Cement: Q3 delivered; improving outlook to drive earnings growth

13 Feb 2023 , 11:44 AM

Q3FY23 sector profitability (for our coverage universe) is 4- 5% better than estimates driven by lower costs — as such volume growth and blended realisations were broadly in line with estimates. The sector Ebitda per tonne was up 35% QoQ (down 15% YoY) to Rs768/MT. Sequentially, realizations were up 1% QoQ, however, costs declined by 3% (operating leverage benefits). This, coupled with 12% YoY and 10% QoQ volume growth, drove sector Ebitda by 48% QoQ (down 6% YoY) to Rs52bn. Management commentary suggests: 

1) Volume momentum to remain strong in Q4 and beyond. 

2) Power and fuel prices can see 8-10% QoQ decline. 

3) Higher volume growth should support price hikes, but so far, attempts to increase prices have not fructified. 

Analysts of IIFL Capital Services believe companies are likely to focus on volume growth in Q4 instead of price hike and thus, the improvement in Ebitda/t would be driven by lower fuel prices and operating leverage benefits. They expect Ebitda/t to improve by Rs200/t, to Rs965-970 in Q4FY23. Sector valuations are in line with long-term averages, and with the improving earnings growth trajectory could see re-rating, even hereon. They remain positive on the sector; maintain BUY on UltraTech, JK Cement, Dalmia Bharat and JK Lakshmi.

Near-term demand outlook looks promising:

The aggregate cement volumes for analysts of IIFL Capital Services coverage universe grew by 11-12% YoY in Q3FY23 – broadly in line with estimates. Gradual pickup in volumes through the quarter and low base of last year (volumes were down 3% YoY last year), helped industry to report double-digit growth. Capacity utilisations for the quarter stood at 79% vs 74% QoQ and YoY. Note that improvement in utilisation is despite 15mtpa new capacity addition in last 12 months.

Based on their preliminary assessment, they expect volumes for the sector to grow by 8% YoY in Q4FY23 and 9% YoY in FY24.

Cost surprised positively; could be the driver in Q4 too:

Although 3QFY23 sector volume growth and blended realizations were largely in line with estimates, at the aggregate level, there was 5% beat on Ebitda per tonne (Ebitda/t was up 35% QoQ to Rs768/t). This was largely on account of higher-than-expected reduction in total cost. We believe the benefits of lower fuel prices are likely to flow through in Q4 results; this would be the driver of Ebitda/t. Analysts at IIFL Capital Services note that USA petcoke price are down 30% from the peak and around 10-12% in last couple of months.

They estimate, Q4FY23 sector Ebitda per tonne to improve by Rs200/t QoQ to Rs965-970. Their channel checks for Jan and early Feb showed no significant increase in prices so far.

Improving earnings growth trajectory to support valuation re-rating:

Despite the uncertainty around fuel prices and ability of cement companies to push price hikes, cement stocks have seen some improvement (except Ambuja Cement and ACC due to Grouprelated concerns), given i) Improvement in Ebitda/t from the lows of Q2FY23 ii) Robust demand environment iii) Cooling-off fuel prices, at least for now.

After a likely 15% YoY decline in FY23 Ebitda, analysts at IIFL Capital Services estimate sector’s operating profits to grow at 25% p.a. over FY23-25 (10% Cagr over FY22-25).