AP, Telangana driving sales; may sustain 30% growth in FY17: NCL

Vaibhav Agarwal, cement analyst at Phillipcapital India feels the volume growth is coming at the cost of pricing as the benefit of lower material cost has been already factored and improving realisations is the need of the hour.Below is the verbatim transcript of K Ravi, Sanjay Ladiwala and Vaibhav Agarwal's  interview with Latha Venkatesh & Sonia Shenoy on CNBC-TV18.Sonia: What exactly the demand situation is. Is it true that demand has picked up quite a bit and if yes, can you quantify for us how much compared to the previous few quarters?Ravi: March was a good month and as far as NCL is concerned; we touched almost 98 percent of our capacity. We are able to see demand in both Andhra Pradesh and Telangana. Of course in Telangana they have taken up the Swachh Bharat scheme, irrigation and concrete road and that's helping the cement industry. Andhra Pradesh also, though not much from the government side but the private demand improved, we could see good volumes in Andhra Pradesh. Latha: There was no demand or has nothing begun on construction of new city in Andhra?Ravi: It has just started.Latha: So that is not engendering any demand just yet?Ravi: No. It's too early but now they have grounded the projects in Amravati, so that will also come from this month and they have taken some infrastructure work in Vijayawada particularly flyovers etc.

Latha: Can you give us some numbers on Andhra in particular first. What was the numbers in March compared to previous March or compared to earlier months? As well what is the visibility looking in April-May-June before the monsoon?

Ravi: I won't be able to give exact number but as far as quarter is concerned, it is much better; last quarter is one of the best quarters in the recent history.

Sonia: In terms of earnings your nine months FY16 revenues have been very strong, you have seen about 30 percent growth of almost Rs 470 crore. What kind of an upmove do you expect to see in FY17? Is this 30 percent growth sustainable?

Ravi: Definitely there is a considerable improvement in south overall and we have good dealer network and we have the capacity and we should be able to maintain.

Sonia: I didn't get how much the prices have gone up by. What is the price currently in south on an average and has it gone up in the last three-four months?

Ravi: The prices have not gone up because we all try to pump a lot of cement into the market in yearend and there is a lot of competition.

Latha: So price went down?

Ravi: It went down in Andhra Pradesh and Telangana.

Latha: Why we were inspired to invite you because we got numbers from Sagar Cements and they were eye-popping. Telangana cement sales were up 119 percent in March, Andhra was up 135 percent but Karnataka and Tamil Nadu were down about 40 percent. How was your performance?

Ravi: We have done better that way but quarter wise as the margins have come down the net profit is not much but turnover wise its one of the best.

Latha: How much have margins come down?

Ravi: It will be between 5 and 10 percent._PAGEBREAK_Sonia: We have seen a lot of these South based players, the stocks hitting record highs, how much of this news flow indicates a sustainable pickup in demand?Agarwal: There has definitely been a lot of demand pickup in Andhra Pradesh (AP) and Telangana especially. February and March if I look at the numbers, they are up by about 45-50 percent year-on-year (YoY) in terms of demand numbers. However, my concern is that this is not a sustainable demand recovery. So, my expectation is that demand will come down to about 6-10 percent kind of a number; that is the number you should look at for FY17 as a whole. It cannot come at a 45 percent YoY growth rate, it will be a sustained demand recovery, it will not be a – there are two three pointers which I would like to tell why this demand is there by 45-50 percent. First reason is that the outflow from South, which is to East and West, that came down by 7-8 percent because the prices in East and West were not very remunerative. So, that material came into Telangana and Andhra Pradesh itself. So, that is one of the reasons. Second is that because of the March year ending, there were a lot of contractors in these two markets who had to submit their final bills to the government for the reimbursements, so that is the second thing. The third point is that there was a lot of holding of inventory by the dealers also in these markets. So, what I am saying is that the demand off take is definitely robust and it is good to hear that but on a longer term sustainable basis, anything beyond 10 percent on YoY basis is a bonus for South India.Latha: We have a lot of data coming in which is extremely positive for cement. Atul Daga was here just the other day from UltraTech Cement, he told us that the first half, they had under 2 percent demand growth, Q3 was like about 4 percent and last quarter was double digit – he didn’t give a number. Then we had Sagar Cement’s numbers which were so eye-popping – Telangana sales up 119 percent, Andhra Pradesh 135 percent and NCL management had to say 98 percent capacity utilisation not priced but volume excellent. What has been your ground check? Ladiwala: I have always said that one month is too short a period to make any comparison in cement. It has to be much larger period. Even a six month period is just about adequate to give a trend indication. Of course the trend is positive and figures will differ from company-to-company and from region-to-region because the base effect is much different. Those companies especially who were not doing too well in the previous years are suddenly able to cater to certain regions and certain sectors in the infrastructure segment especially, they will definitely find that month-to-month if you compare on a yearly basis, the demand would have jumped up. However, like Vaibhav said, that is too short a period and therefore on a yearly basis if you go to see, even double digit would be too optimistic. So, think if we say FY17, if we do 7-9 percent, it would be fantastic.Latha: In volume terms you mean?Ladiwala: I am talking about volume terms. So, these are not very sustainable or not very indicative figures.Latha: We were not expecting 40 percent YoY but even 8 percent is better than last couple of years, isn't it?Ladiwala: I am not saying that we can predict for sure that it will be 8 percent growth but it should be definitely far more than what we have seen in the past two or three years assuming of course that the monsoon this year as has been predicted will be reasonably good. The main cause for concern has been the two years of deficit rainfall in the last two years which have adversely affected the rural demand. If that picks up which is the main sector where the demand is generated from, I think we should be doing pretty well. Sonia: Both of you expect that at best it could be a 10 percent growth that we will see or maybe less than that but what about prices because we saw a lot of weakness in North and Central India till February, then suddenly prices spiked up. So there has been a lot of volatility in prices. On an average what kind of movement do you expect?Agarwal: The main point I am trying to bring out here is that whatever volume growth is coming, it is coming at the cost of pricing. So, that is not a healthy sign for the industry. The industry needs to understand that the price sensitivity to the earnings of the manufacturers is very high. For example, a 1 percent price improvement can lead your earnings improvement of 5 percent, EBITDA improvement of 5 percent and that is not the same case with volumes. So, whatever the industry is doing right now, it is happening at the cost of pricing and there are few smaller players who are pushing up capacity utilisations to as you said 98 percent or so which is as compared to overall South, it is only 60 percent._PAGEBREAK_Latha: For the longest time the CCI has been investigating companies for keeping prices higher, is it not better that utilisation and therefore volume increases even if it is at the cost of price? Also, over the last one year there has been an advantage of lower raw material costs in various ways, so, would there be such a big sacrifice of margins if they were to drop prices? Overall you are not positive on any earnings? Agarwal: What I am saying is that what you are saying is right that the CCI has been investigating but I am saying that it is the need of the hour for the cement manufacturing to improve their pricing in order to improve their EBITDA because right now if Andhra Pradesh prices are down by 60-70 percent per bag, last quarter EBITDA for example was Rs 1,300. It straight away comes down by Rs 700. Sonia: Won’t they make that up by a decline in the other raw materials like petcoke, etc?Agarwal: Your cost savings sensitivity has already played out in my opinion. Your costs have shown the lowest possible bottom in the last quarter and this quarter onwards you have already seen some improvement. Sonia: How much do you think prices will correct in the next three to six months?Ladiwala: Barring the monsoon, it is a cyclical sector so we are always seeing the prices come off during the monsoon because the demand comes off. So, barring that, if you take the average prices, I have a slightly different take on this and that is that we have always seen classically that whenever the net rate of growth in demand is higher than the net rate of growth in additional capacity, it has given pricing power to the industry. So, irrespective of absolute terms where you may still be excess, we are seeing that capacity which is coming on which has been announced in next couple of years is far lower than the increase in the net rate of growth of demand which means the pricing power will be there and the average prices in the coming fiscal will be much higher than the last fiscal which automatically means combined with the higher volumes which are expected by the net growth in rate of demand, it will lead to much better bottomlines. Latha: What is your earnings growth picture therefore for FY17 are you looking at earnings growth for any company, what are your favourites, how are you playing this sector, buy, sells?Agarwal: I have got three picks in the sector which I am strongly recommending. In the largecap we have UltraTech Cement which is a sustainable growth story for the long-term and we can definitely see more than 10 percent earnings growth for sure in UltraTech. The other two midcap picks are Dalmia Bharat and JK Lakshmi Cement. So, these are the two midcap picks. These two stocks have got the first mover advantage against all the peers in the market because they are already with all their capex, they are completely out of the capex move. So, these two stocks are my midcap picks and this is how I will play out the sector for FY17.Latha: What is your expectation in terms of improving prices in all of FY17, post the monsoon? Ladiwala:  I think the average prices would be higher than what we have seen in the last year. Last year was quite dismal. Latha: What 5-10 percent?Ladiwala: It is difficult to say because all regions have a different equation and they play out differently. So, if you take all India average, it would be difficult to say but suffice it to say that it would be higher because last year has been pretty dismal and I think things are looking much better price wise and volume wise for the coming year.