Oversupply to impact margins in near-term: Shree Cement

The cement sector has reported decent numbers this quarter. But the question on oversupply in the sector keeps popping up. What does the road ahead look like for the sector?

In an interview with CNBC-TV18 HM Bangur, Managing Director, Shree Cement and Amit Srivastava, Research Analyst at Karvy Stock Broking spoke about the performance of the sector and the road ahead.

Here is a verbatim transcript of the exclusive interview with HM Bangur and Amit Srivastava on CNBC-TV18. Also watch the accompanying video.

Q: You benefited from pretty high prices and strong demand over the past couple of quarters. Your topline has grown 44% this quarter, operating profit margin has been about 48%. You have seen about 169% increase in your PAT. Are the best days over right now – is this the peak in terms of your margins and demand offtake? How are the next 3-6 months when your 12 metric tonne per annum capacity does come onstream and that is your final large capacity?

Bangur: As far as the demand is concerned, the Indian demand is growing, with a 7-8% GDP growth. So the cement demand growth will be increasing. For the first seven months it is around 11% or so. Speaking in terms of volume is not the question. It will be a continuous increase of volumes.

As far as margins are there, yes in the short term and in the immediate future the margins have peaked and in future because of the supply pressure prices will be down, the margins will be low. So it will be a competitive market and things will not be as rosy as they were.

Q: Your report says that there is already a situation of over supply in southern India do you see this situation expanding to other parts of the country as well, would you see a developing oversupply situation in the other three regions some time in the course of the next 6 months?

Srivastava: Yes I definitely believe that going ahead if we look at the cement industry’s demand-supply scenario; we will find that the situation in regions like Southern India is going to play out on a pan-India basis, which we had started witnessing in northern, western region, looking at the price scenario as well.

Like in the northern region, the first half was good because there was so much construction activity because of the Commonwealth Games. But we believe that this is not going to be the end because construction activity would be finished by the Commonwealth Games, and in the next two-three months we would see that the demand in the northern region would not be so robust.

On the other hand, western market like the eastern market or central market, we had started witnessing supply coming in not because of the incremental supply from the Indian market but also because the export has almost got lesser because the Gulf market is already in oversupply. So that kind of an export which we are already doing, we are not doing that now. So, that kind of 2-3 million tonne of incremental capacity of export is also coming into the market.

Q: Your report says that you are expecting capacity utilisation in the industry to drop from 95% in FY07 to 75% by FY10. Is this only for south or is this a Pan India expectation?

Srivastava: No. 75% would be in the southern region. Overall, for FY10 it could be in the range of 80% because when we consider the capacity utilisation then we consider the effective capacity utilization, and apart from that if some of the capacities are coming in Q4FY10 we are not counting it in that. If we count it, it will go below that as well. But on an effective basis it could be around 80% on capacity utilisation on a pan-India basis.

Continued on next page... _PAGEBREAK_

Q: If you could outline your power plans as well because it did contribute Rs 78 crore to your revenues this time. What is the trajectory in terms of your cement revenues and your power revenues and what sort of a blended margin do you see yourself functioning at over the next couple of fiscals?

Bangur: Up till now we were selling roughly 35 megawatt of power in the open market. Upto June next year i.e. within 8-9 months we will be adding another 145 megawatt of new power capacity that will be available for sale in the market. So our power volumes are going to quadruple in the next four months.

As far as margins are concerned, cement prices will not be known today. So, relative turnover will not be known. Prices of electricity are highly fluctuating because we are selling into the grid, which is Power Grid Corporation or Power Trading Corporation and the prices will be decided daily. So, I will not take a call on the revenue side. But yes, on the quantity side we are pretty sure of making it four times in the next nine months.

Q: How would you react to what the analysts are expecting that the overall cement industry will operate at around 80% for FY10? Do you agree with that assessment?

Bangur: Not at all. There is a situation of oversupply compared to the immediate last two years. But the cement industry had continuously been running between 85% to plus or minus 2%. Now the situation is almost the same as saying that 80% will come across as over pessimistic and to think that the same margins and same utilisation, which is not a normal situation. For the last two years it was an abnormal situation. Otherwise the cement industry has always been creating capacity ahead of the demand. So we are now back to the normal situation.

Q: Give us one word on your input cost and power costs in general. Do you sense margins will be able to be sustained with these volumes panning out the way they are or do you sense that is becoming a bit of a niggling worry?

Bangur: Margins will definitely be lower. We will be better off making profits by more volumes. So more volumes and lower margins and with power plants coming up, for Shree Cement we don’t think there are very big negative forces working on us.

Q: You have a sell or underperform on several of the cement majors, ACC, Ambuja, Grasim, Ultratech, India Cements. Is there any price at which you will turn it into a buy? At current prices I guess these are your recommendations.

Srivastava: No, this report is two months old when we had come out with it. We had underperformer rating on these stocks. After that all cement stocks have underperformed. Currently most of the cement stocks are trading in the range equal to their replacement cost valuation. We believe that from here onwards if the stock prices correct 15-20% then on an asset base valuation we can recommend buys on those stocks on a replacement cost basis as well.