Outlook darkens for cement companies

“Ebitda/tonne on an aggregate basis has declined by ₹200-400 sequentially and year-on-year in the December quarter,” said Mangesh Badhang, research analyst at Nirmal Bang Institutional Equities. Ebitda is earnings before interest, taxes, depreciation, and amortization.

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Cement companies raised prices in the first half of Q3, but these had to eventually be rolled back owing to poor demand. Unseasonal rainfall in many parts of the country kept cement demand muted in a quarter where generally construction-related activities increase.

Put off by these factors, Ebitda estimates for FY22 and FY23 have been revised lower for the sector. However, the worry is that if demand does not improve adequately to support price rises, earnings estimates could go down further.

“Earnings of cement companies have already seen downgrades post Q3, which is reflected in the recent correction of cement stocks. The downgrades could get steeper if prices fail to hold at higher levels,” Badhang said. In the past six months, shares of Shree Cement Ltd, Ambuja Cements Ltd, and ACC Ltd have fallen by 7-17%.

Petroleum coke and coal are the key fuels cement manufacturers use. Power and fuel costs typically are estimated to account for 25-30% of the sector’s total operating cost. In the March quarter so far, cement makers have seen just a small respite from cost inflation, said analysts. They also cautioned about upside risks from rising crude oil prices, which could push transportation costs higher for the sector.

Given the inflationary environment of the industry, Navin Sahadeo, director, institutional equities, Edelweiss Securities Ltd, warned that the operating performance picture of the cement sector appears bleak in the near term. “We have revised our Ebitda estimates for key companies such as Ultratech, Shree, ACC lower by 7-12% for FY23. If cement prices do not improve adequately, these downgrades could get severe,” he said.

Against this backdrop, sustaining price hikes is crucial for the realizations of cement companies to improve. Unfortunately, there is little good news on that front.

The latest dealers’ channel check by Kotak Institutional Equities showed that cement prices in India are up 5% month-on-month at ₹376/bag in February. However, it is mostly driven by East-South while a pan-India hike is not yet visible, said the Kotak report dated 16 February. The domestic brokerage house is of the view that margins may not meaningfully recover in Q4FY22 and, given the elevated costs, there is downside risk to consensus earnings estimates.

Steeper earnings downgrades do not bode well for investors’ sentiment towards these stocks and their valuations.

Bloomberg data shows that on an EV/Ebitda basis, major cement makers Shree Cement, Ultratech Cement Ltd, ACC and Ambuja Cements are trading in the range of 9-18 times FY23 earnings estimates. Shree Cement is trading at the highest valuation multiple of 18.33 times followed by Ultratech’s 14.21 times. EV is enterprise value. “Obviously, earnings risk would weigh on valuations. Stocks such as Ultratech have already seen its EV/Ebitda multiple moderate from 18 times seen in the past. We think earnings risk could become an overhang for cement stocks, which will eventually be reflected in their valuation,” cautioned Sahadeo.