In view of rising input costs, unfavorable demand-supply scenario and continuance of fundamental issues plaguing the cement industry, ICRA Limited expects challenging outlook for the Indian cement sector.
In its report on cement sector, ICRA notes that cement dispatches have shown signs of weakening after reporting healthy growth in Q1 FY13. The domestic cement despatches had increased by 9.8% in Apr-May 2012 as compared to corresponding period in previous year (YoY growth rate of 7% in Apr2012 and 13% in May 2012).
As per the index of eight core industries, the cumulative growth for cement production was 9.9% during Q1 FY13 compared to a growth of 0.1% in the corresponding period in previous year. This growth momentum was mainly attributable to low base effect as well as continuation of construction activities due to delay in onset of monsoons. However, with the arrival of monsoons in some parts of the country, the growth in cement production slowed down to 3.8% in July 2012.
While ICRA expects that the long-term demand for cement would be supported by increasing demand for residential and commercial space, huge investments planned in the infrastructure sector and government expenditure under various schemes such as National Rural Employment Guarantee, Jawaharlal Nehru National Urban Renewal Mission and Indira Aawas Yojana. However, ICRA cautions that since cement demand is highly correlated with economic development, the extent to which the issues affecting investment in projects are addressed would be critical.
The dispatches data released by ACC Limited and Ambuja Cements Limited also shows weakening in demand trends in July-August 2012. Both these companies shave reported de-growth in despatches during this period with ACC reporting a YoY decline of 6% and Ambuja Cements a YoY decline of 2%.
The fundamental issues, affecting cement demand in FY11 and H1 FY12 continue to persist. Infrastructure projects being affected land acquisition matters; delays in securing the requisite approvals and problems in achieving financial closure as well as sector-specific issues such as fuel security for power projects and delays in awarding contracts in road projects.
Further, lack of stable leadership in some PSUs and corruption-related investigations resulted in a slowdown in government spending on projects, and consequently on cement demand. Further political instability in Andhra Pradesh due to Telangana issue, security problems in North-East and ban on sand mining in Punjab, Haryana and Andhra Pradesh have affected development projects in these states, the ICRA report says.
In the last two years, subdued demand and significant capacity addition had put pressures on capacity utilisation of the cement industry with All-India capacity utilisation declining to around 76% in FY11 and FY12 as compared to 100% in FY07. The southern region which witnessed one of the highest capacity additions (largely due to its highest share of cement-grade limestone reserves) experienced the steepest decline in utilisation levels.
The existing capacity has overhang forced the companies to go slow on capacity expansion. For instance, in FY12, the industry has added ~10 MT of grinding capacity as compared to ~20 MTPA in FY11 and 50 MTPA in FY10. Though the capacity expansion is expected to slow down, the existing supply glut will keep the overall utilisation at muted levels and ICRA expects the utilisation level to remain close to FY12 level of 76%. Thereafter the utilisation levels will largely be a function of demand prospects.
Apart from unfavorable demand-supply scenario, the industry is also reeling under the pressure of rising input costs. The prices of key raw materials – limestone and gypsum have increased. The increase in domestic coal prices and non-availability of low cost linkage coal has increased the power & fuel cost for cement manufacturers.
Off late, cement companies depending on imported coal have seen some easing in cost pressures due to decline in price of imported coal. However, the benefit of declining prices has been offset by rupee depreciation to some extent.
The freight costs have also increased due to increase in surcharge and cess by Indian Railways in Oct 2011 and increase in freight rates for some commodities in Mar 2012, says the ICRA report.
The recent hike in diesel prices will further escalate the cost of production for cement companies. The demand in various regions showed resistance at these new price levels and cement prices reduced by Rs. 5-20 per bag across different regions in May 2012.
The prices have again increased in the month of July and have remained stable in some markets in Aug 2012. Going forward, with seasonal weakening in demand during Q2 FY12, companies are likely to find it difficult to raise prices to pass on the costs.
ICRA feels that after the June 2011 a penalty of Rs 63.07 billion imposed by CCI on 11 cement companies, the industry participants will be under CCI scanner will find it difficult to maintain production discipline.
This may impact the pricing dynamics of the industry, particularly when demand will come under pressure in the coming months due to monsoons. The impact on pricing dynamics is likely to be most pronounced in Southern India which has witnessed significant increase in capacities in the last three years.