2QFY18 preview-healthy volumes, costs outweigh realizations. A modest price increase and healthy volume growth, although dented by higher production costs, will likely underpin 2Q earnings. Profitability of cement companies will be down (3% yoy) as cost pressures out-weigh the price increases and volume growth. Sequentially, the price decline has been more severe in North and Central, while contained in South and West. More importantly, the first quarter under GST could yield surprises on realizations as well as benefits from input cost credits.
Seasonal weakness leads to Rs8/bag / qoq decline; GST-related distortions cannot be ruled out
All-India retail cement prices declined by Rs8/bag qoq in 2QFY18 due to seasonal weakness seen during the time of the year. As per our channel checks, prices declined across regions with the highest decline in the North and Central (Rs14/bag qoq). Cement prices in the South declined by Rs7/bag qoq while West and East also saw prices declining by Rs3-5/bag qoq. On a yoy comparison, all-India prices are up Rs12/bag, with prices in West (Rs36/bag) and South (Rs15/bag) showing stronger gains compared to prices in other regions.
A part of the price decline may be attributable to reduction in prices on account of GST benefits in select states, and to that extent realizations may not see an equivalent quantum of decline. Further, the shift in institutional sales from ex-factory to cum-freight also distorts headline realizations for select companies, as the benefit of the same will be off-set through higher freight costs.
Re-stocking of inventories may help volume growth, though headline data still at disconnect
Our coverage universe will likely report 6% yoy growth in cement volumes for 2QFY18, surpassing industry volumes (as per DIPP) that reflect 2% yoy growth for July - August 2017 (4.2% yoy decline in 1QFY18). We do highlight that potential re-stocking of inventories may have helped volumes even as volume trends in the recent past have borne the brunt of GST roll-out, demonetization, and introduction of RERA.
In 2QFY18, we expect pan-India players to report volume growth of 5-8% yoy, with ACC benefiting from an expanded capacity base. Regional names too are expected to show a modest volume growth of 6-8% except Shree Cement and India Cement which would likely report double-digit volume growth of 15% and 10%, respectively.
Fuel cost likely to continue the uptrend, even as pet-coke prices show some moderation
Cement companies will continue to bear the brunt of higher pet-coke prices that increased 13% qoq to US$96/ton in 1QFY18. Although prices have moderated since (6% qoq in 2QFY18), the same will not reflect in earnings due to the lagged effect of price variation (one to two months of inventory). Freight cost will likely moderate owing to the waiver of busy-season surcharge by the railways as well as potential input credit on taxes under the new GST regime.
Lower profitability as increase in input costs outweighs, modest price increases
We estimate profitability of cement companies under coverage to decline 3% yoy to Rs828/ton (-19% qoq), as the burden of higher production costs outweighs the benefit of a modest price increase. We prefer mid cap names over large caps owing to more reasonable valuations. On an average, large cap cement stocks are trading at 12-15X EV/EBITDA on FY2019E earnings, while mid-cap stocks are trading at 6-9X EV/EBITDA.