High input prices, energy costs hurt cement makers; demand likely to improve in second half

Cement companies experienced a tough second quarter of the financial year when the traditionally low seasonal demand was aggravated by prolonged monsoon rains in most parts of the country. Higher fuel and power costs impaired the margins of cement makers.

Moving forward, the fortunes are expected to improve; demand has already improved from October and most cement makers have already hiked prices of the building material by Rs 10 - 30/bag which will help them cushion the impact of rising input costs.

Input cost inflation 

Pet coke, coal and diesel are the key inputs for the sector.  According to a Care Ratings report, the prices of these components, at the end of the second quarter, were up by 20 percent, 111 percent, and 21 percent respectively from the March levels. Although the companies are striving for efficiencies to save on costs, it may not be sufficient to fully offset the higher energy and freight costs.

The prices of pet coke soared to Rs 12,800 per metric tonne in September from Rs 10,660/MT in March. Prices in June 2020 were much lower at Rs 5,700/MT.

Energy costs 

Cement makers are faced with an acute shortage of coal supply, which is largely attributable to an unprecedented increase in imported coal prices. International/imported coal prices rocketed by more than 100 percent in September from March levels in a development linked to a sudden surge in power demand in China, its restriction on import of coal from Australia and reduction in its own domestic production.

Experts say the full impact of rising input costs on the margins in FY22 remains to be seen as majority of the companies had the advantage of lower-cost inventory of coal which helped them curtail the drop in margins to some extent in the second quarter.

This cost is likely to increase by around Rs.175 -200 per tonne of cement in the second half of this financial year.

“Higher energy costs (imported coal and pet coke prices) remain a challenge for all companies. Most companies expect a fuel cost inflation of INR150-200/t in 3Q and further cost pressures in 4QFY22, if coal/pet coke prices remain at elevated levels,” securities firm Motilal Oswal said in a report.

Transport and logistics play a pivotal role in both manufacturing as well as distribution of cement and are a major cost component for the sector. Due to limited connectivity of railways in parts of the country, the industry has higher dependence on road transportation, which is exposed to the vagaries of fluctuations in diesel prices.

The continued increase in diesel prices is likely to impact the cost of production by around Rs 100-110/MT of cement.

Care Ratings expects the combined impact of higher input prices on the production cost of about Rs 275 – 290 per tonne.  Due to this, the companies are expected to witness a decline in earnings before interest, tax, depreciation and amortization levels, a key measure of profitability,  to the extent of Rs 100 - 150 per tonne (200 - 250 basis points margin impact) in the remaining quarters if the costs continue to trend at higher levels.

Optimism for second half of the year

The cement industry is expected to witness high volume growth driven by a revival in demand from both the urban housing sectors as well as rural demand and also by the strong government push to infrastructure projects. The Union budget provided for a higher allocation for infrastructure, affordable housing schemes and road projects to fuel the economy, which will provide much-needed impetus to the cement industry.

“In FY22, the cement production in India is expected to increase by ~12% YoY, driven by rural housing demand and government’s strong focus on infrastructure development,” said a report by ICRA.

Additionally, CRISIL Ratings expects that the Indian cement industry is likely to add ~80 million tonnes capacity by financial year 2024, the highest in 10 years, driven by increasing spending on housing and infrastructure.

The government had approved an outlay of Rs 1,18,101 crore (
$16.22 billion) for the Ministry of Road Transport and Highways in the Union budget for 2021-22 and Rs 27,500 crore ($ 3.77 billion) were allotted under Pradhan Mantri Awas Yojana.

These projects will provide a strong push to the demand for cement. The sector shall also benefit from the pent-up demand due to the halt of new projects because of COVID-19.

The demand momentum is expected to be sustained and with the recent price hikes already implemented by cement companies, price realisations are also likely to remain firm. There may be more price hikes if the momentum in input costs does not relent and also because the industry is entering a busy construction season.

As a result, experts expect the profitability of cement companies to improve quarter on quarter in the third quarter although some expect inflationary trends in construction costs to curtail demand.