Pricing power is crucial in the commodity business, and the Indian cement sector is certainly losing the plot on that front, says ICICI Securities in its latest equity research report.
Despite robust demand and a significant increase in industry clinker utilization to a healthy 77% (89% ex-South) in FY23E, the competitive intensity in different regions has prevented companies from hiking their prices.
In Q4FY23, the prices have slipped by approximately 1% QoQ, despite a surge of about 10% YoY in peak-season volume.
Additionally, the industry's inability to pass on the unprecedented fuel cost surge in H1FY23 was a glaring instance of weak pricing power, it said.
Pricing power: abnormal we stand, normal we fall
The cement industry has displayed a trend of maintaining price stability during difficult times, such as the demand weakness observed in FY20 or the COVID-19 pandemic in Q1FY21 and Q1FY22. However, once the situation starts to improve, cement prices tend to decline.
The brokerage analysis revealed that on an annualized basis since FY11, the industry has only been successful in achieving margin-enhancing price hikes during FY20–FY22 (each of which was an abnormal year).
Tough ride
For cement promoters, "margin loss is temporary while loss of market or capacity share is permanent." The cement industry in south India is a pointed example, as it continues to see capacity additions despite a huge surplus, said the brokerage firm.
In the face of concerns around the group’s finances, Adani Cement’s recent claim to pursue capacity additions at a CAGR of 16–17% until FY28 may stoke a race to maintain capacity share.
Also, the company’s claim of Rs. 300–400 per metric tonne of potential cost-saving edge, which is equivalent to Rs. 20–26 per bag, may keep the competitive intensity high. However, the majority of the players in the industry have a strong balance sheet, which gives them the ammunition to sustain the fight for market share, it noted.
Can the drop in fuel prices translate into margin gains for companies?
ICICI Securities stated that the continuous and gradual reduction in the cost of global fuel, particularly in imported coal and pet coke since the second half of FY23, will assist in further cost-cutting.
However, the brokerage firm observed that increased competitive intensity throughout FY23 has led to an inability to transfer the burden of the fuel cost surge.
Additionally, the weak exit to March 2023 and muted pricing action so far in FY24 do not provide much comfort for substantial margin expansion, it added.
Outlook and valuation
Cement demand is estimated to have grown 10% in FY23E and, despite the high base, the momentum may sustain in FY24 (pre-election year).
The brokerage, however, highlights that lessons from the past (where demand in FY19 rose by 13% but margins declined by over 100 basis points YoY) and the competitive intensity of the industry indicate a potential downside risk to consensus earnings.
With the overhang of aggressive capacity expansion by Adani Cement, the brokerage sees little merit in arguing for any upside revision to the existing rich valuation multiples.
Therefore, it reinitiates coverage on UltraTech Cement, ACC, and Ambuja Cement with a 'Hold' rating; Shree Cement with a 'Reduce' rating, and India Cements with a 'Sell rating.
It has assigned an 'ADD' to Grasim Industries. JK Cement is the only 'Buy' recommendation given by the brokerage.
Why JK Cement?
The upgrade was done based on several positive factors, including the company's improved regional and efficiency mix, steady capacity expansion, and visibility on industry-superior volume growth.
The white cement segment, which is a high-free cash flow-generating segment, was also a positive factor despite margin pressures, it added.
JK Cement has sustained an industry-superior Return on Equity (RoE) of 14–17%, and its leverage is expected to peak at around 3x in FY23E. The company also aims to fortify its balance sheet before making any further capital expenditure.
Given the multiple positives, ICICI Securities values JK Cement at 15x FY25E EV/EBITDA and assigns a target price of ₹3,604 apiece.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie.
