October 2014

Building with optimism

By VAIBHAV AGARWAL

Valuations of listed cement manufacturers have seen new highs after the change in command at the centre. The driving force of these valuations is tremendous optimism. This begets some pertinent questions — has anything really changed or is it slated to change? If it has already changed, what has changed? Various stakeholders (channel partners, distributors, retailers, contractors, decision-making bodies at the centre, zonal/regional sales and marketing heads of select cement manufacturers, housing developers, metro developers, and few other infrastructure development authorities) validate the current scenario. No names have been quoted in this edition as most of these stakeholders spoke on the condition of anonymity.

Takeaways in a nutshell

Its all driven by optimism

• North and West will remain favourite regions vis-à-vis fundamentals. North is likely to continue to operate at around 90% capacity utilisation. South will at best touch 65-70%, even with a revival in demand. Pan-India utilisation is unlikely to improve more than 2-4% in near to medium term even assuming an 8% demand growth.
• Demand revival seems sure in North India. South India is unlikely to see a significant revival immediately, but scenario should improve over 12-18 months.
• Housing will continue to remain the core driver of cement demand in India.
• Infrastructure projects will provide a boost to the sentiment, but infrastructure-led demand can increase despatches only intermittently. This demand is not likely to improve the profitability of manufacturers materially.
• Even in the best case scenario (where infrastructure-led demand grows at 20% p.a. and housing at 8% p.a.), incremental demand from housing will be much higher than infrastructure (in absolute terms).
• That road projects lead to a significant and immediate boost to cement consumption may be a myth. Issues such as corruption, personal interests of contractors (greed), and black-marketing of cement are some key concerns surrounding road projects. In fact, road development is believed to be amongst the most corrupt areas within infrastructure projects.
• Cement prices will continue to remain a function of discipline in regions with low capacity utilisations
• Major sustainable price spurts are unlikely. Prices will not move beyond 5-8% p.a. Cement manufacturers are likely to announce periodic 5% price hikes at set intervals, but their absorption will remain low.
• Intermittent price slumps are not completely ruled out. However, price wars will erode profit margins and will create a fear of survival amongst smaller cement manufacturers. Hence, it is unlikely that price wars (if any) will last long.
• Tier-1 manufacturers are the last ones to announce price cuts; price wars are always initiated from the bottom of the pyramid.
• EBITDA margins of cement manufacturers are unlikely to improve very substantially from current levels. For efficient cement majors, the EBITDA range is likely to remain between Rs 1,000-1,100 for FY15. The discount (EBITDA) between efficient cement majors and the relatively smaller manufacturers/inefficient players will remain at a minimum of 15-20%. The least efficient players will be at a discount of 25-30% to most efficient majors.
• Consolidation moves are very likely and will continue. Smaller manufacturers could seek exits due to family succession issues, lack of vision and sincerity, and undefined goals.
• Valuations of cement manufacturers today are driven largely by optimism and they will correct if the government fails to deliver on its agenda of development and infrastructure creation. However, stakeholders rely on this optimism and believe that the probability of favourable events is high.