Demonetisation and an increase in raw material prices have dealt a double whammy to the cement sector. How long will this pain last? Will there be demand recovery in 2017?
CNBC-TV18's Latha Venkatesh and Sonia Shenoy asks Sanjay Ladiwala, Chairman at Cement Stockists & Dealers Association of Bombay and Mangesh Bhadang, Research Analyst at Nirmal Bang and Jaspreet Singh Arora, Senior VP & Head-Research at Systematix Shares.Below is verbatim transcript of the interview:
Latha: What is your sense? Is any reflation of cash happening; is the pain that you noticed earlier receding at all in the cement off-take?
Ladiwala: There was a setback in the retail segment and the individual housing segment which has not seen any uptake, no rectification of the reversal of demand there as yet. It will last till the cash crunch continues and that is difficult to say till when. However, as yet we do not see any change in that.
Sonia: I was going through your report and in your report you do mention that the street is overestimating earnings for the sector and things are actually quite worse on the ground. How bad do you think the situation is because of the double whammy of demand getting hit because of demonetisation and margins under pressure because of rising costs?
Bhadang: We believe that the demand is actually going to be much lower compared to what the street is expecting. The reason being not only demonetisation, which is impacting demand but the upcoming Real Estate Regulatory Authority (RERA) is going to be a game changer for real estate and probably the developers will find it, at least for the start, pretty slow to launch new projects. So, FY18 housing demand will be impacted by that plus we have the Benami Properties Transaction Act, which changes the way the developers buy land and the goods and services tax (GST) what would be the abatement rate, although sector would actually impact the demand for some time in my opinion and that would be much lower than what the street is expecting. So, we are looking at only 4 to 5 percent demand growth even in FY18-19 and we expect that FY17 demand could actually contract by a percent. So that is getting coupled with a cost inflation which is setting in. So, we have a pet coke cost which have doubled in the past four months; imported coal all the South Africa, Indonesia as well as Australian coal prices have shorted up by 60-70 percent in the past few months and we have diesel, the domestic diesel prices which have increased by 16-18 percent over the past 12 months.
So, all those would actually start flowing into the cost numbers or the profit and loss (P&L) of the companies which is actually coming in at a time when the demand is falling. Therefore, we believe that there is going to be a test for pricing over the coming months and any volatility over there is going to impact margins.Latha: What are your numbers? How much of demand contraction have you factored in for the second half and for the entire year FY17 and FY18?
Arora: Based on our latest detailed analysis of the cement sector we any which ways were looking at somewhere around 5 percent even before this event happened for FY17 and somewhere closer to 6 percent for FY18. So, there would be a hit of more or less about 1 to 2 percent on these numbers. However, broadly given the government’s attack on the black economy, the parallel economy and the dependence of cement on the real estate, this number was never bound to grow at 8 to 9 percent which was a consensus view till about as late as October.
Having said that one also has to see the, as the earlier participant mentioned that there are cost pressures which are far more than it was earlier, we were moving into inflationary zone versus deflationary zone earlier. So, the contraction in EBITDA and profitability will be far sharper than what was anticipated earlier. So, that would be reflected in the stock prices as well. If you look at the last calendar year, the index has been more or less flat, the cement universe per se would have appreciated by about 15 percent and that was on the back of strong EBITDA and profitability growth for the universe as such for calendar year 2016.
If this was not to be the case for the coming few quarters and which obviously will be there for at least the first quarter of next financial year, this would clearly signal that the sector would underperform the broad index and therefore that is going to be the --and within the sector, I think our sense is, the shift would be more towards the largercaps versus midcaps and the valuation gap will again widened.
Sonia: Do you think that days of double digit volume growth in the cement space are behind us and also the point that Mangesh Bhadang was making about a whole host of headwinds whether it is the benami property crack down, GST, the RERA, all of that do you think that could really hamper cement growth at least for the next say three to six months?
Ladiwala: I will try to be realist here and not a very pessimist here, for the current foreseeable future, yes, double digit growth is not foreseen mainly because of demonetisation which will most probably last till the peak period here followed by the monsoon. So, we won’t see real net increase in demand really till October 2017. However, the silver lining here is that the infrastructure is growing pretty strong. There is de-growth in the real estate sector and the real estate sector though consumes only about 20 percent of the total consumption.
Infra is growing quite fast, I mean relatively speaking. Whether it grows fast enough to take up the slack created by the real estate is anybody’s guess or how soon it does, but eventually it will. Demand will actually be supported by infra and having said that we won’t see double digit growth at least for the next couple of years because there has been a setback and till such time that real estate does really pick up which is anybody’s guess - that is not foreseen.
Latha: If I heard you right you are seeing contraction of demand for the current year 1 percent and expansion next year by 5 percent; just give me your numbers? Demand for this year, rate of growth and next year?
Bhadang: This year we are looking at 1.3 percent decline in demand, so this is on the back of 4.50 percent demand growth that we have seen till October. So 1.3 percent decline and 4.2 percent increase in FY18.
Arora: For current year, we are at about 3 to 4 percent and next year 4 to 5 percent.
Latha: What would your estimate be for this year and next year?
Ladiwala: Zero to minus 1 percent for this year and for the following year about 4 percent.
Sonia: Any stocks in the cement space that you would be bullish on in the near-term?
Bhadang: Regional preference, we like north-east and south now and in terms of stocks we like J. K. Cement for its extremely high proportion of EBITDA coming from the white cement business where we think there would be a lesser impact. So, J. K. Cement would be the one which we would look at. Then on the southern side probably The Ramco Cements and India Cements and on the north east Star Ferro and Cement, so these are the stock we would be looking at right now.
Sonia: What about you?
Arora: As I mentioned preference towards largecaps within that UltraTech Cement and Ramco Cement and Shree Cement. Our study indicates stocks don’t really depend on regions; if company is well the stocks will follow anytime. So, maybe Shree Cement and Ramco Cement are north and south, but I believe any region stock will do well if the company is performing well.
Latha: Which is the region that is going to be least affected in the order of preference?
Ladiwala: In the order of preference east would be least affected followed by the north. The west would be the worst I think.
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