaffected by demonetisation (30 per cent). Another 25 per cent demand from infrastructure and industrial capex would also remain immune. So it is 30 per cent of urban and semi-urban housing demand as well as another 15 per cent demand from organised real estate — 45 per cent in all — which could be affected by the demonetisation move. While two-thirds of these transactions are currently in ‘white’, the remaining that accounts for 15 per cent of the overall demand is expected to be vulnerable to crackdown on black money.

 

With uncertainty looming large over the long-term impact of curbs on black money on the cement sector, investors have turned bearish. Cement stocks have fallen anywhere from 13 to 28 per cent in the last one month.

 

While the demonetisation could have a long-term impact on cement demand, its effect on the economic recovery is to delay it by 5-6 months, at worst, according to experts. So, those investing with expectation of a cyclical upturn in the sector still have reasons to stay put. Moreover, with some of the stocks shedding their flab, there are opportunities to buy stocks at reasonable valuations as compared to the past.

 

To zero-in on such companies, we analysed the cement businesses across five parameters — capacity utilisation, market lucrativeness, valuation, cost efficiencies and financial leveraging.

 

Companies with a cement production capacity of 10 million tonnes or more were considered for the analysis.

 

Capacity utilisation

Improvement in capacity utilisation is a good trigger for cement stocks since it contributes to profits at a rapid clip after recovery of fixed costs. Capacity utilisation of the cement industry is currently at 66 per cent — close to the lowest in the last decade. During the last boom witnessed in the cement industry, capacity utilisation had touched 94 per cent levels (2007).

 

Cement demand has a strong correlation to economic growth — with a 1 percentage growth in economy resulting in a 1.2 per cent growth in demand for cement. Since 2001, cement demand has grown at about 8 per cent annually.

 

However, the last four years have been an anomaly — when cement demand clocked average annual growth rates of only 4 per cent. With demonetisation playing spoilsport this year, both FY 17 and FY 18 could be bad.

 

However, over the years, industry players have added capacity at a rapid clip in anticipation of recovery in economic growth and upturn in the cement cycle. And the industry is now almost done with its capex. Over the next three financial years FY 17- FY 20, capacity addition would halve to about 33 million tonnes (mt) as against 70 mt added in the last three years.

 

At current capacity of 410 mt, about 138 mt are lying idle — half of which is in the southern market. While bigger players like UltraTech Cement, ACC and Ambuja Cement had capacity utilisation in the range of 73-77 per cent in 2015-16, it was lower (54-58 per cent) for some regional players like Ramco Cement and Dalmia Bharat.

 

In terms of potential improvement in capacity utilisation, ballpark estimates hint at Ambuja Cement and Shree Cement topping the charts among large players. UltraTech Cement, in contrast, was only 9 per cent away from its peak levels of 2007. Among regional players, Dalmia Bharat and JK Cement look attractive with further potential to improve capacity utilisation by 24 per cent and 19 per cent respectively. The JK group’s capacity utilisation had touched 90 per cent levels in 2007 as against 78 per cent for Dalmia Bharat. It needs to be noted that the regional footprint of players would have changed since 2007 and not strictly comparable.

 

In all, Ambuja Cement and Dalmia Bharat look to have greater potential to benefit from pick-up in capacity utilisation. Many regional players, including Dalmia Bharat, recently added capacities which, in turn, lowered their utilisation rates. They have further scope for improving capacity utilisation rates. On the other hand, JK Lakshmi Cement is already running at a higher capacity utilisation rate of 82 per cent — with relatively less headroom for further improvement.

Source:The Hindu Business Line