How Coal India's new pricing policy to impact cement stocks

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How Coal India's new pricing policy to impact cement stocks

Emkay Global Financial Services has come out with its report on cement space. The research firm has maintained neutral rating on the sector, prefer ACC.

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Emkay Global Financial Services has come out with its report on cement space. The research firm has maintained neutral rating on the sector, prefer ACC .

CIL shifts to new pricing mechanism - estimate a 20% coal price increase for non-power sectors: India's largest Coal producer Coal India (CIL) has announced a new pricing mechanism aligning it to the international practice of pricing coal based on Gross Calorific Value (GCV). Earlier the pricing was on the basis of Useful Heat Value. Under the new mechanism, coal categories will be increased to 17 against current 7 categories. We see that the new pricing mechanism is effectively a price increase at least for the nonpower sector. Based on CIL's notification under this new pricing mechanism we estimate that average price for non coking coal have increased by 27% (Refer to Exhibit 1) with the prices for C & D grade coal going up the maximum 55% & 44% respectively. This is followed by average 37% increase in the prices of E grade coal. The only grade of coal that is likely to have relatively muted increase of 2% is grade B.

However, the average does not take into account the skew-ness of quality towards lower or higher range within a grade. Considering that the quality is normally skewed towards lower range (as highlighted by CIL), the average price increase could be ~20% (assuming GCV skew ness of 70% towards lower range and 30% towards higher range).

Weighted avg coal price hike for cement industry could be as high as ~28%: After a detailed study of CIL's notification on new pricing mechanism and after getting further details on CIL's coal supply to Cement sector, we see that Grade wise volume weighted price increase could be as high as ~37% for cement industry. The increase for the cement industry is higher than average increase for non power since cement industry largely use mid grade coal like B, C, D & E (where the effective price increase is the highest).
 
The weighted average coal price increase of 37% mentioned above does not take into account the skew-ness of quality towards lower range within a grade. Considering that the quality is normally skewed towards lower range (as highlighted by CIL), we estimate that the weighted average coal price hike for the cement industry could be ~28% (assuming GCV skew ness of 70% towards lower range & 30% towards higher range.

Power & Fuel Cost could go up Rs87/ton or 8.8%: The Cement industry gets 45-50% of its coal requirement from domestic linkage coal while the balance part is procured from international market & domestic open market. With CIL shifting to GCV based pricing, (leading to domestic linkage coal prices for cement industry going up by ~28%) we estimate that the power & fuel cost for the industry to go up by Rs87/ton or 8.8% to ~ Rs1095/ton (vs Rs1007/t in Q2FY12). This is cost increase of ~ Rs5/bag.

Elevated cost structure might become the new normal: We believe that CIL's coal price hike of 28% has intensified cost headwinds for the sector which could mean that the Elevated cost structure might become the 'New Normal' for the sector. The industry remains exposed to the risk of proposed new mining tax as it would increase the limestone mining costs by Rs75+80/t. This would inflate raw material prices further which have increased 14% over last one year led by run up in prices of gypsum and fly ash. On the demand side, though the low base effect of FY11 might continue to help volume growth numbers seem better till Jan-12, aggregate demand is still not showing any signs of pick up, with FY12 YTD growth number languishing at just 5%. Hence we believe in a scenario of sluggish demand and rising input cost pressures, the sector is unlikely to see healthy EBIDTA/ton levels of Rs1000+. The recent cement price could just be enough to cover the cost pressures without adding incrementally to EBIDTA/t from Q4FY12 onwards.

For a sustainable pricing power, the industry needs the cement demand to pick up. We believe that aggregate demand momentum is yet to pick as the private capex investments remain sluggish & infra spending at standstill. We are yet to see structural demand drivers in place for a solid demand pick which remains a key trigger to sustain cement prices. We maintain neutral stance on the sector. Prefer ACC (volume growth to help drive operating leverage and protect margins), and Shree cements amongst mid caps (at 25% discount to ACC valuation, cement biz alone yields value of Rs2200/share implying negative value for power biz). 

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To read the full report click on the attachment